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The carve-out helps provide lenders and investors with protection when manufacturing loans.
The carve-out helps provide lenders and investors with protection when manufacturing loans.

QM and Ability to Repay—What’s the Difference?

MAY 20, 2013 10:58am ET
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There seems to be quite a bit of confusion over the new CFPB rules, especially when it comes to defining the new “qualified mortgage” presumption in the context of “ability to repay” (ATR for short). They are, in fact, different.

Notice I said the qualified mortgage presumption; and therein lies the key to understanding the difference.

Basically, the whole thing works like this: the Dodd-Frank Act and the CFPB rules tell us how to properly underwrite a loan…by following eight underwriting guidelines. These guidelines must be followed for every residential mortgage loan originated in 2014 and beyond, without exception.

Problem is, when a borrower defaults, they have the right to defend themselves in court by alleging, affirmatively, that the lender failed to use good underwriting judgment.

This can be costly to the originating lender and to the current holder of the loan.

One industry thought leader commented on how that opens up a Pandora’s Box. Consider his example: a borrower walks into a brokerage (sounds like the beginnings of a joke, right?), sits down at an LO’s desk and applies for a mortgage. In the ensuing discussion, the borrower coughs. Years later, the borrower stops making timely payments and the lender begins legal proceedings to foreclose on the subject property. The borrower’s legal pleadings include an affirmative defense that the lender failed to follow sound underwriting principals because the borrower had been diagnosed with lung cancer which has a direct impact on borrower’s ability to generate income…and which the LO should have known about with all that coughing during the application process.

Sound farfetched? Sure. But so what?

In response to what amounts to an open-ended ticket for all defaulting borrowers to delay legal enforcement proceedings, the qualified mortgage rule is a special carve-out to the ATR requirement to provide lenders and investors with protection against this scenario.

Next time, I’ll describe to you how the QM presumption serves to protect lenders and investors from defaulting borrowers’ claims that a lender failed in some aspect of underwriting tea leaf reading. Until then, remember that an informed lender is best suited to get compliance right from the start.

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