CFPB’s Final Rule: Ability-to-Repay and Qualified Mortgages

On Wednesday, I provided an outline of the Consumer Financial Protection Bureau's (CFPB's) Regulatory Agenda for 2013. As if on cue, the CFPB accommodated us on Thursday with the first of its forthcoming issuances.* This pertains to the Final Rule regarding Ability-to-Repay, which leaves the Final Rule issuances this month for Loan Originator Compensation, Mortgage Servicing, and Requirements for Escrow Accounts.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) required that, for residential mortgages, creditors 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 established a "presumption" of compliance for a certain category of mortgages, which was called “qualified mortgages” or "QMs." These provisions are similar, but not identical to, the Federal Reserve Board's (FRB's) 2008 rule and cover the entire mortgage market rather than simply higher-priced mortgages. The FRB proposed a rule to implement the new statutory requirements before authority passed to the CFPB to finalize the rule. The compliance effective date is January 10, 2014.

I have written extensively about Ability-to-Repay and the Qualified Mortgage.

Please feel free to review these articles.

In this article, I would like to mention the premises used as the reasons for an Ability-to-Repay rule (ATR). Then I will outline the essential features of ATR, followed by a review of the "Qualified Mortgage." Finally, I will provide a general summation in order to provide some context with respect to the Final Rule's implementation.

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IN THIS ARTICLE

Premises for Ability-to-Repay
What is Ability-to-Repay?
What is the Qualified Mortgage?
Types of Qualified Mortgages
Summation

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Premises for Ability-to-Repay

The CFPB believes that when consumers apply for a mortgage they "often struggle to understand how much of a monthly payment they can afford to take on." Thus, according to the CFPB, the consumer may reasonably assume that lenders and mortgage brokers would not make loans to people who cannot afford them. But in the years leading up to the financial crisis, the CFPB asserts that lenders too often made mortgages that could not be paid back.

Therefore, the purpose of ATR is to require lenders to obtain and verify information to determine whether a consumer can afford to repay the mortgage and, per the CFPB, thereby help to restore trust in the mortgage market.

These are the premises upon which the CFPB has established the need for Ability-to-Repay:

-In the lead up to the financial crisis, certain lending practices set consumers up to fail with mortgages they could not afford.

-The deterioration in underwriting standards contributed to dramatic increases in mortgage delinquencies and rates of foreclosures.

-The Dodd-Frank Act recognizes the need to mandate that lenders ensure consumers have the ability to pay back their mortgages.

-The Ability-to-Repay rule protects consumers from risky practices that helped cause the crisis.

In its review of the above-mentioned premises, the CFPB had taken the position that lenders sold no-doc and low-doc loans where consumers were “qualifying” for loans beyond their means. Lenders also "sold risky and complicated mortgages like interest-only loans, negative-amortization loans where the principal and eventually the monthly payment increases, hybrid adjustable-rate mortgages where the rate was set artificially low for years and then adjusted upwards, and option adjustable-rate mortgages where the consumer could 'pick a payment' which might result in negative amortization and eventually higher monthly payments."

In plain English, the CFPB asserts that lenders should not be able to offer no-doc, low-doc loans, otherwise known as “Alt-A” loans, where some lenders made quick sales by not requiring specific, qualifying documentation, yet then offloaded these risky mortgages by selling them to investors.

As it was contended, these actions precipitated the collapse of the housing market in 2008 and the subsequent financial crisis.

Dodd-Frank provides the authority to the CFPB to define criteria for certain loans called “Qualified Mortgages” that are presumed to meet the Ability-to-Repay rule requirements.

The salient observation about ATR is that the CFPB is issuing this rule in order "to ensure that responsible consumers get responsible loans," as well as ensuring that "lenders can extend credit responsibly - without worrying about competition from unscrupulous lenders."

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What is Ability-to-Repay?

There are four (4) ATR components, each in its own way requiring the lender to obtain financial information from the loan applicant and verify them.

CFPB’s Regulatory Agenda - 2013

As we begin a new year and prepare ourselves for the blizzard of new and revised regulations coming our way, I think it is important for us to consider the regulatory agenda that the Consumer Financial Protection Bureau (CFPB) has set for itself.* As you've heard me say so many times, preparation is protection. So, please undertake a review of the agenda that the CFPB has promised to pursue in the coming months, especially with the view of how best to prepare for the changes that are sure to follow.

It is worth noting that the CFPB reasonably anticipates having certain regulatory matters under consideration during the period from October 1, 2012 to October 1, 2013. And the CFPB will publish updates to its agenda periodically through October 1, 2013. These matters will be under consideration by the CFPB, primarily including various rulemakings mandated by the Dodd-Frank Act, such as several mortgage-related rulemakings and rulemakings to implement the CFPB's supervisory program for nondepository covered persons by, among other things, defining "larger participants" in certain consumer financial product and service markets. 

The CFPB is completing several mortgage-related rulemakings in January 2013, even as it continues to assess the need and resources available for additional rulemakings. For instance, the Dodd-Frank Act mandates rulemakings to implement amendments to the Home Mortgage Disclosure Act, and to the Equal Credit Opportunity Act to create a data reporting regime concerning small, women-owned, or minority-owned business lending. Also, the CFPB has inherited proposed rules concerning mortgage loans, home equity lines of credit, and other topics from other agencies as part of the transfer of authorities under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). All of these regulatory changes will require careful planning and clear guidance with respect to implementation.

