Friday, 29 November 2013

USA BUYING - Changes Lending

USA BUYING - Changes Lending

United States: CFPB Ability-To-Repay Rule And Qualified Mortgage Definition

Last Updated: January 15 2013
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More than twenty months ago, the Board of Governors of the Federal Reserve System (the "Board") first proposed a rule amending Regulation Z to implement an expanded ability-to-repay requirement and to define a "qualified mortgage" in accordance with various Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") amendments to the Truth in Lending Act ("TILA"). Responsibility for rulemaking with respect to Regulation Z passed to the Consumer Financial Protection Bureau ("CFPB") on July 21, 2011. On January 10, 2013, the CFPB completed the initial phase of this rulemaking process by promulgating a final rule that will fundamentally reshape the residential mortgage market (the "2013 ATR Final Rule").1 Effective January 10, 2014, the 2013 ATR Final Rule (i) institutes a broad ability-to-repay requirement applicable to virtually the entire residential mortgage market, (ii) defines a new category of "qualified mortgage" and (iii) establishes a two-tier safe harbor/rebuttable presumption architecture for assessing compliance with the ability-to-repay requirement for "qualified mortgages" that roughly distinguishes between "prime" and "subprime" mortgage loans.
The significance of the 2013 ATR Final Rule cannot be overstated: the ability-to-repay requirement and the "qualified mortgage" standard will define the U.S. residential mortgage market for the foreseeable future. At this juncture, we do not believe that there will be a market for loans that do not meet the "qualified mortgage" standard. We further believe that while these new provisions will contract the availability of credit and likely increase its cost, the provisions will also be effective in improving the credit quality of new residential mortgage loans.
It should be emphasized that a mortgage loan that is not a "qualified mortgage" and that does not meet the ability-to-repay requirement would subject the creditor and subsequent assignees to, among other things, civil liability under TILA and provide the borrower with a defense to foreclosure. In addition to actual damages, statutory damages in an individual or class action, and court costs and attorneys fees, the Dodd-Frank Act also amended TILA to include special statutory damages for a violation of the ability-to-repay requirement equal to the sum of all finance charges and fees paid by the consumer, unless the failure to comply was not material.2
The statute of limitations for civil actions arising from ability-to-repay claims has been extended to three years, and the borrower's defense to foreclosure is not subject to any statute of limitations.

Ability-to-Repay Requirement

The amendments to Regulation Z in the 2013 ATR Final Rule, including the ability-to-repay requirement, apply to a "covered transaction," which is defined as a consumer credit transaction that is secured by a dwelling, including any real property attached to a dwelling.3
The 2013 ATR Final Rule establishes the following general ability-to-repay requirement: "A creditor shall not make a loan that is a covered transaction unless the creditor makes a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms."4 The 2013 ATR Final Rule thus expands and extends the ability-to-repay rule in Regulation Z that has been applicable to "higher-priced mortgage loans" since 20095 to virtually all closed-end consumer credit transactions secured by a dwelling. The specific ability-to-repay requirements in the 2013 ATR Final Rule are similar, but not identical, to those currently in effect for "higher-priced mortgage loans" under Regulation Z. To date, "higher-priced mortgage loans" have been originated and sold in the secondary market without incident. They are fully eligible for sale to Fannie Mae and Freddie Mac as long as they satisfy the underwriting and documentation requirements applicable to that category of loan. The concern for the residential mortgage market is whether or not the 2013 ATR Final Rule in any way compromises the current acceptance of such mortgage loans in the secondary market.
Although the 2013 ATR Final Rule does not impose a particular underwriting model, the creditor must, at a minimum, consider eight (8) discrete underwriting factors pertaining to the individual consumer in determining ability-to-repay:
  • the consumer's current or reasonably expected income or assets (other than the value of the dwelling, including any real property attached to the dwelling) that secures the loan;
  • the consumer's current employment status, if the creditor relies on income from the consumer's employment in determining repayment ability;
  • the consumer's monthly payment on the covered transaction, calculated using the greater of a fully-indexed rate or any introductory rate and using monthly, fully amortizing payments that are substantially equal;6
  • the consumer's monthly payment on any simultaneous loan that the creditor knows, or has reason to know, will be made;7
  • the consumer's monthly payment for mortgage-related obligations (i.e., property taxes, insurance premiums and similar charges required by the creditor, fees and special assessments imposed by a condominium, cooperative or homeowners association, ground rent, and leasehold payments);
  • the consumer's current debt obligations, alimony, and child support;
  • the consumer's monthly debt-to-income ratio, meaning the ratio of total monthly debt obligations to total monthly income ("DTI"), or residual income;8 and
  • the consumer's credit history.
Creditors may develop their own underwriting standards and make changes thereto over time in response to empirical information and changing economic and other conditions.
The creditor must verify the information that it relies upon in determining a consumer's ability-to-repay using reasonably reliable third-party records.9 As a corollary, a creditor generally need not verify, for example, income or assets that it does not rely upon to evaluate the consumer's repayment ability. For the verification of income or assets, the creditor may use tax return transcripts from the IRS, copies of tax returns, Form W-2s, payroll statements, financial institution records, government benefit or entitlement records, check cashing service receipts or funds transfer service receipts. The creditor may verify employment orally, if it prepares a record thereof. If the creditor relies on a credit report to verify current debt obligations or the consumer's application states a current debt obligation not shown in the credit report, the creditor need not independently verify such an obligation. Third-party records include records transmitted electronically. In effect, the 2013 ATR Final Rule prohibits no-documentation and low-documentation loans.

