United States: Mid-South Regulatory Compliance Group Quarterly Report – Vol. 12 No. 3


In our recent Steering Committee meeting, several of the committee members agreed that there was considerable confusion among their banks' staff about the whole issue of Ability to Replay and Qualified Mortgages, as it relates to the upcoming implementation of the Truth in Lending/RESPA Integrated Disclosure (TRID) requirements that will go into effect October 3, 2015. And where do High-Cost Mortgages and Higher-Priced Mortgages fit in? The patchwork is confusing, so we agreed to take a shot at trying to make some sense of this jumble of regulatory requirements.

Where To Begin?
Perhaps An Overview Will Be Helpful.

The Truth In Lending Act (TILA) is the primary consumer protection statute for loan transactions. It contains different rules depending on whether a mortgage is open-end or closed-end, whether it is purchase money or not, and depending on the price of the loan. The greatest protections apply to the most expensive loans that are secured by a borrower's home. Purchase money loans have fewer protections than home equity or refinance loans. Open-end mortgages are excluded from many protections that apply to other mortgage loans.

This assortment of laws and regulations makes a little more sense if you view them as a response to two different crises: (1) the crisis in the early 1990s related to high-priced home equity lending, and (2) the failure in underwriting of mortgage loans that led to the subprime mortgage meltdown and its consequent foreclosure crisis some 10 – 15 years later. Needless to say, Congress and the regulatory agencies have taken a number of stabs at trying to address the root causes of these problems.

Hopefully it will make sense to you if we begin with the broadest category of loans (closed-end loans secured by a borrower's primary residence), then move to "higher-priced" (subprime) loans secured by a borrower's principal residence and conclude with "high-cost" (HOEPA) loans which are high cost and high risk, non-purchase money mortgages secured by a borrower's principal dwelling.

The Ability to Repay Rule

A creditor that makes a closed-end home-secured mortgage (excluding timeshares, bridge loans, and reverse mortgages) must make "a reasonable and good faith determination at or before loan closing that the borrower has a reasonable ability to repay the loan based on its terms."

Think of the Ability to Repay as a minimum set of standards. The reasonable and good faith determination required must be based on verified income, assets, and debt (including any simultaneous mortgages). The creditor must also consider either the borrower's debt-to-income ratio (including the mortgage applied for) taking into account all outstanding debts, taxes, insurance and simultaneous mortgages, or the borrower's residual income (subtracting all debt payments from income). The payment that the loan requires must be fully indexed and fully amortizing in terms of affordability and any balloon mortgage must be evaluated for repayment ability using the highest payment in the first five (5) years of the loan.

Under the ATR Rule, there is no set limit on the borrower's debt-to-income ratio or the amount of residual income that is needed. Still, the creditor must collect, verify and assess the borrower's ability to repay using all of this information. Taking into account all of this information, a creditor has leeway to set its own underwriting standards when simply meeting the general ability-to-repay requirements.

Qualified Mortgages

The adoption of the Ability to Repay Rule (ATR) raised serious questions about liability for violations of TILA. To help with those concerns, the CFPB created a category of safer loans referred to as Qualified Mortgages (QM's). Loans meeting the QM standards receive either a safe harbor or presumption of compliance with the ATR Rule, depending on the loan's level of pricing.

General QM

The basic definition of a QM includes the following elements:

  • No negative amortization;
  • No interest only loans;
  • No balloon payments;
  • Income and assets verified and documented;
  • Underwriting based on fully amortizing payments over the entire term for fixed-rate loans;
  • Underwriting for adjustable rate loans based on fully amortizing payments using the maximum applicable rate during the first 5 years of the loan after the date of the periodic payments;
  • Consideration and verification at or before closing of current or reasonably expected income or assets and current debt obligations, alimony, child support, using reasonably reliable third party records;
  • Total monthly debt-to-income ratio not exceeding 43% or, in the alternative, residual income must be considered;
  • Total points and fees payable in connection with the loan not to exceed 3% of the total loan amount;
  • Maximum term of 30 years; and
  • Prepayment penalties not in excess of regulatory limitations.

The CFPB expanded on this definition by adding the following:

  • Monthly debt obligations must be verified; and
  • The total debt-to-income ratio must not exceed 43%.

In addition, there is a points and fees cap for all forms of Qualified Mortgages. The cap is higher for smaller loans with some limits expressed as dollars rather than percentages:

  • Three percent (3%) of the total loan amount for a loan greater than or equal to $100,000;
  • Three thousand dollars ($3,000) for a loan greater than or equal to $60,000, but less than $100,000;
  • Five percent (5%) of the total loan amount for a loan greater than or equal to $20,000 but less than $60,000;
  • One thousand dollars ($1,000) for a loan greater than or equal to $12,500 but less than $20,000;
  • Eight percent (8%) of the total loan amount for a loan less than $12,500.

