Financial regulators on Tuesday finally released the final rule defining Qualified Residential Mortgages (QRM).  The definition is intended to determine which loans are exempt from the risk retention requirements of the Dodd Frank Wall Street Reform and Consumer Protection Act. 

As expected, the final QRM is aligned with the definition of Qualified Mortgages (QM) which defines how lenders determine if a borrower has the ability to repay the loan and sets out a safe harbor for lenders as they make that determination and underwrite the loan.

The regulatory agencies issuing the regulation (Treasury, Housing and Urban Development, the FDIC, Securities and Exchange Commission, Federal Housing Finance Agency, and the Federal Reserve) observed in the preamble to the proposals presenting the rule the securitization markets are an important part of the provision of credit to the nation's households and businesses.  "When properly structured, securitization provides economic benefits that can lower the cost of credit."

Prior to the financial crisis regulators observe that the markets were not properly structured and investors were often at a disadvantage as they did not have the same level of information about their investments as lenders and securitizers who, in turn, did not have to be concerned about risk once loans were sold on the secondary market.

In passing Dodd Frank, Congress attempted to address these problems by requiring that securitizers, retain an economic interest in the credit risk of the assets they securitize, thus giving them an incentive to monitor and ensure its quality.    The regulatory agencies issued a proposal outlining how this "retained risk" would work and which loans, qualifying as QRM, would be exempt from the requirement.

The lengthy memorandum issued today, containing the new rule and explaining the process of revision of the original QRM proposal the regulators issued in 2011 notes that regulators received comments on that proposal from over 10,000 persons and businesses.

The original proposal provided a complete exemption from the risk retention requirements for asset-backed securities that are collateralized solely by QRMs and established the terms and conditions under which a residential mortgage would qualify as a QRM.  The original proposal would generally have prohibited QRMs from having product features that were observed to contribute significantly to the high levels of delinquencies and foreclosures since 2007 and included underwriting standards associated with lower risk of default. The original proposal also provided that sponsors would not have to hold risk retention for securitized commercial, commercial real estate, and automobile loans that met proposed underwriting standards.  It also specified that loans eligible for purchase by Fannie Mae or Freddie Mac would automatically meet the QRM definition.

It also provided several options from which sponsors could choose risk retention requirements, including retention of either a 5 percent "vertical" interest in each class of ABS interests issued in the securitization or a 5 percent "horizontal" first-loss interest in the securitization, and other options designed to reflect market practice in asset-backed securitization transactions. 

The rule issued today defines QRM as follows.  It is a "covered transaction" that meets the general definition of a QM which provides that the loan must have:

  • Regular periodic payments that are substantially equal;
  • No negative amortization, interest only or balloon features;
  • A maximum loan term of 30 years;
  • Total points and fees that do not exceed 3 percent of the total loan amount, or the applicable amounts specified for small loans up to $100,000;
  • Payments underwritten using the maximum interest rate that may apply during the first five years after the date on which the first regular periodic payment is due;
  • Consideration and verification of the consumer's income and assets, including employment status if relied upon, and current debt obligations, mortgage-related obligations, alimony and child support; and
  • Total DTI ratio that does not exceed 43 percent

The agencies believe that a QRM definition aligned with the definition of QM meets the statutory goals and directive of the legislation to limit credit risk and promote sound underwriting. At the same time, the agencies believe this definition will also meet the important goals of preserving access to affordable credit for various types of borrowers and facilitating the return of private capital to the mortgage market.  The final definition of QRM does not incorporate either an LTV ratio requirement or standards related to a borrower's credit history, such as previously proposed.

The ability-to-repay rule is particularly noteworthy for requiring loan originators to document income, debts, and other underwriting factors, which should in turn provide investors a more complete set of information on which to base their investment decision.  

In adopting their QRM definition the regulators said they recognize that mortgage and securitization market conditions and practices change over time and will therefore review the definition no later than four years from the effective date and every five years thereafter.

Federal Housing Finance Agency Director Melvin L. Watt said in a statement following the release of the rule that, "Finalizing this rule represents a major step forward to providing greater certainty to the housing finance market and paves the way for increased participation by the private sector.

Aligning the Qualified Residential Mortgage standard with the existing Qualified Mortgage definition also means more clarity for lenders and encourages safe and sound lending to creditworthy borrowers. Lenders have wanted and needed to know what the new rules of the road are and this rule defines them."

The National Association of Realtors® also issued a statement through their president Steve Brown.  It said in part, "Realtors are confident that the new QRM rule will encourage sound and financially prudent mortgage financing by lenders while also ensuring responsible homebuyers have access to safe and affordable credit. The synchronization with the QM rule will provide lenders with much needed clarity and consistency as they apply the new standards to loan applications while also providing a framework to bring more competition to the secondary mortgage market.

 "Importantly, the final rule relies on sound and responsible underwriting rather than on an onerous downpayment requirement to qualify as a QRM loan. NAR strongly opposed earlier versions of the rule that included 20 and 30 percent downpayment requirements, which would have denied millions of Americans access to the lowest cost and safest mortgages."