The Consumer Financial Protection Bureau (“CFPB”) was created in 2010 as part of a wave of legislation attempting to make the subprime mortgage crisis a one-time disaster. Driven by Senator Elizabeth Warren, the CFPB was designed to put fairly heavy regulations on lending institutions: regulations that not only would punish banks for misdeeds, but also would require all mortgage lending institutions to be more discerning in their lending practices. The carrot for the lenders is that following the strict guidelines to the letter in many cases gives the lender a safe harbor from borrowers. The safe harbor exists when a lender makes what the CFPB is calling “qualified” mortgages.
The rules create a distinction between “qualified” mortgage loans, and “unqualified” loans. Unqualified loans closely resemble the status quo–they involve risk for both lender and borrower, and leave the lender open to legal action if something goes wrong.
The qualified loans protect both the lender and the borrower. The requirements for a qualified loan ensure that the borrower is capable of paying the money back, and for the lender, the qualified loan creates the legal presumption that the lender has done everything right.
For the lender to qualify for safe harbor protection, there are six basic requirements:
- The loan has an annual percentage rate that does not exceed the applicable average prime offer rate by 1.5 or more percentage points (3.5 or more percentage points for junior lien loans);
- The loan term does not exceed 30 years;
- The loan provides for regular periodic payments, with no “interest-only,” “negative amortization” or “balloon payment” features;
- The consumer’s debt-to income ratio does not exceed 43 percent, meaning a borrower’s loan payments do not exceed 43 percent of pre-tax income (but this ratio may change, as it is tied to Federal Housing Administration (“FHA”) guidelines). The creditor must consider and verify the income or assets and debt, alimony and child support obligations of the consumer;
- The loan is underwritten based on the maximum interest rate that may apply during the 5-year period after the first regular periodic payment is due, and is based on a periodic payment of principal and interest. The payments must cover either the principal balance over the term remaining after the date when the rate adjusts to the maximum rate that may apply during this period, or the loan amount over the entire loan term. This means that a lender can’t base their evaluation of a consumer’s ability to repay the loan on initial “teaser” rates; instead the lenders will have to determine a consumer’s ability to repay long-term, or for at least the first 5 years; and
- The points and fees do not exceed 3 percent of the loan amount; except for certain bona fide discount points. Compensation paid to both employee loan originators and mortgage brokers directly or indirectly by a consumer or creditor that is attributable to the transaction is included in the 3 percent amount, as are any third-party charges to the extent retained by the creditor, a loan originator or affiliate of either.
Beginning January 10, 2014 even an “unqualified loan” must satisfy the general ability-to-repay requirements. The process of determining a borrower’s ability to repay is a time-consuming affair. Lenders must do more research, which slows the process. Borrowers are subject to high scrutiny, which makes it potentially more difficult to actually get the loan. But the CFPB hopes that despite these obstacles, having a very clear path to follow–a path with safe harbor at the end–will get the mortgage market moving. Whether its strictures on mortgage lending can accomplish such a feat is in dispute. Some political pundits anticipate major backpedaling before the rules go into effect.