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Friday, June 7, 2013

The Ability-to-Repay Rule: Possible Effects of the Qualified Mortgage Definition on Credit Availability and Other Selected Issues

Sean M. Hoskins
Analyst in Financial Economics

On January 10, 2013, the Consumer Financial Protection Bureau (CFPB) released a final rule implementing the Ability-to-Repay (ATR) requirement of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The ATR rule will require a lender to determine based on documented and verified information that at the time a mortgage loan is made, the borrower has the ability to repay the loan. Failure to make such a determination could result in a lender having to pay damages to a borrower who brings a lawsuit claiming that the lender did not follow the ATR rule.

The final rule provides multiple ways for a lender to comply, one of which is by originating a Qualified Mortgage (QM). To receive QM status, a loan must meet certain underwriting and product-feature requirements. For example, in most cases a QM cannot have a balloon payment (a large payment that is typically due at the end of the loan). If a loan is a QM, then the lender receives a presumption of compliance for legal purposes.

The type of presumption of compliance that a QM receives depends on the rate of the loan. If the loan is a higher-priced mortgage (the mortgage’s rate exceeds the average rate for a prime mortgage by more than 1.5 percentage points for a purchase), then the lender receives a rebuttable presumption of compliance. It is presumed that the lender complied, but the borrower could win his case if, for example, the court finds that the lender should have known that the borrower did not have sufficient residual income after paying his mortgage and other obligations to afford his living expenses. If the QM is not a higher-priced mortgage, then the lender receives a safe harbor. So long as the mortgage meets the QM standards, the lender is considered to have complied with the ATR rule.

Some are concerned that, at least in the short term, only mortgages meeting the QM standards will be originated because of the legal protections they afford, even though there are other means of complying with the ATR rule. The definition of QM, therefore, could determine who would receive a mortgage in the future. To increase access to credit, the CFPB also included a temporary QM option for loans eligible to be purchased by Fannie Mae and Freddie Mac or to be insured by the government through the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the U.S. Department of Agriculture (USDA), or the Rural Housing Service (RHS). According to the final rule, the temporary option would last for, at most, seven years from when the rule goes into effect in January 2014.

The CFPB’s analysis of the mortgage market as of the end of 2011 concluded that, excluding the temporary option, approximately 76% of mortgages would have received safe harbor QM status. An additional 22% would have satisfied the ATR rule through other compliance options and the final 8% would not have complied with the final rule. Including the temporary option, the CFPB estimates that more than 95% of the mortgage market as of the end of 2011 would have received QM status. Underwriting standards and access to credit are considered to have been tighter in 2011 than before the housing crisis, however.

In addition to concerns about credit availability, experts have raised other potential issues with the final rule. Some ask how the temporary QM option might affect the government’s role in the housing market, while others raise concerns about the final rule’s impact on rural and community banks. The ATR rule is one of several mortgage market rules released by regulators; some worry about how the rules, in aggregate, will affect the mortgage market.

Date of Report: May 21, 2013
Number of Pages: 21
Order Number: R43081
Price: $29.95

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