Exemption for Refinancing of "Non-Standard" Mortgages

The 2013 ATR Final Rule includes a special exemption from the general ability-to-repay requirement for a creditor that refinances a "riskier" non-standard mortgage (i.e., an adjustable rate loan, an interest-only loan or a negative amortization loan) into a standard mortgage with more "stable" characteristics. This exemption applies if the following conditions are met:
  • the creditor has considered whether the standard mortgage likely will prevent a default by the consumer on the non-standard mortgage once the loan is recast;10
  • the creditor for the standard mortgage is the current holder or servicer of the existing non-standard mortgage;
  • the monthly payment for the standard mortgage is materially lower than that for the non-standard mortgage;11
  • the creditor receives the consumer's written application within two (2) months after the non-standard mortgage has recast;
  • the consumer has made no more than one (1) payment more than thirty (30) days late during the twelve (12) months preceding the creditor's receipt of the written application;
  • the consumer has made no payment more than thirty (30) days late during the six (6) months preceding the creditor's receipt of the written application; and
  • if the non-standard mortgage was consummated after January 10, 2014, it was made in accordance with the ability-to-repay requirement or was a "qualified mortgage."
The standard loan must have regular periodic payments that do not cause the principal balance to increase, do not allow the consumer to defer repayment of principal and do not result in a balloon payment. In addition, total points and fees may not exceed the level required for a "qualified mortgage," the term cannot exceed forty (40) years, interest must be fixed for at least the first five (5) years, and the proceeds must be used to pay off the outstanding balance of the non-standard mortgage and closing or settlement charges.
These types of transactions would be used to "rescue" consumers in existing adjustable rate, interest-only or negative amortization loans who are vulnerable to default, but likely have far greater prospects of performing under a more conservative obligation.

"Safe Harbor" and "Rebuttable Presumption"

