Last January, the Consumer Financial Protection Bureau set forth new rules and regulations that impact both borrowers and lenders. One part of the statute that is of special interest is the definition of Qualified Mortgages. These would be more difficult for consumers to challenge later on with regard to ability to repay rules.

The Basics

The new rules place responsibility in the hands of mortgage lenders when it comes to determining that a borrower is indeed able to pay back their loan. According to CFPB director Richard Cordray, 2 million households across the country are still at high risk for foreclosure, even after the most recent market crash and flood of foreclosures that followed.

Now, qualified mortgages are prohibited from features like interest-only payments, terms that are longer than 30 years, or upfront fees in excess of 3 percent of the total balance. The goal of these new rules is to allow more first-time buyers to qualify for loans.

  • Expected impacts include prohibited mortgage terms and higher down payments, since the rules are design to completely eliminate some of the most “risky” mortgages that put borrowers at a higher chance of being foreclosed.
  • Higher levels of paperwork for mortgage lenders are also expected, with the tradeoff being that hopefully fewer of these mortgages end up in default and foreclosure.

The policy specifically addresses three challenges of the qualified mortgage concept:

  • With regard to whether the rule on qualified mortgages should be more subjective or objective, the rules clarify that the approach should be objective. This will make it easier to determine whether there is compliance on the back end in addition to increasing the rigor of application for borrowers. In the long run, each application will receive a more individualized approach.
  • In consideration of whether the definition should encompass a broad section of the market or only apply for those at the very high end of the market, the underwriting criteria in place now make about 90% of the marketplace eligible for qualified mortgages. The full impact of how the new points and fees rules will impact eligibility, however, is not known.
  • Previous concerns have been raised about whether qualified mortgage status would generate a liability “safe haven” instead of a “rebuttable presumption” when it comes to a loan meeting the ability to repay requirements. Under these rules, there is a safe harbor for loans with annual percentage rates under the threshold of 150 basis points over the Average Prime Offer Rate, whereas there is a “rebuttable presumption” for loans with an APR above that threshold.

What It Means For Applicants

  • The debt to income ratio for applicants has to be below 43% as a general rule. While this isn’t a firm number, since banks can still make loans to individuals with higher debt to income ratios, there must be other factors like high assets to make up for this. Lenders, therefore, will need to conduct a comprehensive review of each applicant and verify documentation for all reported assets and debts.
  • Upfront fees include a number of factors, such as origination fees, points paid to lower mortgage interest rates, and title insurance. As mentioned above, these fees cannot be higher than 3% of the mortgage balance.
  • No more risky features, as is mentioned above, will make the experience more transparent for borrowers. Borrowers can have the added confidence that they understanding what they are taking on, while lenders have the benefit of reduced defaults down the line. In the short run, this is expected to increase the amount of paperwork and time to process an application, but the tradeoff is that both lenders and borrowers will enjoy an environment where defaults are less common.

Lender Approach

Lenders are likely to approach most of 2014 with caution in order to ensure compliance with these new rules. While many lenders are already offered these kinds of mortgages, it’s beneficial to do a complete compliance review to verify that your company’s work is in line with these requirements. Investigating procedures and application materials now will make for a more streamlined process down the road.

Review existing processes for areas of improvement. Document steps that are made in order to comply with existing and new regulations. Offer training to staff to ensure compliance across the board.

Key Takeaways

The new underwriting criteria included in the final rule on qualified mortgages puts more importance on the separate requirement that fees and points are limited to 3% of the loan amount. This highlights what many consider to be an unresolved aspect of the rue: the components of that very cap. In the final rule, the 3% cap includes indirect and direct compensation for loan originators, in addition to closing charges that are paid out to settlement providers (like a lender-owned title company).