Defining Future Mortgages

While including measures benefiting community banks, the CFPB’s ability-to-repay rules are a major step in defining the future of home finance

By Elizabeth Eurgubian and Ron Haynie

Community banks gained significant accommodations in the Consumer Financial Protection Bureau’s ability-to-repay qualified mortgage rule issued in January, the first of several mortgage rules that will determine the nature and extent of home financing for the future.

Formally set to take effect in January 2014, the CFPB’s qualified mortgage standards will establish a legal and regulatory framework for mortgage lending by community banks and all other residential mortgage lenders. Most significantly, the new set of regulations define product-feature and underwriting standards for qualified mortgages that will carry a legal safe harbor protection that is critical to community banks.

Fortunately for community banks, the CFPB generally followed important ICBA recommendations that will allow balloon-payment loans originated by small lenders for their own portfolios in rural and underserved areas to receive the safe harbor. Because of this important accommodation, the new rules should not be a major disruption to many community banks that operate in rural markets. However, the CFPB still has to release a list of counties it identifies as “rural” to be able to fully assess the regulation’s impact.

As most community bankers can attest to, balloon-payment mortgages have long been a staple of their mortgage lending. Three-fourths of ICBA members responding to a survey late last year indicated they originated balloon-payment mortgages to hold in portfolio. Moreover, such loans made up the majority of these community banks’ residential mortgage lending.

Meanwhile, in response to ICBA’s efforts, the CFPB has proposed a new, broader category of qualified mortgages for other (non-balloon payment) mortgage loans. Per that proposal still under consideration, those new qualified mortgages would have to be originated and held in portfolio by small creditors with less than $2 billion in assets that originate 500 mortgage loans or fewer annually, including loans made outside rural areas. Both rural balloon-payment qualified mortgages and other mortgages made by these lenders with Annual Percentage Rates up to 3.5 percentage points above the average prime offer rate would qualify for the safe harbor.

This carve-out for community bank portfolio loans would recognize that in many cases a community bank is the only source of mortgage credit for certain borrowers, and that community banks have a long history of prudent underwriting—complemented by their unique knowledge of their borrowers and local markets—when it comes to providing mortgage loans that their borrowers can afford. ICBA will be commenting on this proposed amendment to the qualified mortgage rule and stress the need to include all mortgages, including balloon-payment mortgages originated by community banks, regardless of their location or market. ICBA also will seek to increase the small-creditor threshold.

While statutory requirements permit balloon-payment mortgages originated in rural and underserved areas, the regulation’s provisions do not allow them in non-rural areas. ICBA made it clear to the CFPB that community banks have been using these types of loans for decades in a safe and sound manner to meet the needs of their customers, and we want to be sure they can continue to do so with the portfolio-lending amendment.

While awaiting the outcome of the changes from the CFPB described here, we can offer a breakdown for community bank residential mortgage lenders of key components in the final ability-to-pay regulation issued in January. (This article doesn’t address potential ramifications, if any, on CFPB regulations stemming from a federal appeals court ruling that bureau Director Richard Cordray’s congressional recess appointment was unconstitutional.)

Safe harbor. Perhaps most important for community banks, the CFPB included in the definition of qualified mortgages points long advocated by ICBA, particularly a legal safe harbor that presumes the creditor making such loans has satisfied the ability-to-repay standards. Without a legal safe harbor, borrowers could challenge in court a bank’s compliance, even for loans that are deemed qualified.

Under the qualified mortgage definition, the legal safe harbor is provided for loans that satisfy the definition of a qualified mortgage and are not deemed to be “higher priced” loans (those with Annual Percentage Rates of 1.5 percentage points or more above the average prime offer rate). However, higher-priced loans that meet the qualified mortgage definition will carry a less-certain legal protection of a rebuttable presumption that the loan meets the ability-to-repay requirements.

Qualified mortgages will have to meet certain underwriting criteria, such as a debt-to-income ratio generally no higher than 43 percent or comply with underwriting guidelines required by Fannie Mae and Freddie Mac. They also must exclude certain product features, such as negative amortization or interest-only payments. Their upfront points and fees will be generally limited to three points on qualified mortgages. Some exceptions have been made for loans smaller than $100,000, when three points may not cover a lender’s origination costs. Additional points also can be used to reduce the rate on prime loans or cover other bona fide third-party charges or fees.

