February 29, 2020|Ability to Repay/QM, CFPB
Ability to Repay-We need a law for that?
It seems pretty obvious that lenders should only make loans to borrowers who can afford to repay them. Isn’t that the whole raison d’etre of an underwriting department? Yet, the 2014 Ability to Repay Rule (a/k/a “QM/ATR”)makes underwriting loan affordability not just something you do so you can sell the loan, but it’s also the law.
In less than a year, however, the QM/ATR “Patch” is going to expire, pushing something like 15-25% of the loans currently made today outside the “Qualified Mortgage” credit box. Will expiration of the Patch make it illegal to originate loans with over 43% Debt-to-Income ratios (DTI)? Is this another story like last month’s Musings about the LO Comp Rule about how Dodd Frank was really bad for consumers? Do I overuse rhetorical questions and footnotes? No, probably not and maybe. Anyway, read on for my take on QM/ATR and the expiration of the “GSE Patch”, a grilling tip, some farewells and my favorite scene from “This is Spinal Tap”.
But first, I need the wisdom of “the Crowd”
On a recent week-long business trip I had 12 Uber/Lyft rides. On 7 of the 12 rides (58%), my driver was named Michael (I counted Miguel and Mikhail too). Aside from the ridiculous probability of that occurring, should I take it to be a sign or something? If so, what is the meaning?
What’s the Ability to Repay Rule?
Anyone who was in the mortgage business in 2008 (probably 95% of my readers) knows why we have QM/ATR, so I’m not going to give everyone another history lesson like I did about RESPA yield spread litigation. Insomniacs can simply read this brief 663 page Congressional Report. After the “mortgage meltdown”, QM/ATR was seared into the Truth-in-Lending Act, turning underwriting into a compliance function. Which reminds me, searing is my first grilling tip for steaks.[1] Make sure you season the steak before searing too.
Summed up, QM/ATR requires all home mortgage lenders to make sure that every borrower has a “reasonable ability to repay” the loan. That’s it: just make sure the borrower has the resources (other than the loan collateral) to repay the loan. If not, the borrower (and regulators) will have remedies that include preventing the lender from foreclosing in the event of default.
Why do we need a “Qualified” Mortgage?
ATR’s squishy “reasonableness” standard, however, doesn’t play well with Wall Street’s mortgage backed securities (MBS) issuers. MBS sellers want certainty about the ability to foreclose to run their financial models on loss expectancies. They think if underwriting decisions can be second guessed years later by state court judges looking to help consumers avoid foreclosure through hindsight “rough justice”, it threatens the whole concept of the security being sold as “mortgage backed”. As far as I know, that’s never happened in the 6 years we’ve had QM/ATR (a judge preventing foreclosure due to failure to comply with ATR), but we haven’t had another downturn in real estate values in that period either.
QM is essentially a “safe harbor” to know when that squishy ATR reasonableness standard has been met. You don’t have to meet the QM test, but if you do, you are deemed to have determined the borrower reasonably had the ability to repay the loan. The QM standard requires that: (i) DTI can’t exceed 43% of income (calculated pursuant to detailed rules known as Appendix Q), and (ii) loan fees and rates comply with limits set by QM/ATR. The DTI limit, however, doesn’t apply, to loans approved by the GSEs underwriting systems. The GSE part of QM/ATR’s credit box expansion (known as the “GSE Patch”) was given an expiration date of January 2021 in anticipation of GSE privatization or reform.
When CFPB was drafting QM/ATR in 2012-13, the GSE’s had been in Conservatorship for about 5 years, but everyone knew they couldn’t stay there forever. So CFPB picked a January, 2021 deadline (7 years away) on the assumption that the GSE’s would be restructured by Congress well before then. OK, that was a little history lesson, so I will give you your money back for your subscription fees (upon request).
The “GSE Patch” is going to Expire!
GSE reform by 2021 seemed like a totally safe bet in 2013. I thought so too. Back then, I also thought the idea that real estate mogul, marketer, Marla Maples’ former fiance[2], and small time mortgage banker (among other things) Donald Trump would be President was as crazy as the Cubs winning the World Series in my lifetime.[3] Clearly, the time machine is malfunctioning on our Most Excellent Adventure.
Yet, here we are in 2020[4]: less than a year away from GSE Patch expiration and Fannie and Freddie are right where they were in 2008 when the government took them over. We seem to be making some progress with FHFA Director Mark Calabria (GSE’s are starting to grow their capital), but, for now (cue ominous music[5]), housing and GSE policy generates zero viewers on cable news or even as a debate topic in the Presidential primaries. GSE reform before January just isn’t going to happen.
That said, this Patch expiration business doesn’t trouble me much. Failing to address it would cause upheavals in the secondary market for that 15-25% of the market over 43% DTI, but the CFPB is not going to let the deadline pass without action. In fact, CFPB has been explicit in regulatory and other announcements (including Congressional testimony) that they will extend the Patch beyond the deadline and are working on alternatives. Also, at this point we have years of data on the performance of loans with over 43% DTI and can say with confidence that 43% DTI is not a magic number for affordability, so there is good reason to scrap the DTI measure for QM.
My take and the Spinal Tap reference
What does bother me, however, are the alternatives that are being offered for a revised QM. Consumer groups seem to admit that 43% DTI isn’t very predictive of affordability, but they (and conforming loan MBS securitizers) want to use pricing alone as the QM determinant for ability to repay. That makes no sense in that the price of the loan tells you nothing about the borrower’s ability to repay it. In fact, QM’s existing 3% points and fees test is even more senseless from the ability to repay perspective since that is paid at closing. I know saying “more senseless” is like the lead singer from Spinal Tap saying, “but these go to 11”, but it makes my point. Pricing-based proposals focus on the loan’s rate in relation to other loans, but you’d need to assume that mortgage loan pricing is solely based on risk of non-affordability to make that work. I’ll let that concern simmer a bit to highlight how that ignores the predictive value of borrower equity, credit, residual income, job stability, reserves/assets, collateral and a host of other factors that actually might play into whether a loan has a reasonable likelihood of being repaid.
Appreciation and Farewell
If you want to go deep on the proposals to reform QM in light of the GSE Patch expiration, Larry Platt’s recent explanation is solid gold. Larry is a giant among mortgage attorney thought leaders. I don’t always agree with his takes, but I always respect his analysis, views and ability to articulate complicated topics to a broader audience. Sadly, my understanding is that Larry’s Mayer Brown partners Phil Schulman (the joke-telling RESPA uber-guru) and Jon Jaffe are planning to retire within a year or so. Those retirements will be a huge loss for the mortgage banking world, but I hope we will still hear from all of them when they get off the golf course.
[1] You’re welcome Chris S.
[2] Yes, my use of alliteration here was intentional.
[3] 2016 was objectively the craziest year on record. In addition to Trump and the Cubs, in other 2016 news, scientists discovered bears do not poop in the woods and the Pope was not Catholic.
[4] Only 2 months into 2020, a Socialist who honeymooned in Moscow is leading the Democratic presidential primaries, our current President was impeached, but not removed from office, and a new virus arising from a Wuhan “wet market” is isolating modern day China (and the rest of the world) more than the Great Wall ever could. 2016 is going to get a run for its money this year.
[5] Ominous music choice of Rachmaninov’s Isle of Death (or something like that) is courtesy of my son Danny who is the musical talent in the family.