HUD’s Safe and Rebuttable Qualified Mortgages

The anxiously awaited Proposed Rule (“Rule”) outlining the Qualified Mortgage for FHA loans was published in the Federal Register on September 30, 2013. Given the bland, bureaucratic title Qualified Mortgage Definition for HUD Insured and Guaranteed Single Family Mortgages (“Issuance”), HUD is submitting for public comment its definition of a “qualified mortgage” for the types of loans that HUD insures, guarantees, or administers that align with the statutory ability-to-repay (“ATR”) criteria of the Truth-in-Lending Act (“TILA”) and the regulatory criteria of the definition given by the Consumer Financial Protection Bureau (“CFPB”), without departing from HUD’s statutory requirements. The expiration of the comment period is October 30, 2013.

A copy of the Proposed Rule is available in our Library.

In this article, I will provide an overview of the Rule with respect to Title II mortgages of the National Housing Act. I shall offer some practical insights relating to the potential consequences and implementation of the Rule for residential mortgage lenders and originators.*

Birthing HUD’s Proposed Rule

The Rule has its genesis in a foundational document, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which created the new section 129C in TILA, establishing minimum standards for considering a consumer’s repayment ability for creditors originating certain closed-end, dwelling-secured mortgages, and generally prohibiting a creditor from originating a residential mortgage loan unless the creditor makes a reasonable and good faith determination of a consumer’s ability to repay the loan according to its terms.

Briefly, Section 129C is meant to provide lenders a specific format to meet the ATR requirements when lenders make “qualified mortgages” (“QMs”). A new section 129C(b), added by section 1412 of Dodd-Frank, establishes the presumption that the ATR requirements of section 129C(a) are satisfied if a mortgage is a “qualified mortgage,’’ and authorizes the CFPB, to prescribe regulations that revise, add to, or subtract from the criteria in TILA that define a “qualified mortgage.’’ (Section 129C also provides for a reverse mortgage to be a qualified mortgage if the mortgage meets the CFPB’s standards for a qualified mortgage, except to the extent that reverse mortgages are statutorily exempted altogether from the ATR requirements. The CFPB’s regulations provide that the ATR requirements of section 129C(a) do not apply to reverse mortgages. Section 129C(a)(8) excludes reverse mortgages from the repayment ability requirements.)

As you may know, I have published and presented extensively on QMs and have dubbed the non-qualified mortgage with the acronym “NQM.” For some of my work on this subject, please visit HERE, and HERE, and HERE.

Section 129C authorizes the agency with responsibility for compliance with TILA, that is, the CFPB, to issue a rule implementing these requirements. The CFPB already set forth its Final Rule on ATR, QMs, and NQMs, as issued in the Federal Register on January 30, 2013. Along with certain other agencies, HUD was also later on charged by the CFPB, pursuant to Dodd-Frank, with prescribing regulations defining the types of loans that it would insure, guarantee, or administer, as applicable, that are qualified mortgages. In the Rule, HUD now proposes that any forward single family mortgage insured or guaranteed by HUD must meet the criteria of a qualified mortgage, as defined in the Rule.

HUD reviewed its mortgage insurance and loan guarantee programs and, in the Issuance, stated that all of the single family residential mortgage and loan products offered under HUD programs are qualified mortgages; that is, they “exclude risky features and are designed so that the borrower can repay the loan.” However, for certain of its mortgage products, HUD proposes its Rule for qualified mortgage standards similar to those established by the CFPB in its definition of “qualified mortgage.” 

Safe Harbor and Rebuttable Presumption of Compliance

Through its “qualified mortgage” rulemaking, the CFPB established both a “safe harbor” and a “rebuttable presumption of compliance” for transactions that are qualified mortgages. CFPB's label of safe harbor is applied to those mortgages that are not higher-priced covered transactions (i.e., the annual percentage rate (“APR”) does not exceed the average prime offer rate (“APOR”) by 1.5 percent). These are considered to be the least risky loans and presumed to have conclusively met the ATR requirements of TILA. The label of rebuttable presumption of compliance is applied to those mortgages that are higher-priced transactions.

TILA Section 129C(b)(2)(ix) provides that the term “qualified mortgage” may include a “residential mortgage loan” that is “a reverse mortgage which meets the standards for a qualified mortgage, as set by the Bureau in rules that are consistent with the purposes of this subsection.” But the Federal Reserve Board’s proposal, adopted by the CFPB, does not include reverse mortgages in the definition of a “qualified mortgage.” Indeed, the CFPB’s Final Rule does not define a “qualified” reverse mortgage.

HUD proposes to designate Title I (home improvement loans), Section 184 (Indian housing loans), and Section 184A (Native Hawaiian housing loans) insured mortgages and guaranteed loans covered by the Rule to be safe harbor qualified mortgages and HUD proposes no changes to the underwriting requirements of these mortgage and loan products.