Section 1412 of the Dodd-Frank Act amended TILA to provide that a creditor with respect to a residential mortgage loan, and any assignee of such loan, may presume that the loan has met the ability-to-repay requirement if the loan is a "qualified mortgage." However, as the Board observed in its proposed rule, it is unclear whether Congress intended this provision to constitute a "safe harbor" or a "rebuttable presumption" of compliance with the ability-to-repay requirement. The Board offered two alternative formulations to address this statutory ambiguity, based on competing policy considerations. In the 2013 ATR Final Rule, the CFPB adopted both a "safe harbor" and a "rebuttable presumption," albeit using a much different approach than the Board.
The 2013 ATR Final Rule includes a "safe harbor" for a covered transaction that meets the definition of "qualified mortgage" and that is not a "higher-priced covered transaction," a definition that is substantially the same as the one applicable to a "higher-priced mortgage loan" in current Regulation Z.12 The CFPB views covered transactions eligible for the "safe harbor" as being lower-priced, less risky "prime" loans. For any covered transaction that meets the definition of a "qualified mortgage" and is not a "higher-priced covered transaction," the creditor or assignee complies with the ability-to-repay requirement (i.e., will be conclusively presumed to have made a good faith and reasonable determination of the consumer's ability to repay), although the consumer could still subsequently contend that the covered transaction did not actually meet the criteria for a "qualified mortgage."
The 2013 ATR Final Rule also includes a "rebuttable presumption" standard for a covered transaction that meets the definition of "qualified mortgage" but that is a "higher-priced covered transaction." The CFPB considers "higher-priced covered transactions" to be "subprime" loans extended primarily to consumers with a weaker or less established credit history. For any covered transaction that meets the definition of a "qualified mortgage" but is a "higher-priced covered transaction," the creditor or assignee is merely presumed to comply with the ability-to-repay requirement. However, the 2013 ATR Final Rule sets forth limited grounds on which the presumption may be rebutted.
Rebutting this presumption for "higher-priced covered transactions" requires proof that the creditor did not make a good faith and reasonable determination of the consumer's ability to repay at the time of consummation, and specifically a consumer asserting a violation of Regulation Z must demonstrate that, at the time that the loan was originated,13 the consumer's income, debt obligations, alimony, child support and monthly payments (including mortgage-related obligations) on the covered transaction and any simultaneous loans of which the creditor was aware at consummation left insufficient residual income or assets (other than the value of the dwelling and any attached real property) to meet living expenses, including any recurring, material non-debt expenses of which the creditor was aware at consummation. Importantly, the CFPB indicated that a consumer is less likely to prevail in rebutting the presumption the longer that the consumer has made timely payments, without modification or accommodation, and, for adjustable rate mortgage loans, after recast.

