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CFPB Issues Long Awaited Ability-to-Repay Rule and New Proposal
Was the housing collapse caused in part by risky lending practices? The Consumer Financial Protection Bureau (CFPB) thinks so, and on January 10, 2013, it issued a final rule and proposal requiring financial institutions to consider a borrower’s ability to repay a mortgage loan. This new rule is intended to protect borrowers from obtaining loans without the means of repaying them. The final rule and the proposal (if adopted) would be effective January 10, 2014.
The CFPB believes some banks were offering mortgage loans without adequately considering the borrower’s ability to repay the loans. The borrower’s level of debt and income were not always verified, and some lenders were basing a borrower’s ability to pay on initial discount rates; when the rate went up, the homeowner could no longer afford the payments.
In 2008 the Federal Reserve began requiring lenders to assess a borrower’s ability to repay higher-priced mortgages, and the 2010 Dodd-Frank Act required lenders to make a repayment determination based on verified and documented information. The act also established a presumption of compliance for “qualified mortgages.” The new ability-to-repay rule implements many of these earlier provisions.
Ability-to-repay final rule
Specific information must now be provided by borrowers and verified by lenders to show that a borrower has the ability to repay a loan. Eight specific pieces of information must be presented:
- Current or expected income or assets
- Current employment status
- The monthly payment for the loan
- The monthly payment on any simultaneous loan
- The monthly payment for mortgage-related obligations
- Current debt obligations, alimony, and child support
- The monthly debt-to-income ratio or residual income the borrower would take on with the mortgage
- Credit history
In addition, a lender’s analysis of a borrower’s ability to pay cannot be based on low initial teaser rates. Instead, the financial institution must determine if the borrower can repay the loan over the entire term, even if interest rates go up. There is an exemption for the refinancing of riskier loans (e.g., adjustable rate mortgage loans, negative-amortization loans, and interest-only loans). If a borrower is refinancing a riskier loan to a standard loan, the underwriting process can be shortened.
The final CFPB rule specifies what features allow a lender to call a mortgage a “qualified mortgage.” If a lender makes a loan with these features, it is presumed that the bank or credit union has complied with the ability-to-pay rules:
- The loan does not have interest-only payments, balloon payments, negative amortization, terms longer than 30 years, or other risky features.
- The lender verifies the borrower’s assets or income.
- Points and fees are less than 3 percent of the total loan amount (discount points can be excluded for prime loans).
- Monthly payments are based on the highest payment that will apply in the first five years of the loan.
- Debt-to-income ratios are less than or equal to 43 percent.
Because some lenders will hesitate to make loans that are not qualified mortgages, the CFPB has created a temporary category of qualified mortgages that offer more flexible underwriting criteria as long as the borrower satisfies the general prerequisites. In addition, the loan must be eligible for purchase, guaranteed, or insured by either Fannie Mae or Freddie Mac, the U.S. Department of Housing and Urban Development, Department of Veteran Affairs, Department of Agriculture, or Rural Housing Service. This temporary category will phase out in seven years (or sooner).
Safe harbor status
The Dodd-Frank Act provides lenders with a presumption of compliance with the ability-to-repay rule if they make a qualified mortgage (as described above). However, an important distinction is made between two types of qualified mortgages and whether the presumption is absolute (safe harbor) or is rebuttable. First, there is a rebuttable presumption that the lender has complied with the ability-to-repay rule if the mortgage loan is a higher-priced mortgage loan. Second, loans not considered higher-priced and meeting the definition of a qualified mortgage are afforded safe harbor status as qualified mortgages.
For higher-priced loans, the presumption of compliance can be rebutted if the borrower can show that, at the time the loan was made, the borrower’s income and debt obligations left insufficient income or assets to meet living expenses. The longer the borrower demonstrated an ability to repay the loan by making timely payments, the less likely he or she will be able to rebut the presumption.
There is stronger legal protection for loans that are not higher-priced. If the loan is a qualified mortgage, there is a conclusive presumption of compliance with the ability-to-repay rule. In effect, there is a safe harbor for qualified mortgages not considered higher-priced. Most loans made by credit unions will probably fall within the safe harbor category.
Rural balloon-payment qualified mortgages
Some small lenders in rural or underserved areas only offer balloon-payment home loans, and could treat some balloon-payment loans as qualified mortgages. To receive this treatment, the term of the loan would have to be at least five years, have a fixed-rate, meet certain underwriting standards, and must consider the borrower’s debt-to-income ratio (although it would not necessarily have to be less than or equal to 43 percent).
In order to make balloon-payment qualified mortgages, lenders would have to originate at least 50 percent of their first-lien mortgages in counties that are rural or underserved (designated annually by CFPB), have less than $2 billion in assets, and (along with their affiliates) originate no more than 500 first-lien mortgages per year. To keep the qualified mortgage status, lenders would have to generally hold the loans on their portfolios for three years.
Ability-to-repay proposed rule
A CFPB rule would exempt certain programs from ability-to-repay rules because they already have very specific underwriting criteria. These programs include designated nonprofit lenders, homeownership stabilization programs, and some federal agency and refinancing programs.
In addition, the proposal suggests creating a new category of qualified mortgages for non-balloon-payment loans that are made and held by small lenders such as credit unions and community banks that are not located in rural or underserved areas. To be a considered a small lender, the institution would need less than $2 billion in assets, could only fund less than 500 mortgages per year, and must keep the mortgages in their portfolio for at least three years.