by Richard Triplett, CMB, Vice President and Director of Compliance for AllRegs, May 21, 2012
One thing you can always say about those of us in the banking and real estate finance industry is that we are certainly acclimated to fairly consistent change. However, the anticipated final regulations in keeping with the Dodd-Frank Act are game changers for us. In particular, the regulations specifically related to Qualified Mortgages, Qualified Residential Mortgages and proposed and final rules regarding Loan Originator Compensation and Mortgage Servicing are going to be major shifts. Like moving tectonic plates, they are going to shake up the industry and consumers alike, with lots of ripples and aftershocks. With many more rules still to come, you will want to pay particular attention over the next few months. Some of the final rules with direct impact on mortgage loans due to the Dodd–Frank Act are just around the corner.
A new frontier is just about to peek over the horizon for mortgage lending whether you are a mortgage banker, mortgage broker, mortgage loan originator, a financial institution, servicer, investor or consumer. It will likely begin with the “Qualified Mortgage” (“QM”).
Of course, the criterion which establishes a QM by itself is important due to the standards a creditor must follow in establishing (documenting) a borrower’s ability-to-repay, but it is just as important in terms of establishing the basis in which the definition of a Qualified Residential Mortgage (“QRM”) is crafted. Both the QM and the QRM definitions have been proposed, but final rules are yet to be promulgated with the final rule establishing the QM expected first, and shortly. The point: Beyond the ability-to-repay standards of the QM it also sets the outside parameter of what will be the QRM.
Why is this important? By statute, when the definition is promulgated by the Bureau of Consumer Financial Protection (CFPB) via rulemaking, the definition of a QRM can be no broader than the definition of a QM. Remember that the proposed rules were published by the banking agencies, but the final rules will be forthcoming by the CFPB who now has rulemaking authority for Regulation Z.
First, the CFPB will publish the final rules regarding the QM with its tie to the borrower ability-to-repay standards in the Federal Register. Then we will receive final rules containing the definition of a QRM which will have a very different impact because it is tied to the risk retention requirements (skin-in-the-game provisions) applicable to securitizations. We will have more articles in the coming months regarding the QRM (and others), but for purposes of this article I will focus on the QM. You can see the tie-in between the two definitions, but they have very different ramifications for the industry and consumers alike.
Our industry is accustomed to at least the concept, and general standards, regarding verification of a borrower’s ability-to-repay. There are similar rules already in place for higher-priced mortgage loans (HPMLs) and similar laws in several states for high-cost loans or specific refinance loans. Risk retention requirements applied to securitizations is certainly unchartered territory for the industry, and it will have a restrictive effect on the availability of credit products and consumer qualification for those products as the lending industry comes to grips with these major changes.
Qualified Mortgage - Proposed
As an overview (and not all inclusive), the proposed rule regarding ability-to-repay requirements offers compliance via four (4) options. You can:
- Verify the ability-to-repay by following eight listed underwriting factors.
- Originate a streamlined refinance. Referred to as a ‘‘non-standard mortgage’’ into a ‘‘standard mortgage.’’ The income and assets do not require verification. The proposal defines a standard mortgage as a mortgage loan that, among other things, does not contain negative amortization, interest only payments, or balloon payments; and has limited points and fees.
- Originate a ‘‘qualified mortgage,’’ which provides special protection from liability for creditors who make ‘‘qualified mortgages.’’ It is not yet determined whether this protection is going to be a safe harbor or a rebuttable presumption of compliance.
- If you are a small creditor operating predominantly in rural or underserved areas, you can originate a balloon-payment qualified mortgage. You can make a balloon-payment qualified mortgage if the loan term is 5 years or more, and the payment calculation is based on the scheduled periodic payments, excluding the balloon payment.
There are two alternative definitions of a qualified mortgage that were proposed. One is a legal safe harbor and the other offers rebuttable presumption. On April 27, 2012, a letter was sent to the Director of the CFPB from 23 industry organizations favoring legal safe harbor and requesting the CFPB re-evaluate the impact of alternatives to consumers and the industry.
