Tearing up CFPB’s mortgage underwriting rule is the easy part

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Now that the Consumer Financial Protection Bureau has vowed to remove an unpopular measure of loan affordability in its mortgage underwriting rule, the million-dollar question is: What alternative standard should replace it?

Mortgage lenders lobbied heavily for the CFPB to abandon a 43% debt-to-income ratio, a required limit for "qualified mortgages." But settling on a different metric to determine a borrower's ability to repay is no easy task.

Some have called for designing a new underwriting standard in which QM loans have a pricing limit set at a range above the average prime offer rate.

"We believe this structure, along with today’s safe product features, investor liability and insight, and existing CFPB enforcement authority will allow the market to continue to function in a safe, sustainable, and transparent way," Bill Emerson, vice chairman of Quicken Loans, said in a Sept. 16 comment letter to the CFPB.

Yet it is hard to find agreement within the industry and elsewhere about the best alternative. Besides a metric based on APOR, other ideas raised by lenders, trade groups and consumer advocates include basing underwriting standards on those used for government-backed loans or requiring a minimum amount of borrower reserves. Some observers say the CFPB should simply eliminate DTI without offering an alternative.

Many say designing a QM standard around prime rates is a mistake.

“Adopting the APOR rate spread rule as a successor to the QM rule would be dangerous,” said Ed Pinto, director of the American Enterprise Institute’s Housing Center. “It would prolong what is already an unsustainable home price boom and push home prices higher during a seller’s market.”

43% limit finds few if any supporters

A 43% DTI was the centerpiece of the CFPB's original underwriting rule. Loans that met that limit and other requirements were considered QM — an ultrasafe class of mortgages deemed to be in compliance. But the industry says that hard limit is overly restrictive.

Up to now, the effects of the QM rule have been contained because loans backed by Fannie Mae and Freddie Mac are already in compliance under an exemption known as the QM "patch." But the CFPB and the industry are focused on revamping the underlying rule after the agency announced it plans eventually to end the patch. That means the substantial portion of Fannie- and Freddie-backed loans above 43% DTI will suddenly be in violation without other changes.

After announcing plans last year to revamp the QM rule, CFPB Director Kathy Kraninger told Congress in January that the agency plans to move away from DTI and instead include an alternative such as a "pricing threshold" based on the difference between an annual percentage rate and APOR.

Both lenders and consumer groups support CFPB's overhaul of QM.

“There is substantial consensus that a hard DTI limit would be a bad idea in damaging people of low incomes,” said Eric Stein, senior vice president at Self-Help, a community development lender and the parent of the Center for Responsible Lending.

In addition to removing the DTI requirement, stakeholders are also hopeful the agency will remove a subset of underwriting requirements in the rule known as Appendix Q. (The agency says it will issue a proposal by May.)

Banks are open to using DTI as a factor in their internal underwriting processes, but oppose the cap of 43%.

“A DTI measure is good and should be used by lenders to determine ability-to-repay, just remove the 43% limit — that’s what can shift,” said Rod Alba, a senior vice president at the American Bankers Association.

Without a DTI limit, the QM rule still contains significant consumer protections. The Dodd-Frank Act prohibited risky features such as balloon payments, excessive points and fees, interest-only loans, negative amortization and loan terms of more than 30 years.

Some lenders think those safeguards coupled with the other ability-to-repay requirements are enough to maintain a safe mortgage market.

"Lenders like the idea of clear guidelines around what constitutes a qualified mortgage, but what we discovered is there were a significant number of high-qualify loans above the 43% DTI limit," said Pete Mills, senior vice president of residential policy at the Mortgage Bankers Association.

"The products in 2005-2007 were high-risk products by design ... and all those deeply discounted adjustable rates and interest-only loans are now gone," said Mills. “The mortgage products themselves will not be the driver of defaults going forward."

Clarity or manipulation?

The current fine print of the QM rule references a pricing threshold of 150 basis points above APOR as a characteristic of safe loans, but Emerson said a new standard should raise that threshold to 200 basis points.

"Increasing the rate spread threshold to 200 basis points over APOR would maintain regulatory and operational clarity for lenders, while ensuring more credit-worthy borrowers have access to credit," Emerson wrote.

Still, others are warning that the CFPB's plan to eliminate DTI and Appendix Q will loosen credit too dramatically.

Pinto said a rate-spread metric would be subject to manipulation.

“Some members of the housing lobby are proposing a significant loosening of the credit system,” Pinto said. “No one in industry has stepped up with a list of best practices for verifying debt and income.”

Other have different concerns about an APOR-based standard.

A coalition that includes the Independent Community Bankers of America, the Consumer Federation of America, the National Association of Realtors and the National Consumer Law Center also opposes using a rate spread as a proxy for DTI or other underwriting requirements.

“The APOR approach is premised on the faulty idea that pricing fully captures credit risk and that, in turn, credit risk is a reasonable market for ability to repay,” the coalition said in a comment letter to Kraninger. "During periods of low rates and loose credit, borrowers run the risk of being overextended.”

Bill Dallas, president of Finance of America, a national wholesale lender, said he thinks DTI should be replaced with a metric based on the amount of savings and other assets borrowers hold to cover financial losses.

"The one thing that they should have put into QM is some definition around reserves," Dallas said.

'Please open up some other roads'

Kraninger has already told Congress that she plans to extend the "patch" beyond its expiration in January 2021. Lenders prefer that the patch remain, or alternatively that the CFPB base QM on a more flexible approach to underwriting.

“What we are recommending is that once the patch goes away, have alternative means that are proven underwriting standards,” said Sharon Whitaker, an ABA vice president who spent 33 years as a retail lender at the $3.6 billion-asset Bar Harbor Bank & Trust in Maine.

“The market is continually changing and there are new investors that are found to have safe underwriting systems and we don’t want to handcuff ourselves.”

Whitaker wants lenders to be able to use any existing underwriting standards from the Federal Home Loan banks, the Department of Veterans Affairs and the U.S. Department of Agriculture’s Rural Housing Service — as well as Fannie and Freddie’s seller-servicing standards — to get a safe harbor from legal liability under an amended QM rule.

“We could even keep Appendix Q, because it gives us a road we’ve already traveled, but please open up some other roads, some other formulas or definitions,” Alba at the American Bankers Association said.

Meg Burns, a senior vice president of mortgage policy at the Housing Policy Council, a trade group of lenders, insurers and mortgage servicers, said industry is hoping that changes to the QM rule will lead to improvements in underwriting.

“It does open the door for potential innovation in the future for underwriting, which is something that everyone's been looking for,” Burns said.

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