Underwriting Under Qualified Mortgage /Ability-To-Repay Rules
By Anthony Grasso & Mission Global
In the past, loose underwriting practices included failure to verify consumers’ income or debts or using such income to calculate the borrower’s ability to afford the payments based on adjustable rate mortgage lower “teaser” interest rates. Not surprisingly, when the scheduled monthly mortgage interest rate adjustments occurred thereafter, payments would jump to unaffordable levels, a major mortgage crisis contributing factor. Regulators initial response to the skyrocketing mortgage delinquency rate was to adopt a rule under the Truth in Lending Act in 2009 prohibiting creditors from making higher-priced mortgage loans without assessing consumers’ “ability to repay” the loans.
This rule was followed by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), when Congress adopted similar Ability-to-Repay (ATR) requirements for virtually all closed-end residential mortgage loans. The Dodd-Frank Act also provided a presumption of compliance with ATR requirements, and protections from legal liability, for a certain category of mortgages, called Qualified Mortgages (QM). The Consumer Finance Protection Bureau (CFPB) implemented the ATR and QM provisions for covered mortgage loan products (Conforming/FHA/VA/USDA) with new loan applications taken on or after 01/10/2014.
Under the ATR rule, there are the eight underwriting factors that must be considered to meet the requirements of the rule:
- Current, or reasonably expected income or assets (other than the value of the property that secures the loan) that the consumer will rely on to repay the loan.
- Current employment status (if the employment income was relied upon when assessing the consumer’s ability to repay).
- Monthly mortgage payment for this loan.
- Monthly payment on any simultaneous loans secured by the same property.
- Monthly payments for property taxes and insurance that the consumer is required to buy, and certain other costs related to the property such as homeowner’s association fees or ground rent.
- Other debt obligations including but not limited to alimony, and child-support obligations.
- Monthly debt-to-income ratio, or residual income, calculated using the total of all the mortgage and non-mortgage obligations listed above as a ratio of gross monthly income.
- Credit history.
The QM requirements generally focus on prohibiting certain risky features and practices, such as negative amortization, interest-only periods, or loan terms longer than 30 years. In addition, points and fees generally may not exceed 3 percent of the total loan amount, although higher thresholds are provided for loans below $100,000. There for four categories of QM mortgages: General QM, Temporary QM, Small Creditor QM and Balloon-payment QM. For simplicity purposes, we will review the General QM requirements below:
In order for the loan to be a General QM, a lender must:
- Underwrite based on a fully amortizing schedule, using the maximum rate permitted during the first five years after the date of the first periodic payment adjustment.
- Consider and verify the borrower’s income or assets, current debt obligations, alimony, and child-support obligations.
- Determine that the member’s total monthly debt-to-income ratio (DTI) is no more than 43 percent.
- Points and fees are less than or equal to 3% of the loan amount (higher thresholds allowed for loans less than $100,000)
The presumption of compliance for a QM loan depends on whether it is higher-priced or not. Higher priced, according to the CFPB, means that a first lien mortgage’s APR is greater than 1.5% higher than AOPR (the Average Prime Offer Rate), which is based on the average terms offered to highly qualified borrowers (2.5% higher on jumbo loans).
- If a loan is not higher-priced, and meets the QM criteria, a court will conclusively presume that the creditor complied with the ATR rule and the lender is said to have a safe harbor.
- If a loan is higher-priced, and meets the QM criteria, a court will presume it complies with the ATR requirements. However, higher priced QM loans that are presumed to comply with the ATR requirements have conditions allowing borrowers to rebut that presumption (referred to as QM rebuttable presumption loans).
Many lenders have considered the significant potential liability and litigation expenses for an ATR violation and have limited themselves to making only QM safe harbor loans (where the borrower’s claim ends when the lender proves it has made a QM). The lenders that offer non-QM loans charge higher rates to offset the potential legal and compliance risk, although those risks are relatively small. The current ATR QM rule was a giant step in the right direction although we support work with policymakers to support future enhancements.
The following is a link to a compliance guide published by the CFPB:
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