A coalition of mortgage lenders and industry associations is pushing the Consumer Financial Protection Bureau (CFPB) to eliminate the debt-to-income (DTI) ratio requirement from the ability-to-repay/qualified mortgage (ATR/QM) rule, should the agency move forward with its plan to eliminate the so-called “QM patch” in January 2021.
The QM patch – also known as the “GSE patch” – exempts government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac from having to adhere to a rule within ATR/QM that caps a borrower’s DTI ratio at 43%. That means the companies can underwrite, acquire and sell loans that exceed the 43% DTI threshold originated by the lenders they do business with.
The rule also does not apply to loans backed the federal government, including the Federal Housing Administration, Department of Veterans Affairs and Department of Agriculture.
In essence, lawmakers enacted the patch to level the playing field between the government agencies and the GSEs.
Although some in the mortgage industry assert that the QM patch gives Fannie and Freddie an unfair advantage, because loans sold to them do not have to meet the same requirements as loans backed by private capital, others argue that it is a necessity, as it enables lenders to better serve lower income and minority borrowers.
The main message the coalition is sending to the CFPB: Simply eliminating the patch without making adjustments to ATR/QM could have unintended consequences.
“The bureau has a unique opportunity to modify the ATR-QM rule to meet the needs of a changing housing market,” the coalition’s letter states. “Elimination of the DTI requirement for prime and near-prime loans would preserve access to sustainable credit for the new generation of first-time homebuyers in a safe and sustainable way and in accordance with the fundamental ATR requirements.
“This change is especially important for reaching historically underserved borrowers, including low- to moderate-income households, and communities of color,” the letter adds. “Household formation growth is being largely driven by communities of color throughout the nation.”
The coalition recommends that the DTI ratio requirement sunset at the same time as the patch, so as to avoid disruption to the mortgage and housing markets.
“The GSE patch has provided an alternative to the DTI ratio threshold, as well as relief from the rigid requirements for verifying and calculating income, assets, and debts for DTI ratios under Appendix Q for non-W-2 wage earners,” the letter states.
“The GSE patch has facilitated access to homeownership for approximately 3.3 million creditworthy borrowers who collectively represent nearly 20 percent of the loans guaranteed by the GSEs over the last five years,” the letter states. “But lending outside of the patch and the Federal Housing Administration channel has been limited largely because of the difficulty of complying with QM’s hard DTI cap and the related requirements of Appendix Q, while the patch has provided the regulatory certainty that was far more attractive to lenders.”
“After the patch expires, the best way to enable fair market competition across all lending channels while also ensuring that these creditworthy individuals can be served in a safe and sound manner under the existing ATR/QM framework is to eliminate the DTI ratio for prime and near-prime loans and with it Appendix Q,” the letter states.
The letter also calls for the CFPB to “maintain and enhance the existing ATR regulatory language” and “maintain the existing QM statutory safe product restrictions that prohibit certain risky loan features,” such as loan terms longer than 30 years, negative amortization and interest-only payments.
Among the prominent lenders in the coalition are Bank of America, Caliber Home Loans, Quicken Loans and Wells Fargo.
Industry groups include the Mortgage Bankers Association, American Bankers Association, Bank Policy Institute, Consumer Bankers Association, Center for Responsible Lending and Credit Union National Association, among others.
One reason the industry is keen on seeing the DTI ratio requirement eliminated is because lenders and the GSEs have been exploring the use of alternative credit score models that take into account payment history and alternative sources of income in underwriting, as opposed to just traditional W-2 income. This includes the use of alternative sources of credit data such as payment history on rent or utility bills. The DTI ratio requirement, however, limits how much lenders could explore and use these alternative credit score models.
The reason the industry is seeking to embrace these alternative credit score models is because of the increasing number of U.S. workers who are self-employed or who have alternate or additional sources of income that are not traditionally considered in underwriting. Lenders, in particular, see these “gig” workers as an underserved market that includes many creditworthy borrowers who could not otherwise get a mortgage under the current ATR/QM rule.
Part of the MBA’s rationale for doing away with the requirement is simply that DTI ratios are “not a strong predictor of a borrower’s ability to repay.”
