GSE reform, CFPB underwriting rule are on collision course

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As Congress and the Trump administration chart a future for the government-sponsored enterprises, they face a fast-approaching deadline when a huge chunk of Fannie Mae and Freddie Mac's loans could be in violation of federal underwriting requirements.

The White House and Senate Banking Committee are pursuing parallel tracks to end the GSEs' federal conservatorships. Any resulting plan must deal with whether GSE-backed mortgages are still exempt from the Consumer Financial Protection Bureau's Qualified Mortgage rule.

The exemption, known as the GSE "patch," sunsets in January 2021 or when the conservatorships end, whichever comes first. Unless the patch is extended or the CFPB eases underwriting requirements for all loans, nearly a third of loans backed by the GSEs could face new legal liability. Other government-backed loans such as those insured by the Federal Housing Administration have a similar exemption.

“Not doing something to extend the patch would be highly disruptive,” said Bob Broeksmit, the president and CEO of the Mortgage Bankers Association.

The Federal Housing Finance Agency is said to be working with the Treasury Department and White House to end the conservatorships without Congress, which has long been at an impasse over GSE reform. But just Friday, Senate Banking Committee Chairman Mike Crapo released a new legislative outline.

Yet talks are also picking up about the effects of the CFPB mortgage underwriting rule, which discourages loans with debt-to-income ratios above 43%. Under the GSE patch, Fannie and Freddie loans are in compliance with QM even if they have higher DTIs as long as they meet the mortgage giants' underwriting criteria.

The issue of the patch came up at a recent meeting attended by Broeksmit and other trade group leaders with CFPB Director Kathy Kraninger.

Mortgage lenders — which have long fought to ease the QM rule — and others are concerned about either an administration or legislative plan to end the conservatorships that did not extend the GSE patch or take other measures. Some in the Trump administration want to reduce the government’s footprint in the mortgage market while encouraging the expansion of private capital.

If GSE reform stalls or does not address the QM rule, Kraninger could face increasing pressure either to extend the patch or ease the rule by raising the DTI cap. Currently, nearly a third of GSE loans have DTIs between 43% and 50% but still meet the QM definition.

Some observers believe the CFPB should revamp the QM rule to focus on factors other than DTI.

In a sudden twist, some advocacy groups have supported eliminating the DTI cap altogether. Instead of using DTIs as the standard, the Urban Institute has proposed a plan to provide the safe harbor for loans with annual percentage rates of no more than 150 basis points over the average prime offer rate. That APR limit is currently in the QM rule, but the group has proposed removing the DTI limit as a factor.

“The idea is that instead of relying on DTI, if you rely on the APR on the loan, then you could say the loan is not a high-priced loan, it’s not a risky loan, so it’s a good candidate for QM,” said Karan Kaul, a senior mortgage researcher at the Urban Institute. Kaul co-wrote a report on the patch with Laurie Goodman, co-director of the Urban Institute’s Housing Finance Policy Center.

Kaul said that loans with high DTIs should have other compensating factors such as additional reserves, or a higher FICO score.

“If you have a loan with a very high DTI, it probably is going to be a higher-priced loan, and that loan will not be QM,” Kaul said.

Although former acting CFPB Director Mick Mulvaney spoke last year about easing the QM rule, Kraninger has not addressed the issue and revamping the QM rule is not currently on the CFPB’s agenda.

Under the CFPB's mortgage underwriting rule, QM loans are considered ultrasafe and are protected from legal liability. Riskier loans are subject to stricter requirements for the lender to assess a borrower's ability to repay.

Policymakers added the GSE patch to the QM rule in 2014 to avoid harming the housing recovery.

“The bureau was afraid that in a recovering housing market to not have the GSE patch would have some negative repercussions,” said Richard Horn, managing member at Garris Horn and a former senior counsel and special adviser in the CFPB’s Office of Regulations. “If they were to eliminate the patch, the level of industry apoplexy would be something."

The meeting attended by Broeksmit with Kraninger also addressed the prospect of fixing Appendix Q, a set of documentation standards for nonagency loans to document a borrower’s ability to repay in order to get QM status.

Lenders claim Appendix Q has shut out self-employed borrowers from qualifying for QM loans and, as a result, some loans are not being made.

“The crux is that investors — whether banks or private label securities investors — are unwilling to invest in credit risk that carries with it the legal risk of a borrower suing them for failing to meet the ability-to-repay rule,” said Jim Parrott, a fellow at the Urban Institute and a former adviser in the Obama administration.

Housing experts say that the patch, by allowing all GSE loans to be considered QM, has had the effect of further entrenching Fannie and Freddie in the mortgage market.

“Some argue that when lenders use the GSE patch for their QM stamp, that makes the GSE execution an easier path," said Pete Carroll, an executive of public policy and industry relations at CoreLogic and former executive at Quicken Loans and Wells Fargo.

Others argue that loosening DTI requirements is risky and has saddled consumers with excessive debt that has contributed to higher home prices, particularly for low- to moderate- income borrowers.

“The patch was supposed to be temporary, and instead Fannie and Freddie took advantage and loosened underwriting requirements by expanding debt-to-income ratios, which has had the effect of driving up housing prices,” said Ed Pinto, a resident fellow at the American Enterprise Institute’s Center on Housing Markets and Finance. “We’ve looked at tens of millions of loans and their risk factors, and house prices are going up in places with the highest risk, and one of the reasons is because of high DTIs.”

But Pinto said there is no way to determine if the GSEs are using compensating factors for DTIs above 43%.

"This is all a black box," Pinto said. "We can’t tell if the GSEs are using compensating factors such as a borrower having a bigger down payment or a higher FICO. All we know if they are making loans with very high DTIs, which are risky."

Currently, the patch applies to all loans that qualify for the GSEs' automated underwriting engines, but some say that locks in Fannie and Freddie's underwriting process as the only viable standard for borrowers' ability to repay under the QM rule.

Some suggest allowing lenders or other GSEs to create their own underwriting engines that would rival Fannie’s Desktop Underwriter or Freddie’s Loan Prospector.

“It’s understandable that capital markets would be comfortable with the industry standardization afforded by the GSE patch," Carroll said. "Policymakers will likely also assess the benefits and impacts of various additions or alternatives to those underwriting engines.”

Although it is possible to replace the GSEs' underwriting engines, stakeholders need to conduct thorough research of the impact of such changes and whether they offer clear strengths, he said.

Still, others think the GSE’s automated underwriting engines could be turned into a utility that all loans could be run through, for a fee, to determine QM eligibility.

“The QM rule ended up one way and industry likes their punch, and they don’t want it taken away,” Horn said.

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Qualified mortgage rules GSEs GSE reform Housing finance reform Qualified Mortgages Kathy Kraninger FHFA CFPB Fannie Mae Freddie Mac