Overview of CFPB’s New Qualified Mortgage Rules – they need to rethink interest-only jumbos

When the liquidity crisis happened after the Lehman Brothers bankruptcy, the Federal Reserve took over some of HUD’s powers and adopted a rule under the Truth in lending Act which, in essence, prohibited lenders from making subprime loans without assessing the borrowers’ ability to repay the loan.

Subsequently, Dodd-Frank required that this be expanded to mortgages other than subprime. Congress also established a presumption of compliance for a certain category of mortgages, called “Qualified Mortgages (QM’s).” For the past 2 years we have been waiting for a precise definition of a QM. Recently the Consumer Financial Protection Board issued its QM guidelines. Summary here.

The new QM rule is supposed to take effect January 10, 2014. In order to be a QM a mortgage must satisfy the following:

At a minimum, creditors generally must consider 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.

Creditors must generally use reasonably reliable third- party records to verify the information they use to evaluate the factors.

The rules prohibit loans with negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years from being qualified mortgages. There really are no longer any negative amortization loans and the only thing we have at present is interest only loans and loans with 40 year terms.

The key notion is ability to repay (ATR.)

Good for the Borrower and the Lender
Strict definition of a QM affords protection to both the borrower and the lender. While the fact is that we have been following guidelines at least as rigid as QM for about 3 years the insistence that there be a precise definition prevents the industry from backsliding in the future. This protects the borrower and is an entirely good thing. This also affords two classes of legal protection to lenders as outlined below

From the point of view of lenders there will be, under these rules, 3 categories of mortgages:

1) Safe Harbor QM loans. These are loans meeting the 8 requirements and which are first lien loans having an interest rate of less than 1.5% (or 3.5% for subordinate lien loans) higher than the average prime offer rate available. These cover the lender’s butt completely.

2) QM Rebuttable Presumption Loans. These are QM’s that qualify for a rebuttable presumption of compliance as protection from the same penalties and liabilities as Safe Harbor loans. These are first lien loans which have an interest rate equal or greater than 1.5% (or 3.5% for subordinate lien loans) above the average prime offer rate available in the vicinity (“Higher-Priced Loans”) and which meet the QM requirements. Such loans would be subject to a rebuttable presumption that the lender satisfied the ATR requirements. These cover the lender’s butt like a bikini bottom.

3) Non-QM loans which afford the lender no legal protection against suit by the borrowers. These cover the lender’s butt like a thong.

The new rule calls for a 43% maximum debt ratio which is lower than the current maximum debt ratio for both FNMA (44.99%) and FHLMC (49.99%). In order to ease into these new ratios the rules allows the GSE’s to set their own max debt ratios for the next 7 years.

The rules are lengthy but it appears that QM loan can be for primary residence, second home, investment property but not time shares.

The QM rules, if followed, protect lenders not only from borrower lawsuits but, presumably, from being forced to repurchase QM loans from investors

The Effect?
It may well be the case that the set of lenders willing to do QM Rebuttable Presumption Loans decreases substantially. In effect the government may well be curtailing subprime. This could likely result in another socially driven call to make a greater number of loans to borrowers who are less qualified. If serves well to recognize that one of the things which created the problem was HUD’s insistence under the National Homeownership Strategy the FNMA and FHLMC loosen their guideline for qualifying.

Interest Only and 40 year mortgages
The rules eliminate Interest Only and (IO) 40 year amortization from QM. I believe that there are appropriate situations for Interest Only loans. Cases are:

(1) people with spiky income. For example commercial real estate brokers

(2) people with income about to increase. Doctors who are interns is the obvious case and

(3) people who are buying a home and have not yet sold their existing home.

No one is making these loans illegal but not affording QM protection would appear to legally undermine the legitimacy of such loans and seriously discourage lenders from making Interest Only loans.

Most of the IO loan we see are jumbos. I think that here is a place where the QM rules may need rethinking.
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