Get Ready for CFPB’s Ability-To-Repay Rule

The rule will have a significant impact on CUs’ mortgage programs.

September 8, 2013

In January, the Consumer Financial Protection Bureau (CFPB) issued its 800-page Ability-to-Repay (ATR) and Qualified Mortgage (QM) final rule amending Regulation Z.

The regulation prohibits creditors from making higher-priced mortgages without considering the borrower’s ability to repay. However, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, this final rule expands the ATR requirements to include most closed-end mortgages—with a few exceptions.

In late May, the CFPB issued a second final rule, totaling nearly 300 pages, that amends certain limited areas of the ATR and QM rule issued in January. This second rule exempts certain nonprofit creditors, facilitates lending by certain small creditors (including community banks and credit unions), and establishes exceptions for the calculation of loan origination compensation.

The effective date of the ATR and QM rule is January 10, 2014.

This rule certainly will have a significant impact on credit unions’ mortgage programs. The rule impacts more than just disclosures and timing; it creates three categories of loans with different risks and legal treatments:

  1. QM Safe Harbor Loans;
  2. QM Rebuttable Presumption Loans; and
  3. NonQM Loans.

It should be noted that nothing in the ATR and QM rule requires a credit union to make a QM loan, although these loans will offer some protection from liability in the event of borrower-initiated lawsuits. All three categories of loans must comply with the ATR requirements.

Earlier this year the Federal Housing Finance Agency directed Fannie Mae and Freddie Mac to limit their future acquisitions of mortgages on or aft er January 10, 2014, to QM loans under the ATR and QM rule.

Credit unions will have to determine which of the three categories (or combination of categories) of mortgages they will make as of the effective date of this rule.

Scope and overview

The rule applies to all consumerpurpose, closed-end loans secured by a dwelling, including home-purchase loans, refinances, and home equity loans—whether first-lien or subordinate-lien.

The rule does not cover:

  • Home equity lines of credit (HELOC) or other open-end credit;
  • Temporary or “bridge” loans with terms of 12 months or less;
  • The construction phase (12 months or less) of a construction-to-permanent loan;
  • Reverse mortgages;
  • Mortgages secured by an interest in a timeshare plan;
  • Business loans secured by a dwelling; or
  • Loan modifications (except those considered to be refinancings).

A “covered transaction” is a consumer loan secured by a dwelling. This includes any real property attached to a dwelling other than the exceptions mentioned earlier.

The rule requires creditors to make a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan based on its terms.

That requirement may be satisfied by following the rule’s general ATR standards, making a QM, refinancing a nonstandard mortgage into a standard mortgage, and, for small creditors that serve primarily rural or underserved areas, making a QM in a rural or underserved area.

NEXT: Repayment ability and information verification

Repayment ability

When considering a borrower’s repayment ability, credit unions should address:

Income or assets. The creditor may consider any type of current or reasonably expected income, including salary or wages, military or reserve-duty income, bonus pay, interest payments, dividends, retirement benefits, and more.

The creditor may consider any of the borrower’s assets other than the value of the dwelling securing the loan. This includes funds in a savings, checking, or retirement account; stocks; bonds; certificates of deposit; and trust funds.

A creditor only needs to consider the income or assets necessary to support a determination that the borrower can repay the loan.

A creditor may determine that a borrower can make periodic loan payments even if the person’s income is seasonal or irregular.

If the creditor determines that the borrower’s annual income divided equally across 12 months is sufficient to make monthly loan payments, the creditor may determine that the borrower can repay the loan.

That’s the case even if the borrower may not receive income during certain months.

Employment status and income. Full-time employment status is not required, and employment is not required to occur at regular intervals so long as the creditor considers those characteristics of the employment. A creditor must verify a borrower’s current employment status only if the creditor relies on the borrower’s employment income in determining repayment ability.

Mortgage payments and related obligations. The creditor must consider the new monthly mortgage payment, the monthly payment on any simultaneous mortgage, and payments for property taxes and property insurance premiums (or similar charges the creditor requires).

Current debt obligations. Examples of current debt obligations include student loans, auto loans, revolving debt, and existing mortgages that will not be paid off at or before consummation. However, a creditor may take into account that an existing mortgage or any other debt is likely to be paid off soon aft er consummation.

Multiple applicants. When two or more borrowers apply for an extension of credit as joint obligors with primary liability on a loan, a creditor must consider the debt obligations of all joint applicants. If one consumer is merely a surety or guarantor, a creditor is not required to consider the debt obligations of the surety or guarantor.

Credit history. Credit history may include factors such as the number and age of credit lines; payment history; and any judgments, collections, or bankruptcies. A creditor is not required to consider a consolidated credit score or prescribe a minimum credit score that must be applied.

The rule does not specify which aspects of credit history a creditor must consider or how various aspects of credit history should be weighed against each other or against other underwriting factors.

A creditor may give various aspects of a borrower’s credit history as much or as little weight as is appropriate to reach a good faith determination of repayment ability.

Where a borrower has obtained few or no extensions of traditional credit, a creditor may look to nontraditional credit references, such as rental or utility payment history.

Information verification

A creditor must verify the information it relies on in determining a consumer’s repayment ability using reasonably reliable third-party records. A creditor may verify the borrower’s income using a tax return transcript issued by the Internal Revenue Service (IRS).