"Qualified Mortgage" Definition

Under the 2013 ATR Final Rule, a "qualified mortgage" must be a covered transaction that meets the following criteria:
  • the covered transaction provides for regular periodic payments that are substantially equal (except for the effect of interest rate changes after consummation on adjustable-rate or step-rate mortgages) and that
    • do not result in an increase of the principal balance (e.g., no negative amortization loans);
    • do not allow the consumer to defer repayment of principal (e.g., no interest-only or graduated payment loans);
    • do not result in a balloon payment (i.e., a scheduled payment that is more than twice as large as the average of earlier scheduled payments), except that certain special criteria apply to a smaller creditor operating predominantly in rural or underserved areas;
  • the covered transaction does not have a loan term in excess of thirty (30) years;
  • the covered transaction does not have total points and fees (including loan originator compensation14) in excess of three percent (3%) of the total loan amount for a loan equal to or greater than $100,00015, less up to two (2) bona fide discount points if the interest rate without any discount does not exceed the average prime offer rate by more than one (1) percentage point;
  • the creditor underwrites the loan (taking into account the monthly payment for mortgage-related obligations) using (i) the maximum interest rate that may apply during the first five (5) years after the date on which the first regular periodic payment will be due and (ii) periodic payments of principal and interest that will repay either the loan amount (i.e., the principal amount of the promissory note or loan contract, even if not fully disbursed at origination) over the loan term or the outstanding principal balance over the remaining loan term as of the date the interest rate adjusts to the maximum;
  • the creditor considered and verified at or before consummation the consumer's current or reasonably expected income or assets (other than the value of the dwelling and any real property attached to the dwelling that secures the loan) and the consumer's current debt obligations, alimony and child support;16 and
  • the consumer's DTI ratio at consummation does not exceed 43%, determined using the consumer's monthly payment17 on the covered transaction (including any mortgage-related obligation) and on any simultaneous loan that the creditor knows, or has reason to know, will be made.
The 2013 ATR Final Rule contains a special exemption to the DTI limitation for a transitional period, based on the CFPB's concern that creditors may be unwilling to make a loan that is not a "qualified mortgage" in the current market, even if the loan is responsibly underwritten. Under the special exemption, a covered transaction with a DTI in excess of 43% may nonetheless constitute a "qualified mortgage" if the other criteria for a "qualified mortgage" are satisfied and if the loan is (i) eligible to be purchased or guaranteed by either Fannie Mae or Freddie Mac while they operate under government conservatorship (or any limited-life regulatory entity succeeding the charter of either), (ii) eligible to be insured by the Department of Housing and Urban Development, (iii) eligible to be guaranteed by the Department of Veterans Affairs, (iv) eligible to be guaranteed by the Department of Agriculture or (v) eligible to be insured by the Rural Housing Service. If one of the aforementioned agencies in (ii) - (v) implements its own definition of "qualified mortgage" in accordance with TILA, the special exemption will expire with respect to that agency. In no event will the special exemption apply to a covered transaction consummated after January 10, 2021. We suspect that the residential mortgage lending market will avail itself of this special exemption, which is the closest that the CFPB comes in allowing a "near miss" category to enjoy the benefits of a "qualified mortgage."
The 2013 ATR Final Rule addresses issues in connection with the points and fees calculation that are part of a broader, integrated set of revisions to Regulation Z. The provisions adopted in the 2013 ATR Final Rule will have the effect of excluding some covered transactions from the category of "qualified mortgages" because they exceed the total points and fees limit. For example, the 3% limit on points and fees includes charges paid to and retained by an affiliate of the creditor (e.g., affiliated title insurance vendor commission, affiliated appraisal provider fee) without regard to whether such costs were actually lower than the consumer could have obtained from an independent third party.18 Consumers may be unable to avail themselves of the efficiencies that affiliated service providers can offer (i.e., consumers may pay higher overall closing costs), and creditors may simply decline to extend credit if confronted with originating a less profitable loan in order for it to be eligible as a "qualified mortgage." In any event, consumers face the prospect of paying higher mortgage costs while creditors will earn less compensation under these new rules.
On a related matter, the CFPB also invited comment on how to calculate loan origination compensation, which is part of the points and fees calculation applicable to the "qualified mortgage" criteria. The CFPB expects to resolve these additional matters in Spring 2013, well in advance of the January 10, 2014 effective date.

Additional Provisions

The 2013 ATR Final Rule also includes other provisions related to statutory mandates in the Dodd-Frank Act, including:
  • a prohibition on prepayment penalties in covered transactions, unless (i) the covered transaction is a fixed-rate, "qualified mortgage" that is not a "higher-priced mortgage loan," (ii) the prepayment penalties do not apply after three (3) years and do not exceed two (2) percent of the outstanding loan balance during the first two years and one (1) percent during the third year, and (iii) the creditor has offered the consumer an alternative covered transaction without a prepayment penalty that contains certain other specified terms;19
  • extension of the record retention requirement to three years to evidence compliance with the ability-to-repay requirement and the prepayment penalty restrictions;20 and
  • a prohibition on inappropriately structuring a closed-end extension of credit as an open-end plan in order to evade compliance.21

Concurrent Proposal

The CFPB also invited comment on proposed amendments to the general ability-to-repay and "qualified mortgage" rule that were not contained in the original proposal or in the text of the Dodd-Frank Act, including:
  • exemptions for nonprofit community-based creditors that help low- to moderate-income consumers obtain affordable housing;
  • exemptions for housing finance agencies and lenders participating in housing finance agency programs intended to foster community development;
  • exemptions for homeownership stabilization programs that work to prevent foreclosures (e.g., programs operating in conjunction with the Making Home Affordable program);
  • extending "qualified mortgage" status to loans originated by smaller creditors (e.g., community banks and credit unions) that make and hold loans in their own portfolios (i.e., a more broadly applicable of version of the exception that now exists for loans with balloon payments made by small creditors operating primarily in rural and underserved areas); and
  • increasing the threshold separating "safe harbor" and "rebuttable presumption" qualified mortgages for smaller creditors (e.g., rural balloon-payment qualified mortgages) to 3.5 percentage points above the average prime offer rate for first-lien loans to reflect the higher cost of funds for such creditors.