On July 25, 2019, the CFPB issued an Advance Notice of Proposed Rulemaking (“ANPR”) on the definition of a “qualified mortgage” under its ability-to-repay/qualified mortgage rule (“ATR/QM rule”).[1] The ATR/QM rule requires a creditor to make a reasonable and good faith assessment of a borrower’s reasonable ability to repay most residential mortgage loans before the loan is made.[2] A creditor that makes a QM is either conclusively determined (for non-higher priced loans) or rebuttably presumed (for higher-priced loans) to have complied with the ATR/QM/QM rule.[3]

The ATR/QM rule delineates several types of QMs, most significantly including a class consisting of loans eligible for sale to or guarantee by Fannie Mae or Freddie Mac (the temporary GSE QM classification). The majority of home purchase loans made today fall into the temporary GSE QM classification.[4] The ANPR announces that the Bureau will let this classification sunset on January 10, 2021 (or earlier, in the unlikely event that the GSEs exit the conservatorship of the Federal Housing Finance Agency), and seeks comment on possible changes to the ATR/QM rule to facilitate a smooth transition. Comments are due 45 days from publication of the ANPR in the Federal Register.

Origin of the Temporary GSE QM Classification

The current ATR/QM rule includes a “general QM” classification, which caps a borrower’s debt‑to‑income (“DTI”) ratio at 43% and requires the creditor to verify and calculate income, assets, and debts according to the FHA’s 2013 underwriting guidelines (found in the CFPB’s Appendix Q).[5] The temporary QM classification covers loans eligible for purchase or guarantee by the GSEs. While there are various differences between the GSEs’ underwriting standards and the CFPB’s general QM classification, the most significant difference is that the GSEs allow the borrower’s DTI ratio to exceed 43%. The ANPR suggests that the GSEs have used a DTI ratio cap of 45%.[6] However, the ANPR acknowledges elsewhere that, of the GSE loans made in 2018 with DTI ratios over 43%, 69% had DTI ratios over 45%.[7] At the time of its promulgation, the temporary GSE QM classification was designed to sunset no later than January 10, 2021, to allow time for the market to transition to the general QM definition.[8]

However, the Bureau has found that the temporary GSE QM classification continues to dominate the conventional home purchase market, comprising 71% of that market in 2017.[9] The ANPR states that while the Bureau may provide a short extension, it does not intend to make the temporary GSE QM classification permanent.[10] The Bureau explains that a permanent GSE QM classification was not intended when it issued the ATR/QM rule in 2013, and it is concerned about permanent reliance on the GSEs’ underwriting standards, noting that “one GSE loosened its underwriting standards in ways that proved unsustainable” in the lead up to the mortgage crisis.[11] The Bureau also explained that retaining the temporary GSE QM could stifle innovation and the reappearance of a private mortgage market.[12]

What Happens if the Temporary GSE QM Classification Expires?

The Bureau expects the expiration of the temporary GSE classification to impact borrowers who are ineligible for general QM loans because their DTI ratios exceed 43% (“high DTI borrowers”).[13] In 2018, high DTI borrowers comprised 16% of all closed-end first lien residential mortgage originations -- about 957,000 loans.[14] Although some high DTI borrowers could qualify for FHA loans, since FHA insures loans to borrowers with DTI ratios up to 57%, there are various potential limitations on the number of these borrowers who actually could obtain FHA loans. For example, the Bureau notes that 11% of high DTI borrowers likely will not qualify for FHA insurance because their requested loan amounts exceed the FHA’s loan limits.[15]

The ANPR suggests that some high DTI borrowers might be able to get loans originated by small creditors whose loans are deemed to be QMs if held in portfolio, or by other creditors willing to make non-QM loans.[16] According to the ANPR, this would depend on whether “actors in the private market are willing to assume the credit risk associated with funding High-DTI GSE loans.”[17] In this regard, the Bureau notes that competition could spring up, because 55% of high DTI borrowers in 2018 had credit scores of at least 680 and loan‑to‑value ratios of 80% or less.[18] That said, the ANPR implicitly recognizes that the willingness of the private market to step up and make loans to high DTI borrowers is entirely speculative.

The ANPR further states that while some high DTI borrowers will not be able to get loans, others may “make different choices,” including adjusting “their borrowing to result in a lower DTI ratio.”[19] In particular, the ANPR seeks comment on how the CFPB could ensure a smooth transition from the temporary GSE QM classification to the general QM classification, including how much time the industry will need to make that transition.[20]

Should the Bureau Revise the General QM Classification’s Reliance on DTI Ratios?

The ANPR states that the Bureau is considering whether the general QM definition should continue to include “a direct measure of a consumer’s personal finances, such as a DTI ratio or residual income, and how that measure should be structured,” and whether there is “an alternative method for assessing financial capacity.”[21] To that end, the Bureau asks for comments in response to several questions about various measures of a consumer’s personal finances, including:

  • Should the general QM classification include only a DTI ratio limit, or replace, or supplement, that limit with residual income or some other measure?
  • If the general QM classification continues to include a DTI ratio, should the 43% limit be modified?
  • Should the rule include compensating factors for a higher DTI ratio?

In addition, the ANPR, acknowledges some of the problems associated with Appendix Q, such as its rigidity in documenting debt and income and the difficulty in applying its rules for making DTI calculations. The ANPR notes that stakeholders report that these problems are particularly acute for self-employed consumers, consumers with part-time employment, and consumers with irregular or unusual income streams. We would note that these issues are likely to become even more problematic over time as more potential borrowers derive income from the gig economy and other non-traditional sources. Thus the ANPR poses the following questions:

  • What standards should be used to calculate and verify debt and income?
  • Should the Bureau retain Appendix Q, modify it, or require, or allow, creditors to use another standard?

Because the Bureau is considering using alternatives (e.g., credit scores or loan-to-value ratios) to DTI ratios and other direct measures of a consumer’s personal finances, the Bureau asks several questions, including:

  • Are alternative measures consistent with the purposes of the ATR rule? What are the advantages and disadvantages of using alternatives to DTI ratios?
  • If the Bureau adopts an alternative measure, should the rule:
    • Continue to grant a safe harbor to loans with APRs that exceed the Average Prime Offer Rate by less than 150 basis points, and only a rebuttable presumption of compliance for loans with higher rate spreads?
    • Continue to permit consumers to rebut a presumption of compliance for higher-priced transactions by showing they lacked sufficient residual income to pay basic living expenses of which the creditor was aware?

Policy Issues Stemming from Expiration of the Temporary GSE QM

The potential impact of eliminating the temporary GSE QM classification cannot be overstated. The ANPR acknowledges that nearly one million mortgage loans made in 2018 would not have met the general QM test. It appears likely that the vast majority of those loans simply would not have been made. The ANPR states that the FHA and the private mortgage market may fill the void once the temporary GSE QM classification expires, but it is not at all clear that the private mortgage market will step up in this way.

The ANPR discusses the possible market impact of an expired temporary GSE QM classification, but it will be necessary to dig far deeper to fully appreciate the consequences. If hundreds of thousands of potential borrowers can no longer qualify for a residential mortgage loan, what impact will this have on the U.S. economy? Who are the groups that will be most affected – residents of low- and moderate-income communities, minority groups that historically had more difficulty accessing good mortgage financing, and young adults with student debt? What are the social consequences if mortgage loans are no longer readily available to so many people? How will a significant reduction in mortgage originations affect banks and savings associations that are required by the Community Reinvestment Act to meet the credit needs of their local communities? It remains to be seen how the Bureau will tackle these important issues.