Examples of other records the creditor may use to verify the borrower’s income or assets include, but aren’t limited to:

  • Tax return copies;
  • IRS Form W-2s or similar IRS forms used for reporting wages or tax withholding;
  • Payroll statements, including military leave and earnings statements; and
  • Financial institution records.

A creditor must verify records that are specific to the individual. Records regarding average incomes in the consumer’s geographic location or average wages paid by the borrower’s employer are not specific to the individual borrower and must not be used for verification.

A credit report is generally considered a reasonably reliable third-party record for purposes of verifying items such as the borrower’s current debt obligations, monthly debts, and credit history. Records concerning the verification of property taxes are considered reasonably reliable if the information was provided by a government organization or referenced in the title report if the source of the property tax information was a local taxing authority.

If a creditor relies on a borrower’s credit report to verify current debt obligations and the borrower’s application lists a debt not shown on the credit report, the creditor may consider the existence and amount of the debt as stated on the borrower’s application.

 To verify credit history, a creditor may look to credit reports from credit bureaus or to reasonably reliable third-party records such as evidence of rental payments or public utility payments. 

NEXT: Qualified mortgages and GSE-eligible loans

Qualified mortgages

Generally, QMs must have regular periodic payments that are substantially equal, subject to interest-rate adjustments. There may not be negative amortization, deferral of principal, or balloon payments.

Points and fees may not be excessive and are limited depending on the loan amount: 

  • 3% of the loan amount on loans exceeding $100,000; 
  • $3,000 for loans greater than or equal to $60,000 but less than $100,000; 
  • 5% of the loan amount for loans greater than or equal to $20,000 but less than $60,000; 
  • $1,000 for loans greater than or equal to $12,500 but less than $20,000; and 
  • 8% of the loan amount for loans less than $12,500. 

All fee and loan amounts are indexed for inflation.

Terms for QMs can’t exceed 30 years, and underwriting must be based on the maximum interest rate during the first five years.

Decisions must be based on verified current or reasonably expected income or assets and current debt obligations, including alimony and child support. The member’s monthly debt-to-income ratio may not exceed 43%.

The rule provides a safe harbor for QMs that are not higher-priced. This means that if the loan is challenged by a defaulting borrower, the QM will be deemed to comply with the rule’s ATR requirements.

For QMs that are higher-priced, the rule provides a “presumption of compliance” that is a lesser degree of protection from liability than a “safe harbor.”

These loans will not be deemed to comply with the rule’s ATR requirements.

A “higher-priced” mortgage is a covered transaction with an annual percentage rate that exceeds the “average prime offer rate” for a comparable transaction by 1.5% or more for a first-lien loan, or by 3.5% or more for a subordinate-lien loan (Section 1026.35).

To rebut the presumption of compliance for a QM that is a higher-priced mortgage, it must be proven that, despite meeting the requirements for a QM, the creditor did not make a reasonable and good faith determination of the borrower’s repayment ability at the time of consummation.

This could be done by showing that the borrower’s income, debt obligations, alimony, child support, monthly mortgage payment (including taxes and property insurance on the loan), and any simultaneous loans would leave the borrower with insufficient residual income or assets with which to meet living expenses.

Government, GSE-eligible loans

The rule provides for a second, temporary category of QMs that have somewhat more flexible underwriting requirements.

Mortgages eligible to be purchased, guaranteed, or insured by certain government entities—the Department of Housing and Urban Development; the Department of Veterans Affairs; the Agriculture Department; and the Rural Housing Service; or by Fannie Mae or Freddie Mac as long as they remain in conservatorship—will be treated as QMs as long as they meet most general requirements for QM loans.

This temporary provision will phase out over time as the various federal agencies issue their own QM rules and if government-sponsored enterprise (GSE) conservatorship ends, and in any event aft er seven years.

These QM loans do not have to meet the 43% maximum debt-toincome ratio that applies to ordinary QMs.

Other considerations:

Small creditor QM loans. The May amendments to the original rule created a special category of QM loans that may be made by “small creditors.”

These are creditors that had total assets of $2 billion or less at the end of the prior calendar year, and together with all affiliates originated 500 or fewer covered transactions.

In order to receive QM status, these loans must meet all QM requirements other than the 43% debt-to-income ratio and without regard to the standards in Appendix Q.

Rural balloon payment QMs. The final rule also treats certain balloon payment loans as QMs if they’re originated and held in portfolio by small creditors operating predominantly in rural or underserved areas.

Loans are eligible only if they have a term of at least five years and a fixed-interest rate, and meet certain basic underwriting standards.

Debt-to-income ratios must be considered but are not subject to the 43% general requirement.

Creditors are eligible to make rural balloon payment QMs only if they originate at least 50% of their first-lien mortgages in counties that are rural or underserved, have less than $2 billion in assets, and (along with any affiliates) originate no more than 500 first-lien mortgages per year.

Creditors generally must hold the loans in portfolio for three years in order to maintain their QM status.

Record retention. A creditor must retain evidence of compliance with Section 1026.43 for three years after consummation.

Although a creditor isn’t required to retain actual paper copies of the documentation used in underwriting a loan, the creditor must be able to accurately reproduce such records.

If a creditor uses a consumer’s IRS Form W-2 to verify the borrower’s income, for example, it must be able to reproduce the IRS Form W-2 itself, and not merely the income information that was contained on the form.

 MICHAEL McLAIN is CUNA’s assistant general counsel and senior compliance counsel.