CFPB Ability To Repay Rules Issued

On January 10, 2013, the Consumer Financial Protection Bureau issued much-anticipated revisions to Regulation Z to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that require lenders to make a reasonable good faith determination that borrowers have the ability to repay their mortgage loans. The final rule (“ATR Rule”) continues a process that began with a May 2011 proposal from the Federal Reserve Board and is effective for applications received on or after January 10, 2014. But, we're not done yet. Along with the ATR Rule, the CFPB issued proposed changes to it dealing with balloon payments, points and fees calculations, and other possible revisions.

At first blush, the ATR Rule might seem straightforward. Mortgage lenders must make an ability to repay determination by verifying and evaluating a list of traditional indicia of creditworthiness. They obtain a compliance safe harbor or a rebuttable presumption of compliance (depending on the loan's annual percentage rate) if they originate a Qualified Mortgage (“QM”). QMs are regularly amortizing loans, underwritten to standard rules and assumptions, that carry no more than a prescribed number of points and fees (3% of the “total loan amount” for loans of $100,000 or more) and a maximum 43% total debt-to-income (DTI) ratio. The 43% DTI limit does not apply, for a limited time, if a QM loan could be sold to Fannie Mae or Freddie Mac, or guaranteed or insured by a federal agency. In addition, some of the rules don't apply when certain “non-standard” mortgages are refinanced into safer “standard” mortgages.

As it's often said, however, “the devil is in the details” and there are a lot of details in the 800+ page Federal Register notice. The rules contain extensive provisions governing the many elements in the points and fees calculation. Other provisions specify what rates, payments, and loan balances should be used for underwriting ARM's, interest-only, balloon and negatively-amortizing loans. Still others indicate what debts and other obligations need to be considered in underwriting analyses and DTI calculations and what factors must be independently verified (most, and especially income and employment), and how the verification may occur. Given that the rule essentially establishes a federal law of mortgage underwriting procedures, Regulation Z now has a new Appendix Q sporting a set of HUD-based underwriting guidelines that dictate—in numbing detail—how a Regulation Z DTI should be calculated (Tip: rent from boarders may be income; rent from roommates probably isn't.)

The ATR Rule presents significant compliance challenges and litigation risks. The points and fees test is quite complex—over sixty pages in the notice discuss the definition of “points and fees”—and the failure to apply the test correctly could disqualify a creditor from whatever protection is afforded under the QM safe harbor or compliance presumption. Points and fees include originator compensation along with fees paid to affiliates. Including originator compensation requires the measurement and incorporation of a value that has not traditionally been a part of compliance calculations. The Bureau's rule contained few kind words about affiliated business arrangements and including affiliate charges in points and fees could rapidly eat away at the 3 percentage point threshold, thus disqualifying loans involving affiliate services from QM status. And then there is the new Appendix Q. Regulation Z has always had appendices—D and J, for example—that are not for civilians. Appendix Q, however, may set new standards for complexity and regulatory pitfalls. Failure to follow its provisions to the letter could subject creditors to significant liability, and it is not clear that certain requirements are even remotely practical in the real world (i.e., when analyzing the probability of continued employment, considering a consumer's qualifications for a position and their previous training and education).

Finally, one must consider how safe the safe harbor actually will be. There was much debate during the rulemaking over what compliance presumptionseither a conclusivesafe harbor or a rebuttable presumption of compliancewould emerge for QMs. Now we know that the answer isboth. This means that a mortgage can be (i) a safe harbor QM because it meets the full QM definition (limited to loans with a DTI or 43% or less); (ii) a safe harbor QM because it meets more limited criteria but is agency-eligible; (iii) a QM with a rebuttable presumption of compliance but not a safe harbor; or (iv) a plain old mortgage loan that, all by...