A mortgage for which:
- The loan does not contain negative amortization, interest-only payments, or balloon payments, or a loan term exceeding 30 years;
- The total points and fees do not exceed 3% of the total loan amount (see below);
- The borrower’s income or assets are verified and documented; and
- The underwriting of the mortgage
- is based on the maximum interest rate in the first 5 years,
- uses a payment schedule that fully amortizes the loan over the loan term, and
- takes into account any mortgage related obligations.
Includes the requirements under Safe Harbor above and the additional underwriting requirements:
- The consumer’s employment status,
- The monthly payment for any simultaneous loan,
- The consumer’s current debt obligations,
- The total debt-to-income ratio or residual income, and
- The consumer’s credit history.
Total Points and Fees Defined (See below for Tier-Based Threshold Alternatives)
Points and fees shall include (other than bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator):
- All items included in the finance charge, except interest or the time-price differential;
- All compensation paid to mortgage brokers;
- The charges listed below (except an escrow for future payment of taxes), unless—
- the charge is reasonable;
- the creditor receives no direct or indirect compensation; and
- the charge is paid to a third party unaffiliated with the creditor; and
- other charges as the Bureau determines to be appropriate.
Charges under item (C) above:
- Fees or premiums for title examination, title insurance, or similar purposes
- Fees for preparation of loan-related documents
- Escrows for future payments of taxes and insurance
- Fees for notarizing deeds and other documents
- Appraisal fees, including fees related to any pest infestation or flood hazard inspections conducted prior to closing
- Credit reports
Exclusions from Total Points and Fees
The total points and fees will exclude one or the other of the following (not both):
- Up to and including 2 bona fide discount points payable by the consumer in connection with the mortgage, but only if the interest rate from which the mortgage's interest rate will be discounted does not exceed by more than 1 percentage point the average prime offer rate.
- Unless 2 bona fide discount points have been excluded under the above clause, up to and including 1 bona fide discount point payable by the consumer in connection with the mortgage, but only if the interest rate from which the mortgage's interest rate will be discounted does not exceed by more than 2 percentage points the average prime offer rate.
“Bona Fide Discount Points” means loan discount points which are knowingly paid by the consumer for the purpose of reducing, and which in fact result in a bona fide reduction of, the interest rate or time-price differential applicable to the mortgage.
These provisions shall not apply to discount points used to purchase an interest rate reduction unless the amount of the interest rate reduction purchased is reasonably consistent with established industry norms and practices for secondary mortgage market transactions.
In addition to the alternatives proposed for legal safe harbor and rebuttable presumption, there are two tier-based alternatives regarding limitations on points and fees
Tier-Based Alternative #1
% of Total Loan Amount
$75,000 or greater
$60,000 to $75,000
$40,000 to $60,000
$20,000 to $40,000
Less than $20,000
Tier-Based Alternative #2
% of Total Loan Amount
$75,000 or greater
$20,000 to $75,000
Total Loan Amount - $20,000 = Z Z times .0036 = Y 500 – Y = X X times .01
$20,000 or less
The proposed rules also reflect limits on prepayment penalties, lengthen the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions, and prohibit evasion of the rule by structuring a closed-end extension of credit as an open-end plan.
There are many moving parts associated with these forthcoming final rules and additional forthcoming rules. This includes proposals that will re-define what items are considered finance charges under the Truth in Lending Act, which will have an effect on what may be additionally included as points and fees. It is important to understand not only the rules for QM and QRM, but all of the associated provisions involved, including additional changes to loan originator compensation coming in January 2013 (the proposed rules are anticipated in July). We will keep you informed as all of these proposed and final rules make their way through the rulemaking process.
Disclaimer: The information presented in this article represents the opinion of the author and not that of AllRegs. This article is not meant to be nor should it be construed as advice of legal counsel. The applicability of the information contained herein will vary based on the nature of each lending institution's business, under what law it was created, and its loan products and procedures. Readers are strongly urged to consult with their legal counsel and/or contact local counsel as appropriate in the various states and jurisdictions to determine the applicability of the materials contained herein to the specific facts and circumstances of each organization's programs and products and to identify other law applicable to its business operations. The information contained herein was not reviewed or approved by counsel in the respective jurisdictions.