Balloon-payment loans. Significantly, statutory requirements stipulate that qualified mortgages cannot have balloon payments. However, ICBA urged the CFPB to provide an exemption for mortgages retained in a bank’s own portfolio and not sold into the secondary mortgage market. The bureau responded by granting qualified mortgage status for balloon mortgages made by lenders with up to $2 billion in assets that originate no more than 500 first-lien mortgage loans annually, and where 50 percent or more of their first-lien mortgages are in rural or underserved areas.

Under the final rules, mortgages with balloon payments will be deemed qualified mortgages if they are provided to borrowers in rural or underserved areas and if the lender holds the loans in portfolio. Qualifying balloon-payment mortgages must also have a term of at least five years, a fixed interest rate and meet certain basic underwriting standards. Their debt-to-income ratios must be considered but are not subject to the general 43 percent debt-to-income requirement.

The CFPB is expected to publish a list of rural and underserved counties shortly. Updates to that list will be made annually. Other details in the qualified mortgage rule will be further clarified over time. Some specific circumstances—such as when a lender rolls over a balloon-payment mortgage into a similar loan—aren’t addressed in the rules. ICBA will be addressing this issue with the bureau in a future comment letter.

Ability-to-repay underwriting. As conservative lenders, community banks have always consistently underwritten their loans in ways that would conform to the qualified mortgage standard. As ability to repay implies, however, the CFPB’s rules emphasize that all borrowers should continue to have adequate income or assets to meet all their financial obligations after taking out any home loan.

By granting certain exemptions to community banks, the CFPB acknowledged ICBA’s point that community banks, as relationship lenders, are structured to provide responsible loans with safe features supported by common-sense underwriting. However, community banks will need to see how other regulators interpret the qualified mortgage standard as they perform bank examinations.

Additionally, community banks may need to amend, refine or expand their credit policies. For example, they may need to include in those policies more specific verification steps, such as requiring that tax returns be reviewed to confirm a borrower’s income rather than simply assessing a business owner’s receipts or cash flow.

Lenders issuing qualified mortgages may also have to calculate the 43 percent debt-to-income ratio requirement based on a consumer’s total recurring financial obligations. Estimated mortgage payments should be the highest amount likely during the first five years of the loan.

And while qualified mortgages will receive an automatic safe harbor or rebuttable presumption of compliance (depending on their Annual Percentage Rate), all lenders originating home loans that are not qualified mortgages will have to follow and document specific ability-to-repay underwriting requirements written into the ability-to-repay regulations. More specifically, the new regulations set forth a minimum of eight underwriting standards for loans that are not deemed qualified mortgages:

– current income or assets,

– current employment status,

– credit history,

– monthly payment for the mortgage,

– monthly payments on any other loans associated with the property,

– monthly payments for other mortgage-related items, such as mortgage insurance or property taxes,

– other debt obligations and

– the borrower’s debt-to-income ratio under the new mortgage.

Additionally, consumers obtaining an adjustable-rate mortgage will have to qualify for a mortgage based on the fully indexed rate, rather than on the initial “teaser rate.” The CFPB doesn’t advise lenders on how large down payments should be or suggest minimum credit scores.

An exemption to these ability-to-repay underwriting rules will be granted for borrowers refinancing out of an existing “risky loan.” The CFPB defines risky loans as mortgages with features such as adjustable rates and interest-only or negative-amortization payment schedules. Lenders that provide borrowers with a “more stable, standard loan” can do so without fulfilling all the underwriting rigors described by the ability-to-repay rule to qualify for the safe harbor.

On a temporary basis, the CFPB’s rule also will grant qualified standing to certain loans that don’t adhere strictly to the new underwriting standards. Any mortgage eligible to be purchased, guaranteed or insured by Fannie Mae, Freddie Mac, the U.S. Department of Housing and Urban Development, the Department of Veteran Affairs, the Department of Agriculture or the Rural Housing Service is given qualified mortgage status. endmark

Elizabeth Eurgubian is ICBA vice president and regulatory counsel.

Ron Haynie is ICBA vice president of mortgage finance policy.