On January 10th, the Consumer Financial Protection Bureau (CFPB) released the final definition of a Qualified Mortgage. The Qualified Mortgage rule puts into effect new requirements and responsibilities for lenders to ensure that borrowers are qualified for their mortgages. The Rule will go into effect on January 10, 2014. The Bureau is expected to finalize the concurrent proposal this spring in an effort to prepare lenders for the new regulations.
Background on the QM Rule
On July 21, 2010, President Obama signed into federal law the Dodd-Frank Wall Street Reform and Consumer Protection Act. This Act required that creditors must make a reasonable and good faith determination that the consumer has a reasonable ability to repay the loan according to its terms. Within this law, Congress also established a presumption of compliance for a certain category of mortgages, “qualified mortgages.”
The CFPB took responsibility over the Act in July 2011 and was given authority to define the criteria for loans called “Qualified Mortgages.” After months of research and analysis, the new rule was finalized.
What is a Qualified Mortgage?
A qualified mortgage is a loan that a consumer can be reasonably expected to pay. Mortgage lenders are required to consider a consumer’s ability to repay home loans before extending them credit.
Three Main Components of the Qualified Mortgage Definition Ability to Repay Rule
Borrowers will need to provide and lenders will need to verify documentation that proves that a borrower can afford to own the home they are buying, including all property-related expenses (insurance, taxes, maintenance, etc.) over the long term.
At a minimum, a lender must consider eight underwriting standards:
- Current income or assets.
- Current employment status.
- Credit history.
- The monthly payment for the mortgage.
- The monthly payments on any other loans associated with the property.
- The monthly payment for other mortgage related obligations (such as property taxes).
- Other debt obligations.
- The monthly debt-to-income ratio or residual income the borrower would be taking on with the mortgage.
The regulations now calls for a maximum debt ratio of 43%. This is lower than the current maximum debt ratio of 44.99% for both Fannie Mae and Freddie Mac. In order to ease into these new ratios, the rules allow GSE’s to set their own maximum debt ratios for the next 7 years. There is a provision in the rule which would allow those exceeding the limit to still be considered a qualified mortgage, if they are eligible to be sold to Fannie Mae or Freddie Mac after passing through an automated underwriting system which approves them.
Loans that do not meet the definition of a qualified mortgage are ones that have interest-only or negative amortization payments components, balloon payments, repayment periods longer than 30 years, or “no-doc” loans. According to Dodd-Frank, loans not considered “qualified” will subject a party who securitizes the loans to “risk retention” rules, generally about 5% of the loan or security.
About 15% of jumbo mortgages issued last year would not have been considered a qualified mortgage because they were interest-only loans or the debt ratio of the borrower would have exceeded 43%. A big question facing lenders is whether they will make loans that are not considered “qualified mortgages” and at what cost.
Types of Qualified Mortgages
There are two types of qualified mortgages that afford protection to both the borrower and the lender.
- Qualified Mortgage with Safe Harbor: This loan gives the lender the highest level of legal protection. They are lower-priced loans with interest rates closer to the prime rate and are typically granted to consumers with good credit histories. If the borrower defaults on a loan, the lender would be considered to have legally satisfied the ability-to-repay requirement. In turn, this makes it harder for the borrower to sue the lender. However, the borrower may still challenge the lender in court if they feel the loan does not meet the definition of a qualified mortgage.
- Qualified Mortgage with Rebuttable Presumption: These are higher-priced loans which are typically granted to consumers with lower credit scores. A higher-priced loan would be one that has an interest rate that is more than 1.5% higher than the current prime rate. This type of loan offers less legal protection for lenders. The consumer can rebut that the presumption that the creditor took into account their ability to repay the loan if they can prove that “the creditor did not consider their living expenses after their mortgage and other debts.”