The ‘law of unintended consequences’ has become part of mortgage originators' lexicon over the past few years. Typically applied in description of the unforeseen effects of enacted legislation, this ‘law’ has been particularly relevant as of late with regard to the Consumer Financial Protection Bureau's (CFPB) new Ability to Repay rule and qualified mortgage (QM) protection for originators.
The premise of the new rule, as outlined in the Dodd-Frank Act, is relatively straightforward: ‘creditors [are required] to make a reasonable, good faith determination of a consumer's ability to repay.’ Lenders can further protect themselves from legal liability by adhering to a higher standard that includes a 43% debt-to-income (DTI) ratio and a 3% fee cap.
Taken at face value, these rules make a certain amount of sense: Make sure the borrower can repay the loan for which they are applying. Loans with high rates and fees that are offered to a borrower who may have significant existing non-mortgage debt obligations make it harder for the borrower to repay and, therefore, more risky for the lender to extend credit.
We, as an industry, intuitively understand that. The rub, as they say, lies in those pesky unintended consequences – in this case, the effect that tighter lending standards will have on the number of eligible borrowers available, particularly lower income borrowers.
In the first place, there appear to be differing opinions on just how many borrowers could potentially be shut out of the primary mortgage market. Some industry observers have openly stated that restrictions like the DTI and fee caps, and even the 10% down payment requirement being floated in the upcoming qualified residential mortgage standard, could potentially jettison more than 40% of all borrowers from the pool. Contrast that with the CFPB's own studies, which indicate less than 15% of borrowers could be affected. Either way, that is still a significant hit to overall volume.
Furthermore, the 3% cap on fees is a tough standard, especially when applied to smaller loans. Since it costs about the same for a lender to originate a small loan as a large one, the cap could make it difficult to turn a profit. In an industry where margins are already tight, this will most definitely have a disproportionate impact on low- to moderate-income Americans who would be more likely to seek a smaller, affordable mortgage in line with their ability to repay.
It is hoped that the limited seven-year exemptions for loans issued by the government-sponsored enterprises or insured by the Federal Housing Administration will allow for some flexibility here. Most loans with a high DTI ratio qualify for one of these exemptions. However, it is unclear what effect the expiration of these exemptions will have on the market.
There is also the rather thorny issue of affiliated business arrangements (ABAs). It is clear that the CFPB truly believes banks double-dip by virtue of these relationships. Surprisingly, many banks with ABAs appear to be digging in their heels, unwilling to divest their title and appraisal companies, as had been widely expected.
Under the new rules, these companies will be challenged by punitive fee calculations for the 3% cap compared to their competitors that have no such relationships. This, in turn, reduces choice and competition that naturally benefits borrowers.
Each of these challenges may have a direct impact on low- and moderate-income borrowers, which returns us directly to the core issue our industry has faced for the last four-plus decades – by tightening credit standards, large groups of underserved consumers will not have access to credit, resulting in them never being able to share in the opportunity to become a homeowner.
Further complicating matters is the fair lending disparate impact rule recently released by the U.S. Department of Housing and Urban Development. If a lender were to deny a loan based on the fact that it is not a QM, that would be a neutral policy that does not intentionally discriminate against one group or another, yet the lender could potentially be found to have engaged in discriminatory behavior if their Home Mortgage Disclosure Act data shows a disproportionately low amount of lending to people in protected groups.
As a result, the disparate impact rule may be the hammer the government has to finally force the industry to start making a significant volume of unprofitable loans, which could, as an unintended consequence, result in driving up the costs of new loans for all consumers.
Currently, there is a proposed amendment that may address some of these concerns. However, it seems like most of the amendment's attention is focused on getting temporary exemptions for special loans designed to help struggling borrowers through the current economic crisis rather than on long-term solutions to housing inequities.
In the coming months, we will see all of this play out. The CFPB has assumed a very active role in assisting the industry with the challenges presented. One of their next steps is to develop an ‘implementation plan’ and ‘readiness guides’ to help the industry better understand the new rules. Then, we will see ongoing updates to the official interpretations published as more and more questions come to light.
Roger Fendelman is an attorney and vice president of compliance at Interthinx, headquartered in Agoura Hills, Calif. Listen to his industry podcast, ‘From the Bar,’ at www.interthinx.com/solutions/predprotect.php.