Accelerating rate increases could lead to ATR/QM issues for lenders

The rapid rise in the 10-year treasury yield and substantial increase in mortgage rates isn’t just wreaking havoc in a mortgage world scrambling to pivot from a historic refinance market to a possibly historic purchase market. It’s also putting lenders in jeopardy when it comes to the Federal Ability to Repay and Qualified Mortgage Rule (“ATR/QM”) requirements —specifically, ensuring that they meet points and fees requirements as required by the ATR/QM Rule. Now is the time for lenders to carefully review and revisit their points and fees formulas to ensure continued compliance in this environment of rapid rate increases. 

In April 2022, the 10-year treasury yield stood at a three-year high. Accordingly, mortgage rates are also climbing, hurdling the five percent threshold for the first time in years. In addition to overarching market volatility, there is a lack of liquidity for the higher note rates in the marketplace, a likelihood that home values will remain at historic heights and inventory will remain scarce. Lenders have not experienced a market of this type in quite some time and if not considered carefully, policies and procedures that worked well during stronger and less volatile markets could cause unintended (and in some cases expensive) issues in today’s landscape. 

One issue that has come to the forefront over the past few months is the points and fees calculation under the ATR/QM Rule and the use of bona fide discount points. Under Regulation Z, for a loan to be a QM (and therefore presumed to comply with Ability to Repay requirements), the points and fees on the loan may not exceed the points and fees limitations of the ATR/QM Rule. The dollar amounts adjust annually and are higher for smaller loans, but, for example, in 2022 the limit is 3% of the total loan amount for a loan greater than or equal to $114,847. 

To determine whether a loan’s points and fees meet this requirement, lenders must add together all the fees paid in connection with the transaction for various categories, which includes most items comprising the finance charge for the loan. 

However, certain charges are excluded from the points and fees test. One of the exclusions is bona fide discount points. While there are other fees currently impacting lenders’ ability to meet points and fees requirements, the reason that discount points are of particular interest is that they are often misunderstood, and therefore misused, by lenders. 

Lenders are permitted to exclude up to two bona fide discount points if the interest rate before the discount does not exceed the Average Prime Offer Rate (“APOR”) for a comparable transaction by more than one percent. They can exclude one bona fide discount point if the interest rate before the discount does not exceed the APOR for a comparable transaction by more than two percent. The key is that to compliantly exclude discount points from the points and fees calculations, the points must be bona fide, i.e., the points must actually reduce a customer’s interest rate in a matter consistent with established industry practices.

This is where things can fall apart, especially in markets like the one that we are facing today, where there is a lack of appetite for higher note rates, resulting in lenders being unable to offer undiscounted rates. Lenders charge points to offer their customers lower-than-par rates. This is a standard and compliant practice overall, but problems arise when the lenders attempt to consider the full amount that they charge in discount points, including the amounts exceeding the actual price for buying down the rate, as bona fide discount points, and thereby exclude those amounts from points and fees calculations. 

Excluding discount points that are not bona fide from points and fees calculations can be problematic as well. If points and fees limits are exceeded, the loan in question loses its QM status, which significantly changes the scope of investors that will purchase the loan or make the loan unsalable in the secondary market. This is particularly true because the ATR/QM cure provisions expired in 2021, and lenders are no longer permitted to fix errors in points and fees calculations within 210 days of consummation of their loans.

Based on the combination of factors currently at play, it is important for lenders now, more than ever, to ensure they understand what portion of their points can be considered bona fide to maintain the salability or profitability of the loan.