“More specifically, the relationship between borrower DTI ratios and ability to repay, as indicated by early delinquency, is relatively weak,” writes Robert D. Broeksmit, president and CEO of the MBA, in a separate letter sent to the CFPB earlier this week.
“An assessment of historical Fannie Mae loan performance data conducted by the Urban Institute found that moving from the 40-45 percent DTI ratio range to the 45-50 percent range represented just a 7.7 percent increase in loan default risk when controlling for other relevant factors,” Broeksmit writes. “As the Center for Responsible Lending notes when discussing the practical import of this increase, ‘DTI is so weakly predictive for near-prime loans that for a thousand borrowers between 45% and 50% DTI, just two additional borrowers default, not nearly enough to warrant denying QM protections to the remaining borrowers.
“Recent research produced similar findings,” Broeksmit continues. “A study on the effects of the rule found that had the 43 percent DTI ratio threshold been in effect after 2004, ‘the policy would have reduced the five-year default rate by about 0.2 percentage points for loans originated in 2007 and 2008,’ a minor improvement considering ‘the 2007 cohort of loans experienced default rates as high as 24 percent after five years.’This conclusion is consistent with research conducted by the JPMorgan Chase Institute that found that borrowers’ financial buffers are significantly more indicative of their ability to repay than DTI ratios at origination.”
The MBA argues that allowing the patch to expire without making other changes to the ATR/QM rule could disproportionately impact lower-income borrowers including minorities.
“Since its inception, the GSE patch has served a crucial role in the mortgage market,” Broeksmit’s letter states. “By providing an exception to the strict 43 percent DTI ratio threshold and rigid income and debt verification requirements found in the QM general definition, the patch has facilitated access to credit for the large segment of creditworthy borrowers whose DTI ratios exceed 43 percent or whose sources of income prevent qualification through Appendix Q.
“In terms of loan volume, the impact of the patch has been significant,” he continues. “Of the roughly 6.01 million closed-end first-lien residential mortgage loans originated in 2018, the bureau’s estimates suggest roughly one-sixth, or 957,000 loans representing a total of $260 billion in originations, benefited from the GSE patch.”
In addition, “a recent study by CoreLogic examining the composition of this segment – loans purchased by the GSEs that did not meet the requirements for origination under the QM general definition – found that nearly 80 percent had DTI ratios greater than 43 percent, while the remaining 20 percent were to borrowers with non-W-2 wage income,” Broeksmit’s letter states.
What’s more, the number of non-traditional wage earners in the U.S. continues to grow. Broeksmit points to recent research conducted through the Internal Revenue Service’s SOI Joint Statistical Research Program which found that the share of the workforce with income from alternative, non-employee work arrangements has grew 1.9% from 2000 to 2016.
“This segment of non-W-2 wage earners ‘now accounts for 11.8 percent of the workforce,’” Broeksmit’s letter states. “Such trends support the continued need to accommodate sustainable lending to this segment of borrowers after the expiration of the GSE Patch.”
The letter goes on to state that, according to recent studies, “minority borrowers account for a disproportionate share of GSE loans with DTI ratios greater than 43 percent.”
“Based on this finding, we believe it is likely that these populations would be disproportionality harmed by the expiration of the GSE patch,” the letter states.
Broeksmit concludes: “Expiration of the patch without necessary reforms to the existing QM general definition would cause significant short- to medium-term disruption to the mortgage market. To avoid these disruptions, the bureau should reform the QM standard by eliminating the rigid 43 percent DTI ratio threshold and any reliance on Appendix Q as a documentary standard. Neither of these reforms undermines the crucial product feature limitations embedded in the ATR/QM Rule nor impacts the critically important safe harbor that allows lenders the ability to understand the scope of their liability.”
The National Association of Realtors (NAR) also weighed in on the CFPB’s proposal.
“The [ATR/QM] rule should be flexible enough to adopt to changing life patterns in order to ensure homeownership remains within reach for Americans who lack traditional income documentation,” writes John Smaby, president of NAR, in a separate letter to the CFPB released on Tuesday.
“Underwriting is the foundation upon which America’s housing finance system is built. The CFPB’s rules process should not be rushed as the re-evaluation of the patch and a market-wide QM require a thorough vetting of alternatives and their impact on both competition and consumer access.”