The Consumer Financial Protection Bureau (CFPB) is proposing to allow a loan to become a Qualified Mortgage (QM) when it grows up. On August 18th, the CFPB issued a proposal that would amend the agency’s Ability-to-Repay (ATR) Rule to provide that a first-lien, fixed-rate loan meeting certain criteria, that the lender has held in its portfolio, could become a QM after 36 months of timely payments. Figuring that if a borrower has made payments on a loan, the lender must have made a reasonable determination of ability-to-repay, the proposal would open the safe harbor door to non-QMs (including those originated as such intentionally or inadvertently) and higher-priced QMs that otherwise receive only a rebuttable presumption of compliance with the Rule. The proposal also would, consequently, close the door on those borrowers’ ability to challenge the lender’s underwriting determination in a foreclosure, which otherwise would last far beyond the three-year period.

Specifically, the CFPB proposes that a covered loan for which an application is received on or after this rule becomes effective could become a “seasoned QM” and earn a conclusive safe harbor under the ATR Rule if:

  1. The loan is secured by a first lien;
  2. The loan has a fixed rate for the full loan term, with fully amortizing payments and no balloon payment;
  3. The loan term does not exceed 30 years; and
  4. The total points and fees do not exceed specified limits (generally 3%).

In addition, the creditor must have considered the consumer’s debt-to-income ratio (DTI) or residual income and verified the consumer’s debt obligations and income. In alignment with the CFPB’s pending rulemaking revising the general QM definition, the creditor would not have to use the Rule’s Appendix Q to determine the DTI. Also, as indicated above, a loan generally would be eligible as a seasoned QM only if the creditor holds it in portfolio until the end of the three-year seasoning period.

As to timely payments, the CFPB proposes that the loan must have no more than two delinquencies of 30 or more days, and no delinquencies of 60 or more days, at the end of the 36-month seasoning period. Those timely payment requirements apply to the borrower’s obligation to pay principal, interest, and, if applicable, escrow items. If the borrower’s failure to make those payments is the result of a disaster or pandemic-related national emergency, that payment deficiency would not impede the loan’s status as a seasoned QM, although time spent in such a temporary accommodation would not count towards the 36-month seasoning period. The proposed rule would allow an exception for certain small delinquencies ($50 or less) that the servicer does not otherwise treat as such. However, payment amounts advanced by the creditor or servicer or that are pulled from escrow would not count as timely for purposes of qualifying for the seasoned QM safe harbor.

The concept of a seasoning period constituting evidence that the lender met its obligations during the origination process is not unique. That 36-month seasoning period is somewhat similar in concept to the remedies frameworks of Fannie Mae and Freddie Mac (the GSEs) and mortgage insurers for breaches of loan-level underwriting representations and warranties. The GSEs clarify, however, that satisfaction of the seasoning requirement does not undo the prior breach; rather, they elect not to pursue an otherwise available repurchase remedy based on such breach. Either way, after a certain period of loan performance, the thought goes, subsequent defaults cannot reasonably be attributed to a failure of underwriting, but rather are largely due to unforeseeable events for which the originating lender should not be saddled with origination-related compliance risk.

While it is easy to say that a borrower who has successfully made payments on a mortgage loan for a period of time must have, by definition, the ability to repay that loan, commenters in connection with earlier CFPB outreach efforts argued that is not necessarily the case. Borrowers may neglect other financial obligations or necessities in favor of paying the debt secured by their home, the commenters argue, disguising the fact that they cannot actually afford the loan. To address that concern, as mentioned above, the CFPB would retain certain product restrictions and underwriting requirements (including the requirement to consider DTI) for those seasoned QMs, to further ensure the lender is making a reasonable ATR determination.

The CFPB believes that the requirement for the lender to retain the loan in portfolio for the seasoning period also would help incentivize the lender’s ATR determination. The Dodd Frank Act already imposes a similar skin-in-the-game incentive through its credit risk retention requirements for loans placed into securitization, with an exception granted for “qualified residential mortgages” (QRMs). A designated team of federal agencies has defined QRMs to be the same as QMs, and may continue to capture the CFPB’s tweaks to the various QM categories.

As to the possible effects on the mortgage market of a seasoned QM safe harbor, the CFPB predicts that the reduction in compliance uncertainty and litigation risk will expand lenders’ ability to make affordable and innovation mortgage products available, at least marginally. The requirement that the originating lender must hold the loans in its portfolio for three years, however, means that not all lenders may be able to take advantage – independent mortgage bankers relying on short-term funding may not be able to wait that long, even if they are willing to retain the early default risk. At least after the seasoning period, those lenders may be able to find a better outlet for the loans than the scratch-and-dent market. Similarly, the limitation on buy-and-hold puts this seasoned QM out of reach for mortgage securitization. In short, depository institutions are the main beneficiary of this exception.

As mentioned above, the CFPB is currently in the midst of other QM-related rulemakings – one proposal to revise the general QM definition, and one to extend the temporary QM category for loans eligible for purchase by Fannie Mae or Freddie Mac until the time the general QM revisions become effective. The CFPB is similarly suggesting that this new seasoned QM proposal would become effective at the same time as those rules, and that as mentioned above it would apply to loans for which lenders receive applications on and after that date (i.e., not to existing loans).

The CFPB is requesting comments on all these aspects of its seasoned QM proposal, but only for 30 days after publication in the Federal Register. The deadline for comments is September 28, 2020.