CFPB Issues ”Ability to Repay” Final Rule
The Consumer Financial Protection Bureau (“CFPB”) recently issued its “ability to repay” final rule (the “Final Rule”) under the Dodd-Frank Act, which is intended to address the perceived deterioration of many mortgage lenders’ underwriting practices leading up to the “great recession.” Under the Final Rule, lenders are generally required to make a reasonable and good faith determination that a consumer has the ability to repay a closed-end loan secured by a dwelling before making the loan. The Final Rule also provides other alternatives to making such a determination, such as to the extent that the lender makes and adheres to requirements for “qualified mortgages,” refinancing a troubled “non-standard mortgage” into a “standard mortgage,” or certain balloon mortgages made by small lenders in rural areas.
We anticipate that the Final Rule, which takes effect on January 10, 2014, could significantly impact the mortgage industry and the mortgage products lenders offer to consumers by discouraging lenders from making certain types of loans. In addition, the lack of certainty as to repayment ability standards and enhanced statutory remedies for violation of the Final Rule will increase lenders’ compliance risk.
Determination of Repayment Ability
In general, lenders are not permitted to make a covered loan unless they make a reasonable and good faith determination of the consumer’s ability to repay the loan. Loans covered under the Final Rule include all consumer closed-end loans secured by a dwelling, except for timeshare-secured loans, reverse mortgages, and temporary bridge and construction loans with terms of twelve months or less.
There are detailed requirements under the Final Rules as to the information that must be obtained, verified, and considered when lenders make their determination of a consumer’s ability to repay the mortgage loan. Such information includes a consumer’s current or reasonably expected income or assets, credit history, debt-to-income (“DTI”) ratio or residual income, debt obligations, employment status, monthly payment(s) on the mortgage loan and any simultaneous loans, and monthly payment for mortgage-related obligations (such as taxes).
Stating that it wanted to provide lenders with flexibility in developing their own underwriting standards, the CFPB declined to provide any litmus test as to underwriting standards that lenders must adhere to under the Final Rule. However, the Final Rule does list factors that may demonstrate that a lender made a reasonable and good faith determination of the consumer’s repayment ability; these include: (1) the consumer demonstrating the ability to repay the loan by making timely payments for a significant period of time after consummation or after recast (for adjustable rate, interest-only, or negative amortization loans); (2) the lender using underwriting standards that historically resulted in comparatively low rates of delinquency and default during adverse economic conditions; or (3) the lender using underwriting standards based on empirically derived, demonstrably and statistically sound models. In contrast, factors that would indicate the lender’s determination of a consumer’s ability to repay was not reasonable or in good faith include: (1) the consumer defaulting on the loan a short time after consummation or recast; (2) the lender using underwriting standards that have historically resulted in comparatively high levels of delinquency and default during adverse economic conditions; (3) the lender applying underwriting standards inconsistently or using standards different from those applied to other similar loans without reasonable justification; or (4) the lender disregarding evidence that the underwriting standards it used are not effective at determining consumers’ repayment ability. Needless to say, the factors provided in the Final Rule leave many unanswered questions as to how lenders can evaluate whether their ability-to-repay determination would be considered reasonable and in good faith.
Lenders must also be aware of the rather severe consequences for failing to satisfy the Final Rule’s requirements. Specifically, the Dodd-Frank Act includes enhanced borrower remedies, as well as the current remedies provided under the Truth in Lending Act, which apply if the Final Rule is violated. The enhanced remedies include special statutory damages equal to the sum of all finance charges and fees paid by the consumer, unless the lender establishes that the failure to comply is not material. In addition, the statute of limitations for a violation of the Final Rule is three years, and consumers are able to assert violation of the Final Rule as a defense in foreclosure.
As an alternative to complying with the repayment ability requirements, lenders can make and adhere to requirements for a “qualified mortgage.” A lender making a qualified mortgage that is not a higher-priced mortgage is deemed to comply with the Final Rule. If the qualified mortgage is a higher-priced mortgage, the lender is presumed to comply with the Final Rule, although the borrower can rebut the presumption of compliance.
In general, a qualified mortgage is a mortgage with a term of thirty years or less, which provides for regular, substantially equal payments, except for changes in payments based on rate adjustments; generally, balloon loans, negative amortization loans, or interest-only loans are not considered qualified mortgages. In addition, the total points and fees that can be charged on a qualified mortgage are subject to limits that vary depending on the loan amount (e.g., a loan of $100,000 or more cannot have points and fees exceeding 3% of the total loan amount). The lender must also underwrite the qualified mortgage by taking into account payments based on the maximum interest rate that can apply during the first five years. A new Appendix Q to Regulation Z provides detailed requirements that a lender must adhere to in evaluating the consumer’s income, debt, and other obligations. In addition, a qualified mortgage generally cannot have a DTI exceeding 43%.
The Final Rule also provides a “special” qualified mortgage for loans that are eligible to be purchased or guaranteed by Fannie Mae or Freddie Mac, loans eligible to be insured by the Department of Housing and Urban Development (“HUD”) or the Rural Housing Service (“RHS”), and loan eligible to be guaranteed by the Department of Veteran Affairs (“VA”) or Department of Agriculture (“USDA”). These loans are subject to lesser restrictions in that there is no DTI limit or requirement to adhere to Appendix Q requirements in evaluating income, debt, and other obligations. In addition, there is no requirement to underwrite the loan based on the maximum rate that might apply during the first five years. Note, however, that this “special” qualified mortgage alternative will expire no later than January 10, 2021.
We also note that the CFPB proposed a rule to include a new type of qualified mortgage that is made by “small lenders” and retained in portfolio by those lenders. Under this proposed rule, a “small lender” is a lender that has $2 billion or less in assets and originated 500 or fewer first lien covered transactions during the last year. A small lender making such a qualified mortgage would not need to adhere to the 43% DTI limit that applies to qualified mortgages and does not have to calculate DTI limits in accordance with the requirements of Appendix Q. If the proposed rule is finalized substantially as issued, it could provide most credit unions an additional means of qualifying for “safe harbor” protection.
With the changes under the Final Rule taking effect in January 2014, it is critical that credit unions review their loan underwriting policies and procedures and revise them as necessary to address the new requirements. Beyond this, credit unions should be considering whether the Final Rule necessitates some changes in the mortgage loan products they offer, given the potential increase in compliance risk for loans that do not qualify for “safe harbor” protection under the Final Rule. Our office would be pleased to assist your credit union with any questions it may have regarding the new Final Rule.