CFPB May Trip Over Dodd-Frank in Mortgage Rule Revamp

The Consumer Financial Protection Bureau’s plans to create a new category of safer mortgages may run afoul of the law that created a standard to protect home loan borrowers.

The 2010 Dodd-Frank Act requires loans to meet certain standards—such as borrowers’ ability to repay—at the time of origination to get “qualified mortgage” status. The bureau in August proposed a new class of “Seasoned QMs,” which would allow certain loans that didn’t meet the QM status at origination but perform well over a three-year period to count as true qualified mortgages.

The problem is the Dodd-Frank Act doesn’t allow for so-called “seasoning” of loans, according to Eamonn Moran, of counsel at Morgan Lewis & Bockius LLP.

The CFPB’s prpopsal “could be somewhat of a stretch,” said Moran, who previously worked in the bureau’s Office of Regulations.

The QM standard requires that lenders determine that a borrower is capable of repaying a home loan by measuring several criteria, including a borrower’s debt to income ratio. QM loans come without high-risk features, such as teaser rates, balloon payments and elevated fees, and lenders of such loans are shielded from potential litigation.

The proposal would allow mortgages that don’t meet the strict borrower criteria to obtain QM status if a borrower is largely current for three years and the lender keeps the loan on its books. All consumer protections, including the ban on balloon payments and adjustable rates, would also have to remain on the loans to qualify for the seasoned QM status.

The proposed new category of loans will “encourage innovation and help ensure access to responsible, affordable mortgage credit,” the CFPB said in an August statement announcing the proposal. Comments on the proposal ended Oct. 1.

No ‘Legitimate Justification’

While the CFPB has some wiggle room under Dodd-Frank, there may not be enough for the seasoned QM to survive a potential court challenge if it becomes final, Moran and others said.

Moran said the CFPB is relying on other Dodd-Frank provisions—which give the bureau the authority to interpret statute in the rulewriting process— in an effort to reshape QM.

The seasoning proposal falls outside that authority, according to Melissa Stegman, a senior policy counsel and mortgage expert at the Center for Responsible Lending.

The bureau aims to increase innovation and expand mortgage credit, but the seasoning proposal could eliminate a core Dodd-Frank protection designed to prevent mortgages that borrowers can’t pay back, she said.

“I don’t think that that’s a legitimate justification for doing something that’s inconsistent with the statute,” she said.

Industry Support

The mortgage industry largely backs the CFPB’s seasoned QM proposal, according to a review of comment letters.

The Housing Policy Center, an industry group led by former Federal Housing Finance Agency chief Ed DeMarco, called on the CFPB to remove requirements for lenders to hold seasoned mortgages in their portfolios.

The portfolio mandate would hurt nonbank lenders whose business model is to sell mortgages to Fannie Mae and Freddie Mac, the Housing Policy Center said.

The group’s letter said that “market forces are also designed to ensure a credit originates loans based on a borrower’s ability to pay. Standard practices, such as representations and warranties between loan originators and investors, reinforce responsible lending decisions and practices.”

But requiring lenders to retain seasoned mortgages ensures that lenders are more attuned to a loan’s safety and performance since they would bear the risk of a borrower default, the CFPB said.

Removing portfolio requirements would remove most incentives for lenders to make sure they are offering loans borrowers can repay, Stegman said.