In this article, I am going to highlight the regulatory changes that the CFPB has moved into their final stages. I offer a brief outline of the regulatory issues and the CFPB's likely resolution. Each of these regulations, now approaching the status of Final Rule, is extraordinarily significant and, in some instances, constitutes formidable challenges. 

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IN THIS ARTICLE

Chart

Consumer Financial Protection Bureau -
Final Rule Stage (Selected Rules)

Final Rule Stages

Loan Originator Compensation (Regulation Z)
Mortgage Servicing (Regulation X, Regulation Z)
Requirements for Escrow Accounts (Regulation Z)
TILA Ability To Repay (Regulation Z)
TILA/RESPA Mortgage Disclosure Integration
(Regulation X, Regulation Z)

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Chart: Consumer Financial Protection Bureau

Final Rule Stage (Selected Rules)

This chart provides a quick overview of certain regulatory changes that the CFPB will promulgate this year. The chart also provides the anticipated Final Rule dates.

Winning the Future - Losing the Past

Jonathan Foxx is the President and Managing Director of Lenders Compliance Group.

“Winning the Future!” By now, most of us have heard President Obama's new slogan for his 2012 re-election campaign. 

But for the mortgage industry and consumers, it seems like something very vital is at stake: causes of the recent financial meltdown are creeping and clawing their way back. 

Perhaps we are not so much Winning the Future as Losing the Past.

Famous Last Words

Here are the very last words of the 1616 page Senate's amendments to the House's financial reform bill, which together formed the basis of the Dodd-Frank Act (Dodd-Frank):

Amend the title so as to read: An Act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end "too big to fail", to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes. (My Emphasis) 

The nomenclature "too big to fail," otherwise known by the acronym TBTF, was placed into the legislative language right then and there!

But that phrase "too big too fail" itself never actually made it into the 2319 page Dodd-Frank Act.

Did it just disappear forever or merely reappear with a make-over?

What’s In A Name

Dodd-Frank saw to it that the pesky and politically unpopular term "too big to fail" disappeared, but the concept was craftily replaced with a shiny new term, known as a "systemically important financial institution," also prestigiously having an acronym of its very own: "SIFI." (Pronounced in the same way as you would pronounce SciFi!)

Is the SIFI a different kind of indomitable beast than the TBTF monstrosity?

Let's take a closer look, by reading some Dodd-Frank descriptions of this SIFI creature:

• Entities that are systemically important or can significantly impact the financial system of the United States.

• The terms 'systemically important' and 'systemic importance' mean a situation where the failure of or a disruption to the functioning of a financial market utility or the conduct of a payment, clearing, or settlement activity could create, or increase, the risk of significant liquidity or credit problems spreading among financial institutions or markets and thereby threaten the stability of the financial system of the United States.

And here is one of several factors that may be taken into consideration, when deciding to protect us from the flailing SIFI:

• The effect that the failure of or a disruption to the financial market utility or payment, clearing, or settlement activity would have on critical markets, financial institutions, or the broader financial system.

Now you might argue that TBTF is a somewhat colloquial expression, a political and journalistic tool, but its successor, SIFI, is now enshrined into law along with certain actionable remediation. Conceptually, however, I see very little light between the meaning of the two terms.

So did Dodd-Frank conquer the "too big to fail" beast, wrestling the TBTF to the ground, casting it into chains, pulling off its griftopic mask, and finding underneath the "systemically important financial institution," that rapaciously attenuated SIFI?

Are We Safe From The SIFI?      

Let us presume that Dodd-Frank actually provides viable regulatory remedies for keeping this SIFI chained up. As you may know, I have written extensively about the breathtaking lack of formidable brakes in Dodd-Frank to avoid the SIFI debacle. Indeed, certain markets are still exposed to systemic failure, as that term is defined by Dodd-Frank. In some cases, certain markets are inadequately addressed by or they are not even regulated through Dodd-Frank.

In any event, let us just suppose that somehow Dodd-Frank actually has all the regulatory remedies it needs to keep the SIFI under control. What may happen in another meltdown?

Ability-to-Repay: Regulating or Underwriting?

EXCERPT # 1 

It seems to me that the imposition of an ability-to-repay requirement as a regulatory mandate is an admission that market forces cannot discipline lenders or incentivize lenders to act in their own self-interest.

This is an obvious shift in liabilities, because this mandate shifts the burden of compliance to the lenders in order to assure that their contractually bound borrowers can pay back their loans. Parties to any contract can become adversaries!

In other words, the relationship between the creditor and the borrower is innately affected and extensively undermined by this Rule, inasmuch as it imposes a new kind of theory for a regulatory framework and, in my estimation, infantilizes lenders by making them comply with a regulator's ad hoc way of rationing the extension of credit. 

ABILITY-TO-REPAY: REGULATING OR UNDERWRITING? (Part II)

EXCERPT # 2

If the rationing of credit is meted out through this regulatory construct, it can be legitimately asserted as well that lenders are not arms-length, contractual counterparties; that is, lenders now will have a duty to assess a prospective borrower's ability to repay, irrespective of collateral value and securitization.

This change in the dynamics between and the inherent, due diligence tension among the parties to a residential mortgage transaction raise serious issues about the systemic consequences soon to be engendered. 

ABILITY-TO-REPAY: REGULATING OR UNDERWRITING? (Part II)