United States: A Loan Policy For ATR And QM

At the August Quarterly Meeting, we will present and discuss a very general outline of a Generic Loan Policy for the Ability to Repay and Qualified Mortgage Rules. In order to facilitate that discussion and make that time as productive as possible, it seems advisable to provide a basic description of what that outline will entail. Here is where we begin to put on our thinking caps.

Between now and January 10, 2014, every bank that is subject to the Ability To Repay Rule will be faced with a basic decision: whether or not to originate Qualified Mortgages. We have already spent a lot of time and discussion considering what is required under the Ability to Repay Rule and what it will take for a loan to be a Qualified Mortgage. As we think about developing an outline of a Loan Policy for the ATR and QM Rules, we will only make passing reference to many of those requirements. Please refer to earlier Newsletter Articles and materials from our previous quarterly meetings for a more detailed analysis.

As you approach this task, you will be faced with an initial set of three options:

  • Option 1: only originate Qualified Mortgages;
  • Option 2: originate Qualified Mortgages when possible to do so, but also originate loans that will merely satisfy the Ability To Repay Rule if the customer or the loan in question cannot be structured as a QM; or
  • Option 3: originate all loans focused only on satisfying the Ability To Repay Rule.

By now, I am sure everyone realizes that Option 1 is the most risk-free. A portfolio of nothing but Qualified Mortgages should entitle the bank to either a Safe Harbor or a presumption of compliance with the Ability To Repay Rule.

Option 2 is somewhat riskier since only a portion of the Bank's portfolio will be Qualified Mortgages subject to Safe Harbor or a presumption of compliance. The remaining Non-Qualified Mortgages will have to fully and completely satisfy the Ability to Repay Rule, with significant liability attaching to any loan that fails to meet ATR requirements.

Option 3 is very risky. Every loan must fully satisfy the ATR and there will be no presumption of compliance or Safe Harbor available. Examiners will see this as a significant risk, and they will be right.

The bank that chooses Option 1 will then have an additional series of elections to make because there are several avenues available to originate Qualified Mortgages. Those additional options are:

  • Option 1-A: The General Qualified Mortgage;
  • Option 1-B: The Small Creditor Balloon Payment Qualified Mortgage;
  • Option 1-C: The Temporary Authority Qualified Mortgage; or
  • Option 1-D: The Small Creditor Portfolio Qualified Mortgage.

Each of the options for originating Qualified Mortgages is discussed below.

OPTION 1A: The General Qualified Mortgage.

Loans originated under the General Qualified Mortgage Option must have the following limitations, terms and conditions:

Prohibited Terms: loans made pursuant to the General Qualified Mortgage Option will not feature:

  • Negative amortization or interest only payments;
  • Balloon payments; or
  • A loan term in excess of 30 years.

Limit on points and fees. Loans made under the General Qualified Mortgage Option may not have points and fees which exceed:

  • 3% of the total loan amount for a loan greater than or equal $100,000;
  • $3,000 for a loan greater than or equal to $60,000, but less than $100,000;
  • 5% of the total loan amount for a loan greater than or equal to $20,000 but less than $60,000;
  • $1,000 for a loan greater than or equal to $12,500, but less than $20,000; or
  • 8% of the total loan amount for a loan less than $12,500.

Regular Periodic Payment Requirements. Loans made under this Option must provide for regular periodic payments of substantially equal amount that do not result in an increase in the principal balance, allow deferment of principal payments, or result in a balloon payment.

Mortgage-related Obligations. Loans made pursuant to this Option must be underwritten based on the applicant's ability to make, not only the required monthly payment needed to repay the loan itself, but also the monthly payment for all mortgage-related obligations (e.g., taxes, insurance premiums, etc.). Information related to these obligations must be obtained and verified.

Underwriting the Required Payment. The required payment must be underwritten using the maximum interest rate that may apply during the first five years of the loan; and periodic payments of principal and interest that will either repay the outstanding principal balance over the term of the loan using the aforesaid maximum interest rate, or the loan amount over the loan term.

Income or Assets. An applicant's current or reasonably expected income or assets must be considered and verified.

Employment Status. The applicant's employment must be considered and verified.

Current Debt Obligations, Alimony, Child Support. The applicant's current debt obligations, alimony and child support payments must be considered and verified.

Debt-to-Income Ratio. After considering and verifying an applicant's total monthly debt and total monthly income, the two must be compared and an applicant must have a debt-to-income ratio of no more than 43%.

