As consumer bankruptcy practitioners, we can say with assurance that we saw the beginnings of the mortgage and credit meltdown long before 2007. I remember reading an article on Bankrate.com in 2004 that discussed “exotic” mortgages, thinking, “I’m glad somebody is finally waking up to these impossible lending situations.” These were the types of mortgages we were seeing daily in our practice. It seemed obvious to us that these clients could not afford these mortgages, even with adjustable rates, extended paybacks or interest only payments for the first five years. When we would ask our clients how they justified or rationalized the mortgages, almost invariably they’d say, “The bank said we could afford it, so it must have been true.”
Turns out, as a lot of people would agree, that’s exactly what the banks were doing, without the data to back it up.
Congress reacted. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act requires that lenders heed ability-to-repay standards, i.e., the lender must make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling.
The Consumer Financial Protection Bureau (CFPB) issued a rule in January 2013 defining a “Qualified Mortgage.” A Qualified Mortgage will provide a lender with certain protections from suits or counterclaims by borrowers as long as the loan has certain characteristics and the lender followed certain criteria in evaluating the borrower’s ability to repay it.
According to the Final Ability-to-Repay rule, a Loan Cannot be a “Qualified Mortgage” if:
- It provides for negative amortization, interest-only payments, balloon payments#, “teaser” interest rates, or terms exceeding 30 years;
- The total points and fees payable in connection with the loan exceed a specified percentage (generally 3%); or
- It is a so-called “no-doc” loan, where there creditor does not verify income or assets.
Qualified Mortgages do not include HELOCs, timeshare loans, reverse mortgages, Fannie Mae or Freddie Mac loans, or FHA loans, or certain refinances, and loans made by community banks and non-profits. Other refis, however, will come under the umbrella of the Ability-to-Repay Rule and its protections if the lender refinances the loan using the rule’s criteria.
The Types of Underwriting Criteria a Creditor Must Consider and Verify Include:
- The borrower’s current or reasonably expected income or assets;
- The borrower’s employment status;
- The borrower’s monthly payment on the mortgage and any ancillary mortgages on the same property;
- Other related obligations such as property taxes, insurance premiums, homeowner association fees or assessments;
- The borrower’s current debt obligations (the debt-to-income ratio is not to exceed 43 %);
- The borrower’s credit history.
Why Does the Qualified Mortgage Rule Matter for Consumer Lawyers?
Because by all accounts, it will greatly reduce the consumer’s arsenal in either bringing suit against lenders for predatory lending practices or defending foreclosure and collection actions.
The CFPB estimates that the majority of loans made in 2012 meet the criteria for a Qualified Mortgage, which are said to be inherently less risky and therefore less costly than the more broadly defined general loans. In return for adhering to the rule’s stricter standards, a lender will enjoy some measure of protection from borrower suits. For this reason, the mortgage industry on the whole supports the Ability-to-Repay rule.
Dodd-Frank was unclear whether Qualified Mortgages should be, in effect, exempt from liability under the Ability-to-Repay rule, or whether the bill set up a rebuttable presumption in favor of the lender that borrowers can fight in court. The CFPB’s final rule includes both options, but for different types of loans.
In general, the Qualified Mortgage contemplated by Dodd-Frank has an annual percentage rate that is less than 1.5 % over prime for a first-lien, and less than 3.5% over prime for a subordinate-lien. The rule incorporates non-rebuttable safe harbor protections for those lenders, which would in practice allow a judge to dismiss a borrower suit, counterclaim, or defense if the judge determines that the lender met the requirements of the rule.
Loans with higher interest rates are called “higher-priced covered transactions.” These higher-priced loans are still considered Qualified Mortgages under the statute and the rules, but do not enjoy the protections of the safe harbor. Instead, the lender is merely presumed to have complied with the rule. A consumer would have to prove that the creditor did not make a good faith determination of the consumer’s ability-to-repay at the time of the loan origination and that the consumer had insufficient residual income or assets to meet living expenses.
Of course, whether the lender enjoys a presumption or a safe harbor, the borrower could still attack whether the loan meets the definition of “Qualified Mortgage”.
The rule becomes effective 1/10/2014. Although this is the final rule, the CFPB is asking for comments to determine whether certain loans made by certain small lenders should be exempted. Also, the CFPB has announced that it will soon issue a rule on Qualified Residential Mortgage loans that can be purchased by Fannie Mae and Freddie Mac.