Most everyone in the mortgage business agrees that the Consumer Financial Protection Bureau's (CFPB) ability-to-repay/qualified mortgage (ATR/QM) rules, due to take effect in January, will have a chilling effect on the industry, not only reducing the breadth of products in the marketplace, but also the number of small lenders, many of whom will simply exit the business – if only temporarily – for the purpose of avoiding compliance issues.
Of particular concern for lenders is interpretation of the section of the ATR/QM rules that caps borrower debt-to-income at 43%. As per the CFPB's amendments to the Dodd-Frank Act, as well as through implementation of Regulation Z of the Truth in Lending Act within the CFPB's regulations, the new rule requires lenders to dig deeper into borrowers' financial histories and more closely scrutinize their current income and debts in order to make a ‘good faith determination’ that each and every borrower has the wherewithal to repay their mortgage – not just today but throughout the life of the loan.
While this new rule might seem relatively simple at first glance, as with most industry regulations promulgated by federal agencies, the devil is in the details. The challenge for lenders is determining what financial data to use when applying the new ATR/QM rules and, further, how to prioritize, or ‘weight,’ the different criteria in order to arrive at an accurate assessment of a borrower's ability to repay.
Many industry experts say the ATR/QM rules will have rippling effects – and possibly some unintended consequences – on the rest of the industry, although most admit that it will take many months to determine the true impact of the rules and how they will reshape the marketplace.
One thing is for certain: With the threat of hefty fines, civil suits and resultant negative publicity stemming from potential compliancy violations, most lenders will be erring on the side of caution, which means many will be eliminating certain types of loans they currently offer, as these products will not fit comfortably within the QM rule.
This, in turn, will not only lead to a significant reduction in the number of mortgage products consumers have to choose from, it will also eliminate a competitive advantage for lenders seeking to deliver unique or innovative products, not to mention a ‘homogenization’ of the remaining products in the marketplace.
‘We're working our way towards a hamburger, Coke and fries industry – and that's it,’ says David Zugheri, co-founder and executive vice president of Envoy Mortgage, making an analogy between the reduction in choice in mortgage products and the limitations of choice in fast food. ‘With QM, that's all we will have. Do you want cheese on that hamburger? Can't do it. And if you decide to go over to Wells Fargo, well, they can't do it either.
‘We're going to get to a homogenous, one-size-fits-all industry,’ Zugheri adds. ‘And as a business owner, I say 'God, that'll be kind of nice. It'll be easy to measure. There'll be less variation. There'll be less room for exceptions. We won't even have to meet with the loan committee.'
‘And for the consumer, it will be like, 'Hey, you've got a 44 percent debt-to-income ratio? You're out of here. We don't even need to talk,'’ he concludes.
Rod Alba, vice president, mortgage finance, and senior regulatory counsel for the American Bankers Association (ABA), says the main question now is whether lenders will be content to stay within the QM rule or whether they will diversify into other non-QM products.
‘Will lenders dare to go outside of QM and operate in the gray area without the safe harbor?’ he asks. ‘That's the big question – and the answer is no; in general, they are not going to go outside QM.’
This, Alba says, raises serious questions about the future competitiveness of the market.
‘Do we need a system that defines a qualified mortgage versus everything else?’ Alba asks rhetorically. ‘Should we just get a plain vanilla 30-year product out there that is geared for everyone? Or is there still a way to tailor credit to borrowers?
‘When you look at this in terms of policy, if you want to create an absolutely safe product, then you're going to have to limit how you can vary the loan,’ he says. ‘But if you want to create accessibility, you're going to have to liberalize the rules. So, which is it?’
Alba says the ATR/QM rules will have a particularly harsh impact on smaller lenders, such as community banks, which have historically relied on their own ingenuity to devise products that are tailored to meet the unique needs of borrowers in the areas where they operate.
‘It used to be that community lenders used to go out into the town and look at the needs of the community – then they would come back and assemble loan products that meet the community's needs,’ he says. ‘Now, [all communities] will only have QM, and that's all.’
To their credit, Congress and the CFPB have tried hard to walk the fine line between standardizing lender underwriting and freeing up credit to borrowers at the lower end of the income scale.
‘And that's why the ABA is being sensitive about this,’ Alba says. ‘We're not trying to destroy this law but fix it. What Congress is saying is, 'OK, we're not going to impose a strict new world – what we're going to do is create this general rule of ability to repay, and then within it, we're going to create a 'QM zone' that is going to be safe. We're going to give you the big universe – but we're going to give you a reward for being within QM.'’
The problem is regulators have ‘filled the non-QM world with so much liability and so much potential regulatory and reputational risk that no one wants to be outside of QM,’ Alba says. ‘They didn't think about that.
‘So, as of right now, there is no equilibrium,’ Alba adds. ‘You're either in or you're out, and there's no real way to ensure certainty if you're out. And that's the kernel of the debate right now.’
While Alba agrees that the new rules will result in a tightening of credit in the short term, he also believes that lenders will eventually find ways to work around the CFPB rules and bring new financial products to market; ‘it's just going to take some time.’
‘In the short term, we're going to see some lenders pull back and we're going to see some experiment,’ Alba says. ‘We will see some offer only half the amount of product they offer today, simply because they won't know if the other half is compliant. They will wait on lawsuits, they will wait for regulators to speak and they will wait for Congress to act – and eventually, we will come back to something close to what we have now.’
Alba says in his opinion, the biggest threat posed by the new rules is that of regulatory and/or civil action resulting from violations. He points out that the courts currently have no case law to work from; therefore, the new rules will be wide open to legal interpretation.
‘One of the uncertainties of all of this is how a court of law will apply these novel rules,’ Alba says. ‘And that's a complete unknown – which is why the banks are so nervous.
‘Think about a judge looking at a family that's going to lose their home – and suddenly, they uncover that there is fraud in the paper,’ he adds. ‘The fraud may have been perpetrated by an entity other than the lender. The rule on the books says you now have to verify and consider. So, if the judge is sympathetic to the homeowner, it's going to mean disaster for the lender.’
When asked why the new ATR/QM rules pose such a serious threat to the industry, Alba points out that ‘it's not any one particular element.’
‘It's not that this calculation makes it bad or that this disclosure makes it bad – the problem is that you're taking every underwriting condition and you're turning it into regulatory compliance rules,’ he says. ‘That wholesale transformation of underwriting into regulatory compliance is what makes this dangerous. Now you have a problem where very small technical rules can get you into trouble. If I have a consumer who has three jobs and I verify two but fail to verify the third, for some reason, I have now violated not just the rules of underwriting, I've violated the law.
‘In this sense, underwriting is being transformed into strict liability,’ he adds.