OPTION 1B The Small Creditor Balloon Payment Option. For those small creditors that qualify (have less than $2 billion in assets,

fewer than 500 covered loans in the previous year and 50% or more of those loans originated in "rural" or "underserved" counties) this option 1B will be available.

These loans cannot have negative amortization and cannot have terms in excess of 30 years. Like the General Qualified Mortgage these loans must also satisfy the same Points and Fees limitations.

The Small Creditor Balloon Payment Loans will then have to be underwritten and documented using the applicant's reasonably expected income and considering the applicant's current debt obligations, alimony and child support obligations. These criteria must be documented and verified, but these loans will not have to adhere to the standards set forth in Appendix Q of Regulation Z as other Qualified Mortgages must. These loans must be underwritten using loan payments of equal amount and an amortization that does not exceed 30 years. The minimum term of the loan must be for at least 60 months plus the balloon payment that follows.

OPTION 1C Temporary Authority Qualified Mortgage. This option will allow a bank to originate Qualified Mortgages using the ATR criteria of one of the GSE's (FNMA, GNMA) or a government agency (HUD, VA, USDA, etc.). This option could be attractive to a bank that has access to, or is familiar with, the automated underwriting processes used by these entities. A qualified mortgage of this type must not:

  • Allow negative amortization;
  • Feature interest only payments;
  • Result in a balloon payment;
  • Exceed a term of 30 years; or
  • Exceed the points and fees limitations.

OPTION 1D Small Creditor Portfolio QM's

To be eligible to originate dwelling-secured loans using this option, a bank must have total assets of less than $2 billion and cannot have originated more than 500 covered loans in the previous calendar year; however, it is not required to originate any certain percentage of its loans in "rural" or "under-served" counties.

Loans that use this option must not feature negative amortization or permit interest-only or balloon payments. Payments on the loan must be substantially equal and cannot have a term that exceeds 30 years.

The same points and fees limits that apply to other types of Qualified Mortgage loans will apply here.

Underwriting of these loans must take into account the monthly payment using the highest interest rate that can apply during the first five years and periodic payments of principal and interest that will repay the loan over the term of the loan. Mortgage-related payments must also be taken into account.

Current and reasonably expected income and assets must be considered and verified, but the standards contained in Appendix Q do not have to be observed.

Current debt obligations, alimony and child support must be considered and verified. A debt-to-income analysis must be performed, but the 43% debt-to-income ratio that applies to other Qualified Mortgages does not apply to these loans so long as it can be determined that the applicant has sufficient resources to make payments and sufficient residual income to provide necessary support.

OPTION 2: Bank's choosing this option will originate some loans as Qualified Mortgages

and others that simply satisfy the Ability To Repay Rule. These banks will have to choose their method of originating Qualified Mortgages from the Options 1A through 1D above and then look to the following general procedures for originating loans that simply underwrite for the Ability To Repay Rule (Option 3 below)

OPTION 3: In order to originate a consumer loan that is secured by a dwelling, including any real property attached to the dwelling, the bank must first make a reasonable and good faith determination that the loan applicant will have a reasonable ability to repay the loan applied for according to its terms.

To do so, each loan must be underwritten for the following criteria.

  • Income or assets. The bank must consider the applicant's current or reasonably expected income or assets, other than the value of the dwelling, including any real property attached to the dwelling.
  • Employment status. If the applicant's income is relied upon as a source of repayment, the bank must determine and verify that applicant's current employment status.
  • Monthly payment. The repayment ability must be determined using the monthly payment of the loan that is applied for and the payment calculation methods set forth below.
  • Monthly payment on simultaneous loans. Any payments on simultaneous loans that the bank is aware of must be included when considering the overall ability to repay.
  • Mortgage-related obligations. The monthly payment for mortgage-related obligations such as taxes, insurance PMI or condominium dues and assessments must be considered.
  • Other obligations. The applicant's debt obligations in the form of a monthly payment, alimony and child support must be determined and considered.
  • Debt-to-income ratio. A debt-to-income ratio must be calculated or an assessment of residual income after meeting all currently monthly obligations must be determined and considered.
  • Credit history. Finally, the applicant's current credit history must be determined, verified and considered.
  • Verification. Each of the underwriting criteria listed above must be verified using reasonably reliable third party records and following the techniques below:
  • Verification of income or assets. The income or assets of an applicant may be determined and verified using any, or some combination, of the following:
    • Copies of tax returns;
    • IRS Form W-2s;
    • Payroll statements; etc.
  • Verification of employment. Oral confirmation of an applicant's employment by the employer will suffice; however, a written record of the oral confirmation must be placed in the applicant's file.
  • Current debt obligations. [optional] A current credit report for each applicant will be used to independently determine and verify both the debt obligations that each applicant has and the applicant's current debt history.
  • Payment calculation. The bank must verify the applicant's ability to make the payment required if his or her loan is approved. The payment must be calculated using the fully indexed rate and substantially equal monthly payments that amortize the loan. If the loan is originated with a balloon payment feature, then the maximum payment scheduled during the first five years after the date on which the first regular periodic payment will be due must be used, provided that the loan is not a "higher priced" loan (i.e. does not have a rate of interest that exceed the APOR by 1.5% or more for first-lien loans or 3.5% or more for subordinate lien loans). However, if the loan falls into the category of a "higher priced" loan as explained above, the loan must be underwritten for the full amount of the balloon payment, excluding the value of the dwelling. NOTE: It will be an unusual situation where an applicant is able to repay a higher-priced balloon payment loan without resorting to the sale or refinancing of the dwelling that serves as collateral.

