Big changes are coming for residential mortgage lenders starting next year. That’s when new rules from the federal Consumer Financial Protection Bureau (CFPB) go into effect concerning the origination of home mortgages.
Fannie Mae has made some changes to its eligibility standards as a result, but before looking at those, it’s helpful to understand the new Ability-to-Repay and qualified mortgage (QM) rules.
Underlying the QM concept is the Ability-to-Repay rule that the CFPB issued on January 10, 2013. This rule, which takes effect on January 10, 2014, requires mortgage lenders to consider consumers’ ability to repay their home loans before extending credit to them.
Broadly speaking, the Ability-to-Repay rule requires a lender to only make a loan that the lender reasonably believes the borrower has the ability to repay at the time the loan is made. Borrowers must provide financial documentation to support this, and lenders must verify all the documents that the borrower provides.
Under the Ability-to-Repay rule, lenders have to consider and document at least eight underwriting criteria in deciding whether to lend money for a home purchase or refinance, said John Burley, associate general counsel for Fannie Mae. The criteria are:
- The borrower’s current or expected income or assets.
- The borrower’s income and employment status if the borrower is claiming to have employment income.
- Monthly payments on the loan, including any possible changes if the interest rate is adjustable.
- Monthly payments on other loans being made at the same time secured by the property that the lender is aware of.
- Monthly costs of other mortgage-related obligations the borrower has, such as homeowners’ association dues or property taxes.
- Other loans and debts the consumer has, such as alimony, child support, or credit card debt.
- The borrower’s debt-to-income ratio.
- Credit history.
What Makes a Mortgage Qualified?
Think of a QM in three ways. At one level, it’s a loan that meets various standards that the CFPB has established. In a more simple sense, it’s a loan for which the lender presumes the borrower has the ability to repay. And for the lawyers in the crowd, the granting of QM status provides a defense for lenders against legal actions that borrowers can now bring over loans they’ve taken out and later claim they can’t afford under the ability to repay standards.
Under CFPB rules, a QM must have the following characteristics:
- Loans may not have terms that extend beyond 30 years, and all principal must be paid in substantially equal installments over the life of the loan.
- Points and fees, which are costs that the lender charges to the borrower during the process of applying for the loan, are capped at 3 percent of the total amount the borrower takes out for loans of $100,000 or more.
A Degree of Legal Protection
A major reason why lenders are interested in QM is that they can receive a degree of legal protection from borrower lawsuits if the borrower claims the lender failed to consider the borrower’s ability to repay the loan. Broadly speaking, there are two classes of QMs. The amount and type of legal protection the lender gets will depend on criteria of the QM loan they’ve made:
- Safe harbor loans have annual percentage rates (APR) that are not more than 1.5 percentage points (or 150 basis points) of the “average prime offer rate” (APOR). (The APOR is determined weekly and relates to Freddie Mac’s survey.) A safe harbor loan is harder for the borrower to challenge in court because the lender is conclusively considered as having fulfilled the Ability-to-Repay rule.
- Rebuttable presumption loans have APRs more than 1.5 percent above the APOR. The lender in this case gets less legal protection than with safe harbor loans. Borrowers with such loans can potentially win a lawsuit based on the Ability-to-Repay rule if they can prove that the lender didn’t give adequate consideration to living expenses after the mortgage and other debts they were aware of.
Fannie Mae’s New Eligibility Rules
Starting next year, Fannie Mae will impose new limits on the types of loans it can buy from lenders. This is because of instructions that it received on May 2, 2013, from the Federal Housing Finance Agency, which serves as its regulator and conservator.
For loans with applications on and after January 10, 2014, if a loan is subject to the CFPB’s Ability-to-Repay rule, then Fannie Mae can buy it only if:
- It is “fully amortizing,” meaning that the borrower can pay the entire principal by making all monthly payments on time. This means Fannie Mae cannot accept negative amortization, balloon or interest only loans for purchase.
- The term of the loan is a maximum of 30 years.
- Points and fees are less than 3 percent of the total amount of the loan (higher limits apply to loans under $100,000).
The first two items are relatively straightforward. The third is not. Burley notes that a plethora of rules govern what lenders must include, or may exclude, in points and fees.
“It’s very technical,” he said. “That’s where most of the concerns will be.”
If a loan is exempt from the Ability-to-Repay rule, points and fees must be less than 5 percent of the total loan amount for Fannie Mae to buy the loan.
It’s not Fannie Mae’s role to establish whether a given loan is a QM, nor whether it is of the safe harbor or rebuttable presumption variety. The burden for complying with those regulations rests with the lender.
Nevertheless, Fannie Mae recognizes that lenders face challenges in complying with all of the new regulations. Therefore, during a transitional period of as-yet undetermined length after January 10, 2014, Fannie Mae will not require a lender to buy back a loan on the basis of a Fannie Mae determination that the loan doesn’t comply with the QM points-and-fees requirement, as long as the loan in question is otherwise eligible for Fannie Mae to purchase.
However, lenders will be required to buy back those loans from Fannie Mae if a court, regulator, or other authoritative body determines that points and fees violated CFPB standards.
For More Information
Since the CFPB made the rules governing matters such as QM, Ability-to-Repay, safe harbor, and rebuttable presumption, that agency is the first place lenders should go to get questions answered.
Lenders may want to start with the CFPB’s website, which has a lot of resources to help lenders comply with the new rules. MBAA is also another good source of guidance.
In addition to going to the CFPB, lenders may also consult with the various law firms and advisory shops that are offering advice on complying with CFPB regulations. Fannie Mae can’t endorse any outside firm’s advice for legal compliance.
Fannie Mae has also published guidance around the eligibility requirements, including SEL 2013-06, LL 2013-05, LL 2013-06, and LL 2013-07.