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QM Rules and the GSE Patch

Over the past few months, lots of commentary and speculation has been shared around the QM rule changes, the GSE patch, the patch's expiration and how it will all affect mortgage lenders. In this discussion, we will examine how these rules came about, what the expected changes are, and how these changes may affect future mortgage originations.

History of Qualified Mortgage Rules

In January 2014 the Consumer Financial Protection Bureau (CFPB) enacted the Ability to Repay and Qualified Mortgage Standards (ATR/QM) as an amendment to Regulation Z of the Truth in Lending Act, in an effort to provide greater rights and protections to homebuyers. Primarily the ATR/QM rule addressed a core question of mortgage lending: did the lender determine during the underwriting process that the borrower can reasonably repay the loan over the full potential life of the mortgage?

These 2014 rules were enacted upon the legacy of multiple legislative actions and federal regulations:

  • In 1968, the Truth in Lending Act established the Federal Reserve Board's ability to enact rules and regulations implementing the statute, referred to as Regulation Z, which strove "to safeguard the consumer in connection with the utilization of credit by requiring full disclosure of the terms and conditions"
  • In 2008, the Federal Reserve Board enacted a rule requiring "high-priced" mortgage borrowers to be assessed for an ability to repay the loan, directly in response to sub-prime lending
  • In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act further required assessing a customer's ability to repay a loan in full for nearly all mortgage loans
  • In 2011, the TILA rule-making authority was transferred to the newly-created CFPB (as directed by Dodd-Frank)

The 2014 QM rules have three key elements that defined the Regulation Z amendment.

First is the Ability to Repay Determinations; in the underwriting process the borrower must be evaluated to determine if they will be able to repay the loan based upon - at least - income, employment history, credit history, debt service, and debt to income levels. These items must be considered, verified, and (where applicable) included in the underwriting DTI.

Second is the Presumption for Qualified Mortgages, which establishes QM loans as a "safe harbor" from legal liability - in contrast to the "rebuttable presumption". This clarifies that a borrower in a QM loan bears the burden in overcoming the presumption of compliance on the part of the lender. Conversely, in a non-QM loan the burden of proof would fall on the lender should the borrower default and appeal the subsequent foreclosure.

Third, and perhaps the most straightforward of the components, is the General Requirements for determining a QM loan. The requirements are comprised of excluded products (Interest Only, Negative Amortization, Balloon Payments) and excluded terms (greater than 30 years), required income and asset third-party documentation, a points and fees limit of 3% of the loan amount, and an upper limit to the debt-to-income ratio of 43%. While there are several named exceptions to these rules, mostly specific to rural and underserved areas, most are beyond the scope of this summary discussion. There is one notable exception, however, that affects most originators.

The GSE Patch

While the ATR/QM rules do set an upper limit for DTI, there are situations where a borrower's DTI can reasonably be higher than 43% while still meeting the spirit of being a qualified mortgage. In order to allow a case-by-case exception process, the CFPB placed the QM determination authority in the hands of the Federal guarantors: GSE's in conservatorship, the VA, the USDA, and HUD (FHA). These exceptions, commonly known as the "GSE Patch", were to be allowed for seven years (until January 2021), with the intention that Federal agencies issue their own rules to identify qualified mortgages and that the GSEs would eventually exit conservatorship. With only 11 months remaining until this expiration, both investors and originators are intent on understanding how this deadline will be resolved.

In July 2019, the CFPB issued an advance notice of proposed rulemaking announcing the intention to let the GSE patch expire in January 2021. While the headlines covering this seemed worrisome, the CFPB provided two potential options to prevent a major disruption to the industry: 1) extend the term or 2) remove the DTI limit. Amending the regulation to extend the expiration date would be a short-term solution and would require the variety of guarantors to design and implement their own QM guidelines and standards. The second option of removing the DTI limit seems more likely in the next year but could have larger impacts on home prices and mortgage demand.

The End of the Patch?

According to Informa Financial Intelligence data, approximately 20% of Conventional originations in 2019 had debt-to-income ratios exceeding 43%, FHA and VA exceeded the limit on 21% of volume, and only 6% of Jumbo loans exceeded the cap. While this has fallen from a peak of 25% of Conventional and 50% of FHA/VA in 2017, the decline appears to primarily be driven by falling interest rates, as opposed to borrower or lender behavior. This suggests that a large portion of borrowers, 20-50%, are seeking mortgages that are at or near the maximum that they can afford, since a 50-70bps change in interest rate can drive such a large change in debt service requirements. The transactional data bears this out as we see a close direct correlation between interest rates and DTI: when interest rates fall, deb-to-income ratios decline as well. This is expected as the mortgage payment is frequently the largest component of a borrower’s total "back-end" DTI.

With the recent years of historically-low interest rates on mortgages, combined with the flat long-term rate projections from the Federal Reserve, FNMA, and other institutions, DTI ratios may not increase rapidly as borrowers' payments remain manageable. Still, if the CFPB was to remove the upper DTI limit as a general requirement for QM loans, we may see an overall expansion of credit as borrower approval for high-DTI loans becomes more customary. Additionally, this could put upward pressure on home prices as the pool of approved potential buyers for a price point expands.

Lenders are watching the GSE patch decision closely as it will have significant impacts across mortgage originations, especially in underwriting and compliance. Many are hoping the decision will potentially help expand credit offerings while still producing qualified mortgages. Regulators in turn will be working to provide a solution that minimally disrupts the three-trillion-dollar industry while still achieving the de-risking changes driven by statute.

Look for our follow-up analysis as the situation develops over the coming months.

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