In our initial article announcing our top 10 considerations for financial institutions in 2016, which can be found here, our eighth consideration was the Ability to Repay rules. This is another of the areas the Consumer Financial Protection Bureau (CFPB) has specifically identified as a priority for supervision and enforcement in 2016. Generally, under the Ability to Repay (ATR) rules, a creditor is required to make a reasonable, good-faith determination that the borrower(s) has the ability to repay the loan. While creditors have some flexibility to determine that a borrower has an ability to repay a mortgage loan, the CFPB will be looking for how that flexibility is being used, especially in the context of certain higher-risk loan categories.
Generally, the ATR rules, originally published on January 10, 2013,1 require that, prior to extending credit for the purchase of a residential property, creditors make a reasonable and good faith determination based on documented and verified information that the consumer has the ability to repay the loan according to its terms.2 The ATR rules apply to consumer credit transactions secured by a dwelling, as otherwise defined in Regulation Z,3 including any real property attached to a dwelling, with some exemptions.
When assessing a borrower(s) ability to repay, creditors generally must consider the following eight underwriting factors: the consumer’s current or reasonably expected income or assets; the consumer’s current employment status, if the creditor relies on employment income to determine ability to repay; the consumer’s monthly payment on the mortgage loan; the consumer’s monthly payment on any simultaneous loan the creditor knows or has reason to know about; the consumer’s monthly mortgage-related obligations; the consumer’s monthly debt obligations, alimony, and child support; the consumer’s monthly debt-to-income ratio or residual income; and the consumer’s credit history.4 Information relevant to these eight factors must also be verified with respect to each consumer.
In addition to the underwriting factors, when assessing a borrower(s) ability to repay, creditors must accurately calculate the payments the consumer will be obligated to make. Under the ATR rules, the creditor must generally calculate the monthly payment using the greater of the fully indexed rate or any introductory rate, and monthly, fully amortizing payments that are substantially equivalent.5 However, there are special rules associated with calculating the payments on loans with balloon payments, interest-only loans, and negative amortization loans.
Compliance with the ATR rules can be achieved in a few different ways. First, a creditor could follow the general ATR rules outlined briefly above. Second, a creditor could refinance a non-standard mortgage into a standard mortgage, under certain conditions, and will not be required to comply with the general ATR requirements outlined above.6 Finally, a creditor could originate one of four variations of a “qualified mortgage” (QM). QMs not only prohibit harmful loan features, such as interest only periods, negative amortization, balloon payments, and loan terms which exceed 30 years, but also contain limits on debt to income ratios and upfront points and fees.
The four types of QMs include what we refer to as the General QM, the Temporary QM, the Small Creditor Portfolio QM, and the Small Creditor Balloon Payment QM. In response to the special concerns of small creditors and to preserve access to nonconforming mortgages and mortgages in rural and underserved areas, there are special provisions for QMs held in portfolio by small creditors, including some types of balloon-payment mortgages, as long as the small creditor originated at least one covered mortgage on a property located in a rural or underserved area.
Whether a QM is deemed higher-price dictates the level of protection from liability a creditor is awarded. QMs that are not higher-priced are conclusively presumed to comply with the requirements of the ATR rules, and enjoy a safe harbor. If a court finds that the mortgage originated was a QM, such finding conclusively establishes compliance with the ATR rules. QMs that are higher-priced carry a rebuttable presumption of compliance with the ATR rules. Under the rebuttable presumption, if a court finds that the mortgage originated was a higher-priced QM, a consumer can argue that the creditor failed to make a reasonable, good-faith determination of the consumer’s ability to repay before making the loan. The ATR rules also permit a consumer to raise violations as a defense to foreclosure.