The final rule to implement those parts of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act relating to consumers ability to repay home loans was released by the Consumer Financial Protection Bureau (CFPB) today. The rule will take effect on January 10, 2014.
CFPB also released a proposal to seek comment on possible adjustments to the final rule for certain community-based lenders, housing stabilization programs, certain refinancing programs of Fannie Mae and Freddie Mac (the GSEs) and Federal agencies, and small portfolio creditors. (The Concurrent Proposal). That rule would be finalized this spring in order to also take effect on January 10, 2014.
Dodd Frank requires creditors writing residential mortgages to make a "reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan according to its terms". Congress also established a presumption of compliance for a certain category of mortgages, called "qualified mortgages." These provisions are similar but not identical to a 2008 rule from the Federal Reserve that prohibits creditors from making "higher-price mortgage loans" without assessing consumers ability to repay. Under this rule, which has been in effect since October, 2009, a creditor is presumed to have complied with the ability-to-repay requirement ifthe creditor follows certain specified underwriting practices. Under Dodd-Frank the rule covers the entire mortgage market rather than only higher-priced mortgages.
The final rule contains the following key elementsAt a minimum, creditors generally must consider eight underwriting factors:
- current or reasonably expected income or assets;
- current employment status;
- the monthly payment on the covered transaction;
- the monthly payment on any simultaneous loan;
- the monthly payment for mortgage-related obligations;
- current debt obligations, alimony, and child support;
- the monthly debt-to-income ratio or residual income; and
- credit history
As a general rule, creditors must use reasonably reliable third- party records to verify the information they use to evaluate the factors.
The rule does not mandate specific underwriting models but does provide guidance as to the application of these above factors. For example, a monthly payment calculation should generally assume substantially equal payments throughout the term; adjustable rate mortgages (ARMs) must be calculated using the higher of the introductory or the fully indexed rate.The rule provides special provisions to encourage creditors to refinance "non- standard mortgages" into "standard mortgages" with fixed rates for at least five years if that would reduce consumers' monthly payments.
While Dodd-Frank provides that "qualified mortgages" are entitled to a presumption that the creditor making the loan satisfied the ability-to- repay requirements, the Act did not specify whether the presumption of compliance is conclusive (i.e., creates a safe harbor) or is rebuttable. The final rule provides a safe harbor for loans that satisfy the definition of a qualified mortgage and are not "higher-priced," in the Federal Reserve's 2008 definition, strengthens the requirements needed to qualify for a rebuttable presumption for subprime loans, and defines the grounds for rebutting the presumption.
Specifically, it provides that consumers may show a violation with regard to a subprime qualified mortgage by showing that, at the time the loan was originated, the consumer's income and debt obligations did not leave sufficient residual income or assets to meet living expenses. The analysis would consider the consumer's monthly payments on the loan, loan-related obligations, and any simultaneous loans as well as any recurring, material living expenses of which the creditor was aware. Guidance accompanying the rule notes that the longer customer has demonstrated an actual ability to repay by making timely payments after origination, modification, or in the case of an ARM, recast, the less likely the consumer will be able to rebut the presumption based on insufficient residual income.
The Federal Reserve's ability to repay rule does not apply to prime loans. The new rule does apply to prime loans but creates a strong presumption for those that constitute qualified mortgages (as defined below) where it will be conclusively presumed that the creditor made a good faith and reasonable determination of the consumer's ability to repay.
Dodd-Frank sets some loan feature prerequisites and underwriting requirements for qualified mortgages and vests discretion in CFPB to determine whether additional underwriting or other requirements should apply. The final rule generally prohibits loans with negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years from being qualified mortgages as well as so-called "no-doc" loans where income and assets are not verified. Finally, a loan cannot generally be a qualified mortgage if the points and fees paid by the consumer exceed three percent of the total loan amount, although certain "bona fide discount points" are excluded for prime loans. The rule does provide guidance on the calculation of points and fees and thresholds for smaller loans.
The most important of the general underwriting criteria established for qualified mortgages is that monthly payments be calculated based on the highest payment that will apply in the first five years of the loan and that the consumer have a total (or "back-end") debt-to-income ratio that is less than or equal to 43 percent. CFPB believes that these criteria will protect consumers by ensuring use of underwriting requirements that safeguard affordability while providing bright lines for creditors who want to make qualified mortgages.
CFPB concedes there are instances where a debt-to-income ratio above 43 percent may be appropriate based on individual circumstances but believes these loans should be evaluated on a case-by-case basis under the ability-to-repay criteria rather than with a blanket presumption. Given the fragile state of the mortgage market however CFPB is concerned that creditors may initially be reluctant to make loans that are not qualified mortgages, even though they are responsibly underwritten. The final rule therefore provides for a second, temporary category of qualified mortgages with more flexible underwriting requirements so long as they satisfy the general product prerequisites for a qualified mortgage and are also eligible to be purchased, guaranteed or insured by the GSEs (while under conservatorship), HUD, The VA, or The USDA. This temporary provision will phase out as these agencies issue their own qualified mortgage rules, if GSE conservatorship ends, and in any event after seven years.
The final rule also implements a special provision in the Dodd-Frank Act that would treat certain balloon-payment loans as qualified mortgages if they are originated and held in portfolio by small creditors operating predominantly in rural or underserved areas. This provision is designed to assure credit availability in rural areas, where some creditors may only offer balloon-payment mortgages. Eligible loans must have a minimum term of five years, a fixed interest rate and meet certain underwriting standards but are not subject to the 43 percent debt-to-income ratio requirement. Creditors may utilize this provision for rural balloon-payment qualified mortgages if they originate at least 50 percent of their first-lien mortgages in rural or underserved counties, have less than $2 billion in assets, and originate no more than 500 first-lien mortgages per year. Creditors must generally hold the loans on their portfolios for three years in order to maintain their "qualified mortgage" status.
The final rule also implements Dodd-Frank Act provisions that generally prohibit prepayment penalties with certain exceptions, and lengthens to three years the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions.
The concurrent proposal seeks comment on whether the general ability-to-repay and qualified mortgage rule should exempt designated non-profit lenders, homeownership stabilization programs, and certain Federal agency and GSE refinancing programs from the ability-to-repay requirements because they are subject to their own specialized underwriting criteria.
The proposal also seeks comment on whether to create a new category of qualified mortgages, similar to the one for rural balloon-payment loans, for loans without balloon-payment features that are originated and held on portfolio by small creditors. The proposal also seeks comment on whether to increase the threshold separating safe harbor and rebuttable presumption qualified mortgages for both rural balloon-payment qualified mortgages and the new small portfolio qualified mortgages because small creditors often have higher costs of funds than larger creditors. Specifically, the Bureau is proposing a threshold of 3.5 percentage points above APOR for first-lien loans.
The rule and proposed amendments will be available here.
A factsheet further explaining the new rule.
A summary of the final Ability-to-Repay rule.