In addition to the General QM, there are three other types of QM that are available to certain creditors that either meet specific requirements or originate certain types of loans. These three types of QM are:

  • The Temporary or GSE QM;
  • The Small Creditor Portfolio QM;
  • The Small Creditor Balloon Payment QM.

Temporary QM

Certain loans originated during a transitional period that are eligible for purchase by FNMA or FHLMC or are insured or guaranteed by certain federal agencies, can receive QM status. This transitional period expires when FNMA or FHLMC exit receivership or January 10, 2021, whichever comes first. Loans using an automated underwriting tool from one of these GSE's qualify.

Small Creditor QM's

A creditor is considered to be a "small creditor" if it has total assets of $2 billion (adjusted annually, so somewhat higher now) and if it originated 500 or fewer first lien covered loans during the prior year (this limit is proposed to be relaxed soon). There are two types of Small Creditor QM's potentially available: (1) the Small Creditor Portfolio QM and (2) the Small Creditor Balloon Payment QM.

Small Creditor Portfolio QM

This type of QM must meet the same product features and points and fees standards that apply to the General QM. However, there is no 43% debt-to-income ratio limit and the creditor must use the maximum interest rate in the first five years and an amortizing payment to determine the monthly payment amount. These loans must be held in the creditor's loan portfolio for at least three years.

Small Creditor Balloon QM

All small creditors can originate Small Creditor Balloon QM's for a time. As presently proposed, after April 1, 2016, small creditors will also have to satisfy a "rural or underserved" test (more than five percent of first-lien loans made during the preceding year must be in rural or underserved areas).  

These Small Creditor Balloon QM's must satisfy General QM product features except for the prohibition on balloon payments and deferment of principal.

The loan must have:

  • Scheduled payments that are substantially equal, using an amortization schedule that does not exceed 30 years;
  • A fixed interest rate;
  • A loan term of five years or longer;
  • No interest-only loans or loans with adjustable rates.

And, of course, the loan must satisfy the Standard QM points and fees test. There is no 43% debt-to-income limit and the creditor must base its decision regarding repayment ability based on the borrower's actual debt-to-income ratio or residual income.

Both Small Creditor QM's use verification procedures similar to the General QM option and both types of Small Creditor QM loans must be held in portfolio.

Higher-Priced Mortgage Loans

Two additional classes of loans require more in the way of consumer protections. These are referred to as "higher-priced" mortgage loans (HPML's) and HOEPA loans. First let's consider the additional requirements for HPML's.

In 2008, the Federal Reserve Board issued regulations addressing "higher-priced" mortgage loans. The rule applied to loans with an APR above a certain threshold and prohibited four (4) acts or practices:

  • Failure to evaluate a borrower's ability to repay;
  • Inclusion of a prohibited prepayment penalty;
  • Failure to establish an escrow account; and
  • Structuring the loan as open-end credit to avoid or evade the requirements.

In 2013, the CFPB amended the HPML rules to implement provisions of the Dodd-Frank Act that apply to escrow accounts. The CFPB also implemented the Dodd-Frank appraisal rules by applying them to HPML's. (These two sets of rules are discussed in a separate article in this edition of the Quarterly Report).

The HPML rules apply to all closed-end mortgages, including purchase money mortgages secured by a borrower's principal dwelling.

A loan is an HPML if it is a first-lien loan secured by the borrower's principal dwelling and the APR exceeds the average prime offer rate (APOR) for a comparable transaction by 1.5% or more. A subordinate lien loan is an HPML if the APOR exceeds the APOR by 3.5% or more.

Once again, TILA imposes four (4) restrictions on HPML's:

  • Ability to repay restrictions;
  • Limits on prepayment penalties;
  • Escrow requirements; and
  • A prohibition on evading these requirements by structuring the loan as open-end credit.

A creditor that makes an HPML must now evaluate the borrower's ability to repay using the requirements of the ATR Rule relevant to the ability to repay.

After the January 10, 2014 rule changes, prepayment penalties became very restrictive. The HPML with a prepayment penalty of any amount will not meet the standards for a QM. Regardless, an HPML may not have a prepayment penalty that goes beyond 36 months from closing or assesses more than a two percent (2%) penalty on the amount prepaid. Any violation of these restrictions would trigger HOEPA loan provisions (discussed below) and simultaneously violate HOEPA.

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