Written By: Christine E. Howson
The “Qualified Mortgage” rule is among the most anticipated new regulations the Consumer Financial Protection Bureau (CFPB) will issue under the Dodd-Frank Wall Street Reform and Consumer Protection Act, which became federal law on July 21, 2010. Under the Act, when a mortgage lender originates a “qualified mortgage” by following the guidelines of the Act, the lender is presumed to have satisfied the ability-to-repay requirements and receives some protection from liability in connection with the mortgage origination.
The Dodd-Frank Act provided a general definition (essentially an outline) of the “qualified mortgage” loan. The CFPB was then given the task of finalizing that definition, which it recently published on January 30, 2013. Loans that meet this “qualified mortgage” definition will be presumed to have complied with the new ability-to-repay standard. The rule will take effect on January 10, 2014.
As promulgated, the Qualified Mortgage rule generally requires creditors to make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling and establishes certain protections from liability for loans that meet these requirements.
Here are the main components of the Qualified Mortgage rule:
Ability to Repay
An “ability to repay” standard, where borrowers will need to provide, and lenders will need to verify, documentation that proves a borrower can actually afford to own the home they are buying, including all property-related expenses (required insurance, taxes, maintenance, etc.) in their calculation. Under the ability to repay standard, lenders must consider and verify, using reasonable third-party records, the following eight underwriting factors:
(1) Current or reasonably expected income or assets;
(2) Current employment status;
(3) The monthly payment on the covered transaction;
(4) The monthly payment on any simultaneous loan;
(5) The monthly payment for mortgage-related obligations;
(6) Current debt obligations, alimony, and child support;
(7) The monthly debt-to-income ratio or residual income; and
(8) Credit history.
The rule describes certain minimum requirements for creditors making ability-to-repay determinations, but does not dictate that they follow particular underwriting models.
Debt Ratios
To be considered a “qualified mortgage”, the regulation now calls for maximum debt ratios of 43%.
There is, however, a provision in the rule which allows a loan exceeding the debt ratio limit to temporarily still be considered a “qualified mortgage” if it is eligible to be sold to Fannie Mae or Freddie Mac according to an automated underwriting system.
Limitations on Prepayment Penalties
Separate and apart from the ability-to-repay provisions of the new rule, the Qualified Mortgage rule generally prohibits prepayment penalties except for certain fixed-rate, qualified mortgages where the penalties satisfy certain restrictions (e.g., limited to no more than three years after consummation, and do not exceed certain amounts) and the creditor has also offered the consumer an alternative loan without prepayment penalties.
Other Prohibitions for Qualified Mortgages
To meet the definition of a “qualified mortgage”, loans cannot have interest-only or negative-amortization components, balloon payments (except in certain instances) or repayment periods longer than 30 years. In addition, the points and fees for “qualified mortgages” generally do not exceed three percent of the total loan amount. “No-doc” loans cannot be qualified mortgages, either.
Presumption for Qualified Mortgages and Consequences of Not Being Qualified
The Dodd-Frank Act provides that “qualified mortgages” are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. However, the Act did not specify whether the presumption of compliance is conclusive (i.e., creates a safe harbor) or is rebuttable. The recently issued final rule provides a safe harbor for loans that satisfy the definition of a “qualified mortgage” and are not “higher-priced.” For those loans exceeding the price threshold, the Qualified Mortgage rule now provides a lesser standard of protection in the form of a rebuttable presumption of compliance. The dividing line between the protections of the safe harbor and the rebuttable presumption for qualified mortgages will be those made to prime borrowers and those made to subprime borrowers.
According to the Act, loans not considered “qualified” will subject a party who securitizes the loans to “risk retention” rules, generally of about 5% of the loan or security.
Further Information
Please note that this article is an overview of the qualified mortgage rule as published by the CFPB on January 30, 2013, and does not address all aspects and details of the rule. Creditors will need to carefully review the final rule in order to determine what changes may be needed to their policies, procedures and systems. Please contact Christine E. Howson for more information.