IT’S OFFICIAL. President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law last Wednesday as expected. As we mentioned in our first report on the legislation, this massive (2300 page) new law contains a subsection called the “Mortgage Reform and Anti-Predatory Lending Act”, which imposes wholesale changes on the mortgage lending industry and may have a direct impact on your day-to-day business and bottom line.
This is the second in a series of reports on what’s in the law, what’s not in the law, what we know and what we don’t. Considering that massive amounts of new powers were given to the new “Consumer Financial Protection Bureau” to create a structure of regulations (that carry the force of law) to implement the requirements of the Act, details are sketchy on many of the items addressed in the legislation, but we’ll do our best to share as much as possible with you.
In this update, we will discuss the requirement for creditors to consider a borrower’s ability to repay a loan before making it, and the exemption from that requirement given to a new category of “qualified mortgage loans.”
Title XIV, Subtitle B, Section 1411 of the Act prohibits creditors from making a residential mortgage loan without making “a reasonable and good faith determination based on verified and documented information” that the consumer “has a reasonable ability to repay the loan … and all applicable taxes, insurance … and assessments.” This determination would specifically have to include consideration of the following items:
- Credit history
- Current income
- Expected income the consumer is reasonably assured of receiving
- Current obligations
- Debt-to-income ratio, or the residual income the consumer will have after paying mortgage and non-mortgage debt
- Employment status
- Other financial resources other than the equity in the subject property
Note that the law does not say which of the factors above must be prioritized, as long as all of them are considered. Given the perceived intent of the 7 items above, it is ironic that there is also a provision in the Act that would permit the originator to “consider seasonal and irregular income” in underwriting.
The Act also contains guidelines directing creditors how to calculate the monthly principal and interest payment for purposes of determining the borrower’s ability to repay. We can expect these guidelines to be added to the applicable Selling Guides for FNMA and FHLMC in the near future, we’ll omit a discussion of them here for the time being.
The final item we’ll go over in this update is the “safe harbor” provision of the Act that says that a borrower is presumed to have the ability to repay a “qualified mortgage loan.” This will essentially give lenders an automatic defense against any lawsuits brought for violation of the “ability to repay” requirement for loans that meet the criteria. Although the Act defines what a “qualified” loan is, it gives power to the Bureau to issue regulations changing the definition, so we can’t yet know what the final definition will look like. However, as of now, a “qualified mortgage loan” is defined as a loan in which all of the following apply:
- The payments of the loan may generally not result in an increase of the principal balance
- The terms of the loan do not result in a balloon payment, except for certain limited exceptions
- Any income and financial resources relied upon to qualify are verified/documented
- For a fixed rate loan, underwriting is based on a fully amortizing payment and includes applicable taxes and insurance
- For an ARM loan, underwriting is based on a fully amortizing payment at the maximum rate the loan can attain during the first 5 years, including taxes and insurance
- The loan complies with any guidelines the Federal Reserve Board establishes regarding Debt-to-Income ratios or residual income requirements
- The total points and fees payable in connection with the loan do not exceed 3 percent of the total loan amount (with the FRB to issue regulations for “smaller” loans)
- The loan term does not exceed 30 years, except in limited circumstances
For the purposes of computing “points and fees” for number 7 above, include all charges paid to the originator or an affiliate of the originator (in the case of a broker, this means that lender fees would be included in this calculation), including the maximum prepayment penalty (if any) and any upfront credit insurance premiums. Third party fees not retained by the originator or an affiliate are excluded, as are up to two (2) “bona fide discount points” in many circumstances. The wording of this section, while certainly not friendly to the mortgage lending industry, is much more favorable than the wording in the original Senate bill which would have included a portion of the FHA MIP or VA funding fee. Given that the Act specifically gives the new Consumer Financial Protection Bureau the power to amend/change these requirements in the future, it is possible that these rules may change significantly and may become even more restrictive.
A key concern raised by the safe harbor is whether banks will make loans that are NOT “qualified” loans, or whether they will pull out of that space altogether. Such a result would resemble the initial market response to Section 32 high cost loans when HOEPA went into effect. When you combine these provisions with the effective elimination of Yield Spread Premiums (to be discussed in the next update), it is reasonable to expect that mortgage brokers and table-funders will be impacted by these requirements much more than correspondent lenders or chartered banks.