June 26, 2014
Credit Union Management magazine’s Web-only “On Compliance” column runs the fourth Thursday of the month.
Effective Jan. 10, mortgage lenders were required to start implementing a complex array of underwriting standards designed to create safer mortgages by prohibiting or limiting certain high-risk products and features. These standards help to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Consumer Financial Protection Bureau implemented the rule, and the National Credit Union Administration will enforce the rule.
The gist of one of the main rules is this: Lenders, including credit unions, are required to ensure that borrowers have the ability to repay their mortgages. When determining the borrower’s ability to repay, eight items must be considered:
- current or reasonably expected income or assets, other than the value of the dwelling (including any real property attached to the dwelling);
- current employment status;
- monthly payment on the transaction;
- monthly payment on any simultaneous loan;
- monthly payment for mortgage-related obligations (property taxes, insurance premiums, mortgage insurance, etc.);
- current debt obligations, alimony, and child support;
- monthly debt-to-income ratio or residual income; and
- credit history.
In addition, lenders will be protected from borrower lawsuits so long as they issue “safe” or “qualified” mortgages that follow guidelines.
There are four types of qualified mortgages:
- General – loans that do not have negative amortization, interest-only payments, balloon payment features, terms that exceed 30 years, excessive points and fees, or a debt-to-income ratio that exceeds 43 percent. General qualified mortgages can be originated by all creditors.
- Temporary – loans originated during a transitional period that are eligible for purchase or guarantee by government-sponsored enterprises, like Fannie Mae or Freddie Mac, or for insurance or guarantee by certain federal agencies, like the Federal Housing Administration or the U.S. Department of Veteran Affairs. Temporary qualified mortgages also can be originated by all creditors, regardless of asset size.
- Small Creditor – loans that can be granted by financial institutions with assets below $2 billion at the end of the last calendar year and those that have – together with any affiliates – originated in the preceding calendar year no more than 500 first-lien, closed-end residential mortgages that are subject to the ability-to-repay requirement.
- Balloon-Payment – loans that can be granted by financial institutions with assets below $2 billion and those that originate 500 or fewer mortgage loans in a year and originate more than 50 percent of their mortgage loans in rural and underserved counties as determined by the CFPB. It’s important to note that a two-year transition period will be provided to all small creditors that offer balloon-payment QMs. After Jan. 10, 2016, only small creditors that operate predominantly in rural or underserved areas will be able to make balloon-payment QMs.
According to CFPB, even if a loan is not a qualified mortgage, it can still be considered an appropriate loan, so long as the financial institution has made a reasonable, good-faith determination that the consumer is able to repay the loan based on common underwriting factors, and the information considered has been documented. Interestingly, CFPB estimates that 92 percent of mortgages being made today already meet the QM requirements.
The following high-risk features are prohibited in all QMs:
- negative amortization;
- prepayment penalties (except QMs with either fixed or step rates, which can be used only if the creditor has offered the consumer an alternative loan without such penalties. Additionally, the prepayment penalty cannot be imposed after the first three years of the loan term and cannot be greater than 2 percent of the outstanding loan balance during the first two years and 1 percent of the outstanding loan balance during the third year of the loan.);
- interest-only payments;
- no-documentation loans;
- balloon payments (except smaller lenders);
- loan terms extending more than 30 years; and
- points and fees exceeding 3 percent of the loan amount greater than or equal to $100,000 ($3,000 for a loan amount greater than or equal to $60,000; 5 percent of the loan amount greater than or equal to $20,000; $1,000 of the loan amount greater than or equal to $12,500, but less than $20,000; and 8 percent of the loan amount less than $12,500)
So what happens if a credit union intends to originate a QM loan, but later determines that the points and fees actually do exceed the 3 percent cap? Luckily, CFPB is working to address this somewhat common occurrence. In April, the CFPB proposed a “cure” provision to the QM rule, allowing a lender finding itself in this situation to refund the excess within 120 days. If the institution does so, it will be able to maintain the legal protections afforded to QMs.
The following loan products are not considered to be QMs and are therefore not included in the regulation:
- construction loans of 12 months or less;
- temporary (bridge) loans of 12 months or less;
- home equity lines of credit;
- reverse mortgages;
- business purpose loans and
- consumer credit transactions secured by vacant land.
One of the more frequent questions we receive from financial institutions in the SHAZAM Network is whether a renewal of a balloon loan (not a refinance) that was originated prior to Jan. 10, 2014, is required to meet the QM requirements? The answer is no, it is not required.
It’s important for credit union compliance officers to understand that structuring transactions as open-end home equity lines of credit to evade the ability to repay/qualified mortgage requirements is not an option. CFPB has stated that it intends to closely monitor HELOCs.
In addition, the record retention required for transactions secured by dwellings has been extended from two years to three years following consummation. However, CFPB believes that responsible creditors will retain records beyond three years because of the risk posed by borrower lawsuits.
A financial institution needs to be able to prove a loan is a qualified mortgage, and that is hard to do if three years have passed and loan documents have been shredded.
Like any new regulation that changes “the way we’ve always done things,” the QM and ability to repay rules will require significant training on the part of all lenders, including credit unions. Keep in mind, though, that you are not alone. Many of your vendors, providers and partners have digested every single line in the thousands of pages of final rules. Lean on them when a tough question or confusing situation comes before your staff – because I can guarantee they will. Although regulators make a strong effort to understand how their rules will work “in the real world,” they are not always able to imagine every possible scenario.