Community banks should begin preparing now for new mortgage rules that take effect in January 2014. The rules, finalized by the Consumer Financial Protection Bureau (CFPB) last January, are designed to protect consumers from risky lending practices.
The CFPB in July made several amendments to the rules, including easing certain requirements for smaller banks. Here are the highlights.
The ability-to-repay (ATR) rule, which amends Regulation Z, requires most lenders to make a reasonable, good-faith determination of a borrower’s ability to repay a mortgage. The rule prohibits “no-doc” and “low-doc” loans, instead instructing lenders to document and consider certain underwriting standards, including current income or assets, employment status, credit history, monthly expenses, and debt-to-income ratio (DTI).
Lenders must evaluate a borrower’s ability to repay principal and interest over the long term. So, for example, if you employ teaser rates the ability to repay must be calculated using the undiscounted interest rate and payment amount.
Qualified mortgage rule
Evaluating each borrower’s ability to repay can be burdensome, but the CFPB provided a shortcut. Lenders that issue “qualified mortgages” (QMs) are presumed to comply with the ATR rule. To qualify, loans must:
• Not include excessive points and fees (generally, no more than 3% of the loan amount, with certain exceptions),
• Not include risky features, such as interest-only provisions, negative amortization or terms longer than 30 years,
• Be made to borrowers with DTIs of 43% or less (with an exception for small portfolio lenders and a temporary exception for loans that meet the underwriting requirements of Fannie Mae, Freddie Mac or certain other government-sponsored enterprises), and
• Not include balloon payments (with an exception for smaller creditors in rural or underserved areas).
As discussed below, these requirements are relaxed for community banks.
The level of protection the QM rule provides depends on the interest rate. If it exceeds the average prime rate by less than 1.5%, the QM rule provides a safe harbor. So long as a loan is a QM, it’s deemed to satisfy the ATR rule.
But for higher-priced loans — those with interest rates that exceed the average prime offer rate, also known as the APOR, by 1.5% or more for first lien mortgages or 3.5% or more for subordinate lien loans — a lender receives only a rebuttable presumption of compliance. In other words, even if the loan is a QM, the lender can be liable for violating the ATR rule if the borrower proves that the lender failed to make a reasonable, good-faith determination of the borrower’s ability to repay.
Relief for community banks
The new rules place many community banks in a difficult position. They must strike a balance between 1) protecting themselves from liability and penalties by making QMs, and 2) making loans that serve the needs of their communities.
In July, the CFPB amended the rules to provide some relief for “small creditors” — those with assets of $2 billion or less and that make no more than 500 first-lien mortgages per year. For these lenders, loans held in their portfolios for at least three years will be considered QMs even if a borrower’s DTI exceeds 43%, so long as they otherwise meet the QM requirements.
The amendments also increase the interest-rate threshold from 1.5% to 3.5% for both first lien and subordinate lien mortgages. Thus, a small lender that charges less than 3.5% over the APOR can still qualify for the safe harbor. And, during a two-year transition period, small lenders can make QMs with balloon payments, even if they’re not in rural or underserved areas.
Review the requirements
In addition to the ATR and QM rules, several other mortgage-related rules will take effect in January, 2014. They include new mortgage servicing rules — covering topics such as periodic billing statements and interest-rate adjustment notices, enhanced appraisal requirements for certain loans, and new restrictions on loan originator compensation.
All community banks should review their loan portfolios, policies, procedures and documentation and develop plans for implementing the new rules.
For more information on this topic or any questions, please contact Susan Roemer at [email protected]