The largest volume of HUD mortgage products - those insured under Title II of the National Housing Act – would be bifurcated into qualified mortgages similar to the two categories created in the CFPB final rule: a safe harbor qualified mortgage and a rebuttable presumption qualified mortgage.

Specifically, the Rule would define the safe harbor qualified mortgage as a mortgage insured under Title II of the National Housing Act (excepting reverse mortgages insured under section 255 of this act) that meets the points and fees limit adopted by the CFPB in its regulation at 12 CFR 1026.43(e)(3), and that has an APR for a first-lien mortgage relative to the APOR that is less than the sum of the annual mortgage insurance premium (“MIP”) and 1.15 percentage points. HUD would define a rebuttable presumption qualified mortgage as a single family mortgage insured under Title II of the National Housing Act (excepting reverse mortgages insured under section 255 of this act) that meets the points and fees limit adopted by the CFPB in its regulation at 12 CFR 1026.43(e)(3), but has an APR that exceeds the APOR for a comparable mortgage, as of the date the interest rate is set, by more than the sum of the annual MIP and 1.15 percentage points for a first-lien mortgage.

Revolving Door Regulators

Senator yesterday. Lobbyist today.

Representative yesterday. CEO today.

Cabinet level appointee yesterday. Bank Chairperson today.

Government Agency Director yesterday. Law firm senior partner today.

CFPB Regulator yesterday. Competitor today.

_______________________________________________________________________

IN THIS ARTICLE

The Inside-Outside Gambit

The Four Horsemen

A Business Model for Former Regulators

Partners in Business

Making a Market in Non-QM

Timeline

What did they know, and when did they know it?

Extinguishing the Fire

Library

_______________________________________________________________________

The Inside-Outside Gambit

There are many forms of corruption. Perhaps the most pernicious is where an elected or duly appointed representative of the citizenry leaves office to use the sloughed off position for financial gain in the private sector.

Let's set up a definition for such (mostly unregulated) behavior. I will give it a phrase: "inside-outside gambits."

What is an inside-outside gambit? It is the use of information obtained in the course of a former governmental position by an official for financial gain, directly or indirectly, soon or immediately after leaving government employment in that position. Such information includes contacts with decision-makers in the government; providing information about proprietary conversations leading up to the promulgating of laws, rules, and regulations; access to insiders and knowledge of their views; navigating the systemic and organizational structure; non-public facts regarding the governmental plans or condition that could provide a financial advantage. Note that I use the phrase "inside-outside," not "insider trading."

I am not talking about a situation where there is the illegal trading of a public company's stock or other securities (such as bonds or stock options) by individuals with access to non-public information about the subject company (such trading being illegal).

However, the effect of “inside-outside gambit” and “insider trading” is practically the same: these strategies lead to an unfair, usually economic, advantage.

A basic concept of law is that an injury must be sustained by a plaintiff. Broadly speaking, no injury, no case.

So who is harmed when an equity trader uses inside information for personal financial benefit? The public, of course. Certainly, that part of the public that invests in the stock market, relying on rules, regulations, and laws to be impartially applied, with equal access to all. And who is harmed when a former government official uses inside information for personal financial benefit almost immediately after being employed in the government position. Of course, the public. Certainly, that part of the public that relies on rules, regulations, and laws to be impartially applied, with equal access to all.

How about when regulators in the most powerful agency that regulates the origination of residential mortgage loans, the Consumer Financial Protection Bureau (CFPB), leave that agency and start a mortgage company soon after leaving the CFPB, to compete or partner with mortgage companies?

When Thomas Jefferson advocated that legislators should have term limits in order to prompt the return to private life in order to live under the rules they promulgated, somehow I don't think this is what he had in mind.

In a letter of 1776, Jefferson wrote:

[His] "reason for fixing them [elected representatives] in office for a term of years rather than for life was that they might have an idea that they were at a certain period to return into the mass of the people and become the governed instead of the governor, which might still keep alive that regard to the public good that otherwise they might perhaps be induced by their independence to forget."

In other words, Jefferson viewed public service as a privilege. He fully expected government officials to return to private life and live under the laws they passed. I quite doubt that he viewed such a return to be a means for an ex-official’s self-enrichment, by utilizing public service to exploit – or even appear to exploit - the very laws promulgated by the ex-official.

_______________________________________________________________________

The Four Horsemen

On July 31, 2013, the House Committee on Oversight and Government Reform and the House Committee on Financial Services sent an eight page Congressional letter (Letter) to Richard Cordray, the Director of the Consumer Financial Protection Bureau (CFPB). Signed by a bi-partisan group of Representatives, it expressed concern about the recent departure from the CFPB of four high level officials. The Letter forms the basis of further inquiries by the Committees. Noting a news report, the Representatives indicated it appears that certain officials "have left the CFPB in order to profit from rules they helped create."

Who are these individuals? What were their former CFPB positions?

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.

_________________________________________________

IN THIS ARTICLE

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

Library

_________________________________________________

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."

_________________________________________________

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.

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)