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CFPB sets new standards for mortgages

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This morning, the Consumer Financial Protection Bureau released its long-awaited final rule to establish new standards for mortgages and, of particular importance, clarified what constitutes a "Qualified Mortgage." The new rules are expected to take effect on Jan. 10, 2014.

Safe Harbor or Rebuttable Presumption?

There has been a great deal of debate about whether to provide a "safe harbor" for Qualified Mortgages, or whether instead to create a "rebuttable presumption" of compliance that could later be challenged by borrowers. The Bureau has apparently split the difference by creating a rebuttable presumption for higher-priced QM loans – essentially all subprime mortgages – while giving safe harbor protection to all prime QM loans.

To demonstrate the difference between the two standards, the Bureau noted in its release summary that "consumers may show a violation (of these rules) with regard to a subprime qualified mortgage by showing that, at the time the loan was originated, the consumer's income and debt obligations left insufficient residual income or assets to meet living expenses."

Qualified Loan Characteristics: Under the proposed rule, characteristics of a qualified loan include the following:

• The borrower has a debt-to-income ratio no greater than 43 percent;
• Points and fees are limited to 3 percent of the total loan amount (note that certain "bona fide" fees on prime loans are excluded);
• Lenders must verify a borrower's income; and
• These loans cannot include certain characteristics of nontraditional mortgages such as interest-only loans, negative-amortization loans and mortgages for a period of longer than 30 years.

Ability to Repay: Most importantly, lenders must make certain they document that a borrower has the ability to repay the mortgage loan in question. At a minimum the following elements must be reviewed, analyzed and documented by the lender:

• Current income or assets of the borrower;
• Borrower's employment status;
• Borrower's credit history;
• Monthly payments on the mortgage as well as any other mortgage-related obligations and loans associated with the property;
• Other debt obligations; and
• Monthly debt-to-income ratio.
• Teaser rates are essentially prohibited – lenders are required to base their analysis of ability to repay on the mortgage principal and interest over the life of the loan;
• Use of the so-called no-doc or low-doc loans is, as a practical matter, eliminated.
• Pre-payment penalties are preserved for certain fixed-rate, qualified mortgage loans.
• Lenders must be able to demonstrate compliance with the ability-to-repay rule and maintain such records for at least 3 years.

Balloon Payments: Many community banks have made residential real estate mortgage loans that include a balloon feature and have done so for years. Under the new rules such loans (i.e., those that include a balloon payment feature) will generally not be considered QM loans, but there is an exception for those made by smaller lenders in rural and underserved communities. Such rules include:

• The lender must have no more than $2 billion in assets;
• Must make at least half of its first-lien mortgages in counties considered rural and underserved (as determined each year by the CFPB);
• Such loans must have terms of at least five years, fixed interest rates and meet certain other basic underwriting criteria;
• Lenders must also consider debt-to-income ratios as part of underwriting requirements but, importantly they do not have to comply with the 43 percent ratio.

In addressing the fear that no loans outside of these established criteria will be made, the Bureau indicated it would allow some flexibility for the debt-to-income ratio requirements set forth in the proposal for seven years or until Congress addresses the issue of housing finance reform, whichever comes first. These loans will also have to satisfy the underwriting requirements for loans insured by Fannie Mae, Freddie Mac or the federal government.

In prepared remarks to be delivered this morning, CFPB Director Richard Cordray said the Bureau's goal "is not only to stop reckless lending, but to enable consumers to access affordable credit. We can draw up the greatest consumer protections ever devised, but if consumers cannot get credit, then there is nothing to protect."