Following the disastrous lending mishaps of the Millennium Boom, the 2008 recession provided lawmakers some much needed fuel to improve the mortgage industry. The result was the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).
Dodd-Frank amended Regulation Z, which implements the Truth in Lending Act (TILA) to establish qualified mortgage (QM) definitions. Lenders who issue residential mortgages that meet QM criteria are given protection from penalties that arise from noncompliance with the broader ability-to-repay (ATR) rules.
A lender may still originate mortgages that do not meet the QM standard but doing so exposes the lender to more risks. To cover the increased risk, non-QM mortgages tend to be less palatable for lenders and more expensive for consumers. Thus, QM mortgages continue to be preferred.
Four types of QMs have been established, the:
- general QM;
- temporary QM;
- small lender QM; and
- balloon-payment QM. [12 Code of Federal Regulations §1026.43(c)-(f)]
The general QM definition includes loans that meet six criteria:
- Regular periodic payments. No interest only, negative amortization or balloon payment features are allowed. [12 CFR §1026.43(e)(2)(i)]
- A mortgage term of 30 years or less. [12 CFR §1026.43(e)(2)(ii)]
- Maximum points and fees of no more than 3% of the principal amount for mortgages of $107,747 or more in 2019, adjusted annually for inflation. [12 CFR §1026.43(e)(3)]
- Monthly payments used to determine repayment ability are to be based on a full amortization schedule, using the maximum interest rate that applies during the first five years. [12 CFR §1026.43(e)(2)(iv)]
- Assets, debts and two years’ income are to be verified and documented. Income used needs to be verified, stable and expected to continue. The lender is responsible for verifying the most recent two years’ employment. [12 CFR Appendix Q Parts A-B]
- The maximum total debt-to-income (DTI) ratio, also known as the back-end DTI, is 43%. [12 CFR §1026.43(e)(2)(vi)]
The temporary QM carries the same standards for regular periodic payments, maximum mortgage terms, and total points and fee restrictions. But instead of the DTI limits in the general QM, loans qualifying under the temporary QM definition need to be eligible to be purchased, insured or guaranteed by a government agency or one of the government-sponsored entities (GSEs), Fannie Mae or Freddie Mac. This includes Federal Housing Administration (FHA)-insured mortgages and U.S. Department of Veterans Affairs (VA)-guaranteed mortgages, among others.
This temporary QM definition is known as the GSE Patch and it expires January 10, 2021.
The GSE Patch effect
The Consumer Financial Protection Bureau (CFPB), which issued the original QM definition and GSE Patch, recently released a report on the effect the expiration of the GSE Patch will have on consumers, lenders and the housing market.
The report’s findings are meant to guide rule-makers on next steps for the GSE Patch. For example, should the GSE Patch be made permanent? Or ought it to be eliminated? Or just extended for a little bit longer?
The report shows that approximately 16% of residential mortgages originated in 2018 were issued under the temporary QM definition, using the GSE Patch. That’s a significant chunk of the mortgage market. The natural follow-up question to this information is: if the patch is to expire, will the mortgage market lose 16% of its originations due to an inability to qualify under the general QM?
It’s possible that the mortgage market will see fewer originations, but the drop won’t likely be a full 16%. In some cases, consumers will be able to borrow through private lenders who are willing to take on clients with higher DTIs. But this will come with higher rates and fees, and therefore reduce buyer purchasing power, cutting into the amount homebuyers qualify to purchase and thereby creating more obstacles for home price trends.
The CFPB’s current plans are to let the GSE Patch expire, though they are considering a temporary extension to ensure a smoother transition (and perhaps allow homebuyers more time to reduce their DTIs and qualify under the general QM). They are also considering changing the general QM definition to be more inclusive, so that some of the mortgages which otherwise would be originated with the GSE Patch may be allowed by the general QM.
Real estate professionals: Do you have suggestions for how the CFPB ought to proceed? The CFPB is soliciting comments on possible changes to the general QM definition from the public until September 16, 2019. Comments may be submitted here. Search docket number CFPB-2019-0039 and in the search results, click the button that says Comment Now.