Tuesday, November 12, 2013

Impact of “Qualified Mortgage” Rule on Homebuyers

The Dodd-Frank Wall Street Reform Act of 2010 requires the creation and implementation of 398 rules.  That is quite a hefty meal for lenders to digest.  As of September 2013, only 160 of those rules (slightly over 40%) have been finalized.  There are a couple of those rules going into effect on January 10, 2014 as a result of Dodd-Frank that are impactful to homebuyers.  

The mortgage industry already felt the effect of a number of rules from this law, but there are more rules coming soon, and those won't be the last either.  The Act requires that lenders “must make a reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan according to its terms.”  It also establishes a “Safe Harbor” and presumption of compliance for a certain category called “Qualified Mortgages.”  Of course the lending industry should make sure borrowers can repay the loan.  That is common sense, and the way the industry has operated since “no doc” loans went extinct over five years ago.  The law and accompanying regulations have the purpose of ensuring that those risky loans don’t come back to life.  So what is really changing on January 10?  Basically, lenders have to document that loans meet the characteristics of “Qualified Mortgages” if they want to be protected from litigation.

Mortgage firms are working tirelessly on implementing plans to be compliant ahead of the January 10 deadline.  This includes integrating new technology into the process, fine-tuning processes to ensure only compliant loans are originated, updating documents, and modifying or potentially eliminating loan products that will not meet QM rules.

Qualified Mortgages (QM)

Under the QM Rules, loans generally cannot contain risky features (i.e., interest only, negative amortization or balloon payments), and the loan term cannot exceed 30 years. Points and fees are limited to 3% for loans of $100,000 or more (higher thresholds are permitted for loans below $100,000). In addition, for most QM loans, Debt-to-Income (DTI) ratio is limited to 43%. The max DTI does not apply to Fannie, Freddie, FHA, VA, or USDA eligible loans that have a valid automated underwriting system approval.  There is no minimum down payment requirement for QM.  Within QM is a requirement that the lender make certain the borrower has the ability to repay the loan.

Ability to Repay (ATR) 

ATR focuses on underwriting practices and requires lenders to consider a borrower’s ability to repay the mortgage before extending credit to the borrower. The ATR Rule establishes minimum standards (eight specific factors) for lenders to use in determining whether consumers have the ability to repay the mortgage. Loans that meet the QM standard (discussed above) are presumed to be compliant with the ATR Rule. Non-QM loans can still meet the ATR Rule standards, but must be separately underwritten with the specific ATR factors in mind.

Safe Harbor

QM loans that are not “higher-priced” under the Rule have a “safe harbor.” This means that these loans are conclusively presumed to comply with the ATR requirements.  Higher-priced loans that meet the QM criteria are also presumed to be compliant with the ATR Rule; however, a consumer may rebut this presumption in a lawsuit. A first-lien mortgage loan is considered “higher-priced” if the APR is 1.5 percentage points or more over the Average Prime Offer Rate

(APOR). This “safe harbor” provides some added level of legal protection for lenders defending ability to repay lawsuits. 


Here are some areas of potential impact:

  • Programs with "risky features" such as interest only, balloon payments, and terms longer than 30 years will not meet the QM rule.
  • Mortgage brokers will have a harder time meeting the max 3% points and fees as the broker compensation is included in the calculation.  Mortgage brokers will find it harder to compete and be profitable with this new rule.
  • Upfront Mortgage Insurance (MI) on conforming loans is included in the max 3% points and fees calculation unless it is refundable.  Refundable MI policies will carry a higher premium than non-refundable policies.  Still any amount of the refundable premium that is above the FHA upfront premium must be included in the calculation.
  • For Adjustable Rate Mortgage (ARM) products, the 43% maximum debt-to-income ratio (DTI) is calculated based on the highest possible rate in the first 5 years of the term.
  • Allowing Fannie & Freddie loans to exceed the max 43% DTI with a valid AUS approval only applies while the GSE's are under conservatorship of the Federal government.  The good news is that they will likely stay in control of the government for at least several years as there is no clear plan to wind them down.

In principal the concept of documenting a borrower’s ability to repay a loan was already addressed by the market over five years ago.  Lenders with any memory of the financial crisis are not going to offer “no doc” loan products again; however, the law is designed to ensure that lenders can’t offer them ever again.  Lenders will want the majority, if not all, of their loans to fall into the “safe harbor.”  This will lead to a greater workload that burdens lenders, but it should have minimal impact on consumers’ ability to obtain a home loan.

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