On September 21, 2015, the Consumer Financial Protection Bureau (“the CFPB”) finalized several changes to the mortgage rules that impact community banks and credit unions. The CFPB proposed these rules in January to help smaller banks and credit unions lend in rural and underserved areas. The effective date for this proposed rule (with additional clarifications and technical revisions) is January 1, 2016. To access the rule, click here.
In 2013, the CFPB issued several mortgage rules, including the Ability-to-Repay rule, which took effect in January 2014. The Ability-to-Repay rule requires that lenders, when originating consumer mortgage loans, make reasonable and good-faith determinations that consumers have the ability to repay their loans. Lenders must consider eight identified underwriting factors and rely on “verified and documented information” of a consumer’s income or assets. Lenders that run afoul of this rule may face liability from both regulators and borrowers. A borrower can bring an action against a lender within three years of an Ability-to-Repay rule violation or can assert a violation as a defense to foreclosure without any time limitation. The CFPB can enforce any violations of the Ability-to-Repay rule by imposing cease-and-desist orders or civil money penalties through its administrative enforcement authority.
Market Dominated by Qualified Mortgages
Not surprisingly, the predominant loans currently originated in the market are qualified mortgages, which are presumed to meet the Ability-to-Repay rule and therefore entitled to a “safe harbor” from liability. If a mortgage meets the safe harbor, a borrower is unable to challenge whether the lender met the Ability-to-Repay requirements. The consequences of the Ability-to-Repay rule can be seen in the market. We have received informal feedback from many community banks and credit unions that mortgage lending is now considered a “high-risk” business and that the 800+ page rule is fraught with potential technical violations that make mortgage lending costly and compliance difficult. Others joke that “QM” should really stand for “Quitting Mortgages.” According to a Fannie Mae mortgage lender sentiment survey issued in 2014, 80 percent of the surveyed firms do not pursue non-qualified mortgage loans. Although the original rule contained special provisions and exemptions for small creditors from various requirements in the original rule, there is a perception that these exemptions are too small and technical to be worth the effort, given the larger package of compliance requirements.
In the original rule, there are four kinds of qualified mortgages, each of which has the following criteria:
- Mortgage loan terms cannot exceed 30 years;
- Points and fees paid by the borrower cannot exceed 3 percent of the total loan amount in most cases;
- Loan must be fully amortizing (no negative amortization, no interest-only loans as a payment feature);
- Adjustable-rate loans must be underwritten to the maximum rate permitted during the first five years.
The first kind of qualified mortgage is that in which the borrowers have a “back-end” debt-to-income (DTI) ratio of 43 percent or below using verifiable evidence that the borrower has income, assets, debt, and other obligations in accordance with the requirements established in the regulation. The second kind of qualified mortgage is eligible for insurance or guaranty by Fannie Mae, Freddie Mac, the Rural Housing Service, and the Veterans Administration. These mortgages are temporarily qualified mortgages for seven years after the effective date of the rule, and the agency guidelines allow borrowers to have a DTI that exceeds 43 percent due to compensating factors approved by agencies. The FHA has also issued its own “Qualified Mortgage” definition, which also allows compensating factors and DTI that exceeds 43 percent.
The third and fourth kinds of qualified mortgages are available only for small creditors. The original rule required a lender to meet two criteria to count as a small creditor: no more than $2 billion in assets and loan originations of no more than 500 first-lien mortgage loans per year. Additionally, these loans must be held in portfolio for three years. Although the small must consider the consumer’s DTI ratio or residual income to verify the underlying information, a borrower does not need to meet the 43 percent DTI ratio threshold. The CFPB also created a category of qualified mortgages relating to balloon loans. Small creditors, whether they operate in rural or underserved areas, can obtain qualified mortgage status for balloon loans that are held in portfolio for a two-year transition period from the effective date. After two years, only lenders that operate in rural or underserved areas are entitled to qualified mortgage status for balloon loans. This was criticized by many in the industry as too restrictive, especially given how the CFPB originally defined “rural.”
What’s Changed in the Final Rule?
In response to industry comments, the CFPB has changed the definition of “small creditor” by raising the loan origination limit for small-creditor status from 500 first-lien mortgage loans to 2,000, and excluding from that limit any originated loans held in portfolio by the creditor and its affiliates. This is likely to be a significant change because a community bank can now originate unlimited amounts of portfolio loans and still retain small-creditor status. Second, the original rule contained a $2 billion asset limit for small-creditor status, which unfortunately remains unchanged in terms of asset size (except as adjusted for inflation). The final rule requires a creditor to include the assets of the creditor’s affiliates in calculating the asset limit and also adds a grace period to the annual asset limit, as described below.
Definition of Rural and Underserved Areas
Currently, the CFPB posts a list of rural counties on its website, which is based on the original rule’s definition of “rural.” The original rule defined “rural” as a county not in a metropolitan statistical area (MSA), and not in a micropolitan statistical area adjacent to an MSA. The amended rule keeps these counties and also adds census blocks that are not in an urban area as defined by the U.S. Census Bureau to the current county-based definition. The Census Bureau defines two types of “urban” areas: “Urbanized Areas” (UAs) of 50,000 or more people and “Urban Clusters” (UCs) of at least 2,500 and fewer than 50,000 people. Everything that is not in a UA or UC is considered “rural.” To get an idea of where the urban areas are, take a look at the Census Bureau’s 2010 map showing UAs and UCs.
In addition, the final rule adds two new safe-harbor provisions related to the rural or underserved definition for creditors that use the automated tools that will be provided: (1) on the CFPB’s website to allow creditors to determine whether properties are located in rural or underserved areas, or (2) on the Census Bureau’s website to assess whether a particular property is located in an urban area according to the Census Bureau’s definition.
Finally, the final rule establishes a grace period from calendar year to calendar year to allow a small creditor that exceeded the origination limit or the asset limit in the preceding calendar year to operate in certain circumstances as a small creditor for transactions with applications received before April 1 of the current calendar year. This grace period will also apply to small creditors that operated in a rural or underserved area in the preceding year.
In our opinion, the rule changes that will have the most impact are: (1) the changes to the definition of “rural” and (2) the exclusion of portfolio loans from the calculation of loan origination limits. Yet these changes will help only those small banks and credit unions that already have a fairly robust compliance system in place to originate consumer loans. For many credit unions and small banks, the compliance challenges and risks posed by all mortgage and servicing rules, including the 2014 Ability-to-Repay rule and the TILA-RESPA Integrated Disclosure rules going into effect on October 3 of this year, continue to be a disincentive to entering the mortgage business, notwithstanding the loosening of the qualified mortgage definition.