CFPB Races the Clock in Qualified Mortgage Rule Rewrite

The Consumer Financial Protection Bureau wants to provide more flexibility in determining what counts as a safer qualified mortgage, and is moving quickly to finalize a rule before a potential change in administrations.

The CFPB is proposing to eliminate a borrower debt-to-income ratio that has been a key measure for determining whether a mortgage is safe, and a lender is shielded from potential litigation, as part of a broader Trump administration push to take Fannie Mae and Freddie Mac out of government conservatorship.

The proposal to rewrite the qualified mortgage standard, unveiled June 22, comes with a brief 60-day comment period and would take effect April 2021, a tight timeline for a major regulatory shift in how lenders underwrite mortgages.

The speed isn’t an accident. The upcoming presidential election could result in the Democratic nominee, former Vice President Joe Biden, taking office in January and replacing CFPB Director Kathy Kraninger. The U.S. Supreme Court ruled Monday that the bureau’s director an at-will employee of the president.

“They want to get something on the books,” said Richard Andreano, a partner at Ballard Spahr LLP who represents mortgage lenders.

Manipulating Loans?

A product of the 2010 Dodd-Frank Act, a qualified mortgage is a home loan that meets strict borrower ability-to-repay standards and therefore protects the lender from potential litigation if a borrower defaults. A key feature of those ability-to-repay standards is a requirement for the borrower’s debt-to-income ratio not to exceed 43%.

The CFPB is proposing to create a new way to expand the QM definition by using the price of the mortgage while including DTI as part of a broader review of a borrower’s ability to repay the loan.

Removing the 43% DTI requirement could “blow a hole” in the qualified mortgage rule, said Susan Wachter, a professor at the University of Pennsylvania’s Wharton School of Business.

Basing the definition of a safe mortgage on the interest rate or price works when times are good and home values are rising, Watchter said. But it doesn’t take into account a potential fall in home values or economic shocks for borrowers.

That’s especially worrying as the U.S. economy is mired in a recession stemming from the coronavirus pandemic, she said.

“It’s just a roller coaster ride to disaster. There’s nothing left,” Watchter said.

Rather than relying solely on borrower debt-to-income levels, the CFPB is proposing that any mortgage with a rate spread between the mortgage interest rate and the prime rate of less than 200 basis points would be considered a qualified mortgage. For lenders to get full litigation protection, the spread would have to be 150 basis points or below.

Allowing lenders and the CFPB to use price as a way to determine whether a mortgage should get the full range of QM protections opens the door to “manipulating how people’s loans are structured,” said Alys Cohen, a staff attorney at the National Consumer Law Center.

Market Flexibility

The CFPB created another way for mortgages to qualify for the coveted QM status when the Dodd-Frank rule came into effect in 2014. All mortgages guaranteed by Fannie Mae and Freddie Mac were counted as qualified mortgages, regardless of borrower debt levels, because the mortgage finance giants are backstopped by the federal government.

That exemption, known as the GSE patch, is set to expire in January.

With the Trump administration pushing hard to privatize Fannie and Freddie in the coming years, the CFPB needed to provide additional flexibility to the entire mortgage market. Banks and other mortgage lenders were among those pushing the agency to drop the 43% debt-to-income requirement for all qualified mortgages, not just government-backed loans.

“This is a step forward to improve the QM rule in a way that protects borrowers and the financial system alike from excessive risk, while responsibly preserving access to homeownership for credit-worthy borrowers,” the Housing Policy Council, an industry group including mortgage giants like Quicken Loans and Wells Fargo & Co., said in a June 22 statement.

Financial data provider CoreLogic estimates that around $260 billion of the $1.63 trillion in mortgage loans issued in 2018, or 16%, were originated through the so-called GSE patch slated to expire in January.

The CFPB has proposed to keep the the GSE patch until the new qualified mortgage rule is in place. The effective date for the new QM definition would be the earlier of April 2021 or when Fannie and Freddie exit conservatorship.

Better Forecast

Expanding mortgage access would be impossible while leaving in place the hard 43% debt-to-income cap, the industry and even some consumer groups say.

Debt-to-income ratios still would be considered when underwriting loans, but wouldn’t be the deciding factor in determining whether a loan is considered safe, Andreano said.

Moving to a price-based approach would allow lenders to have a more fulsome view of a borrower when underwriting a loan, rather than denying a mortgage based on one metric that might not be as predictive of default, said Mike Calhoun, the president of the Center for Responsible Lending.

While debt levels seem intuitive to a borrower’s ability to repay a mortgage, “it is the least predictive of success” when compared to other major loan criteria, like credit scores and down payments, Calhoun said.

The Center for Responsible Lending is an affiliate of the Self-Help Credit Union, which has a portfolio of over $1 billion in home loans to low- to moderate-income borrowers. The credit union retains all the credit risk on those loans.

The CFPB isn’t proposing to eliminate any of the other consumer protections that are part of qualified mortgages, including provisions that bar interest-only loans or those with balloon payments. Those protections alone would have prevented around half of the foreclosures during the financial crisis, Calhoun said.

But other consumer advocates say the qualified mortgage standard won’t work as intended without full consideration of a borrowers’ cash flow and debts.

“Everyone knows that DTI is imperfect, but what the law requires under Dodd-Frank is an assessment of whether a borrower can repay,” Cohen said.