[Drafting notes:]

1. The Bank is required to retain sufficient evidence to demonstrate compliance with the documentation

requirements of the Ability to Repay and Qualified Mortgage Rules for a minimum of at least three (3) years following consummation of the loan. Adequate evidence of compliance does not necessarily mean paper copies of the required records. These records may be retained by any method that accurately reproduces those records on a prompt basis. Care should be taken when detailing the methods that will be used to obtain, consider, verify and retain in accessible form the information needed for consideration when making a Qualified Mortgage, or when simply documenting compliance with the Ability to Repay Rule if the loan is not eligible for Qualified Mortgage status.

2. Almost certainly the bank should retain the above-referenced documentation in a retrievable format for longer than the minimum three (3) year period.

3. In light of the significant risks associated with any violation of the Ability to Repay Rule or the Qualified Mortgage Rule, it is vital that the Bank put in place controls to assure that all covered loans are underwritten using each and every one of the required underwriting criteria. It is equally important that every loan satisfies the points and fees test and otherwise complies with the requirements and limitations imposed on Qualified Mortgages. And finally, there should be controls to assure that every loan file contains the verified third-party documentation to prove that loans comply with the Ability to Repay and Qualified Mortgage Rules. Careful consideration should be given to the type and degree of post-loan closing procedures, monitoring and review that should take place.

4. This generic Qualified Mortgage Loan Policy does not attempt to address the policies, practices, and procedures that you will need to adopt in order to satisfy the requirements for verification and documentation of required underwriting information such as income, assets, employment, debt obligations, alimony, child support, etc. since those practices will differ from one institution to another.

5. This draft policy does not address the policies that may be needed to monitor and review each loan either at or after closing, in order to determine that all requirements for a Qualified Mortgage have been satisfied and that a sufficient retrievable record of the collection and verification of required information has been established.

6. No effort has been made to establish loan pricing guidelines, other than to say that every loan closed as a Qualified Mortgage must meet the limits for fees and charges established by law and regulation. Where within those limits your pricing will fall should be an individual consideration for each Bank.

7. The same approach holds true for interest-rate pricing of Qualified Mortgages; however, one important point bears mentioning: recent changes to the Qualified Mortgage provisions of Regulation Z allow certain small creditors to originate Qualified Mortgages with higher pricing than was originally proposed and still receive so-called "Safe Harbor" protection for compliance with the Ability to Repay Rule. These loans fall into two (2) categories:

a. Loans originated by creditors with assets of less than $2 billion and less than 500 total covered loans originated in the previous calendar year, but not limited with respect to percentage of loans originated in "rural" or "under-served" counties. These loans must be first-lien loans and must be held in the Bank's loan portfolio. They cannot feature a balloon payment, and they must otherwise meet the requirements for Qualified Mortgages set out in the applicable Option selected above. Then, if all of these requirements and limitations are met, that first-lien loan can be priced at an interest rate that is less than 3.5% above the APOR and still qualify for Safe Harbor Protection.

b. For a two-year period beginning January 10, 2014, creditors with total assets of less than $2 billion and that originated fewer than 500 dwelling-secured loans in the previous calendar year, may originate balloon payment loans without regard to whether a certain percentage of those loans are originated in "rural" or "under-served" counties, so long as all of the requirements listed in Option 1B are observed. These loans may also be priced at a rate equal to the APOR plus 3.5% and still receive "Safe Harbor" treatment.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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