CFPB: Re-Opening "Ability-to-Repay"

On June 5, 2012, the Consumer Financial Protection Bureau (Bureau) announced that it is "reopening the comment period" for the proposed rule, issued on May 11, 2011 by the Federal Reserve Board (Board), addressing the new ability-to-repay requirements that generally will apply to consumer credit transactions secured by a dwelling and the definition of a "qualified mortgage."

The ability-to-repay requirements were set forth in the May 11, 2011 proposal to amend Regulation Z (the implementing regulation of the Truth in Lending Act (TILA) to implement amendments to TILA made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

Since then, pursuant to Dodd-Frank, the Board's rulemaking authority for TILA was transferred to the Bureau as of July 21, 2011. The original comment period to the proposed rule closed on July 22, 2011.

The Bureau is reopening the comment period until July 9, 2012 to seek comment specifically on certain new data and information submitted during or obtained after the close of the original comment period.

I have written extensively about the ability-to-repay. And I would urge you to read some of these articles to become familiar with these important requirements:*

Ability-to-Repay: Regulating or Underwriting? Part I
Ability-to-Repay: Regulating or Underwriting? Part II
Ability-to-Repay: The Basics and a Chart
Ability-to-Repay: The Chart
Ability-to-Repay: Additional Analysis
FRB: Proposes Rule - Ability-to-Repay

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IN THIS ARTICLE

History

New Data

Questions and Comments

Litigation and Liability

Foreclosure

Litigants and Complaints

Outcomes from Litigation

Factors or Costs

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History

Sections 1411, 1412, and 1414 of the Dodd-Frank created new TILA section 129C, which, among other things, established new ability-to-pay requirements. If a mortgage is a so-called "qualified mortgage," the compliance with the ability-to-repay rule would offer a presumption of compliance.

The word 'presumption' is a dispositive word in this proposal. Please keep the phrase "presumption of compliance" in mind as you read through this brief outline.

On May 11, 2011, the Board published for notice and comment a proposed ability-to-repay rule, amending Regulation Z to implement new TILA section 129C. The comment period for this initial proposal closed on July 22, 2011.

Then, on July 21, 2011 Dodd-Frank transferred the Board's rulemaking authority for TILA, among other consumer financial protection laws, to the Bureau. Accordingly, all comment letters on the proposed rule were also transferred to the Bureau. According to the Bureau, in response to the proposed rule approximately 1800 comment letters were received from numerous commenters, including members of Congress, lenders, consumer groups, trade associations, mortgage and real estate market participants, and individual consumers.

Even after the comment period closed, various interested parties, including industry and consumer group commenters, submitted to the Bureau oral and written ex parte presentations on the proposed rule.

Through various comment letters, ex parte communications, and the Bureau's own collection of data, the Bureau has received additional information and new data pertaining to the proposed rule.

The Bureau is now interested in providing opportunity for additional public comment on these materials. Thus, it is reopening the comment period until July 9, 2012, in order to request comments specifically on certain additional information or new data, but not other aspects of the proposed rule already submitted previously.

So, what are the new data?

New Data

The Bureau now seeks comment on mortgage loan data that the Bureau has received from the Federal Housing Finance Agency (FHFA). To date, the Bureau has received a sample drawn from the FHFA's Historical Loan Performance (HLP) data along with tabulations from the entire file.

The data include a one percent random sample of all mortgage loans in the HLP data from 1997 through 2011. Tabulations of the HLP data by the FHFA show the number of loans and performance of those loans by year and debt-to-income (DTI) range.

The HLP data consists of all mortgage loans purchased or guaranteed by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (jointly, the GSEs), but does not include loans backing private-label mortgage-backed securities (MBS) bought by the GSEs.

The data contains loan-level information on characteristics and performance of all single-family mortgages purchased or guaranteed by the GSEs. FHFA updates the HLP data quarterly with information from each GSE.

Among other elements, the data includes product type; payment-to-income and debt-to-income (PTI/DTI) ratios at origination; initial loan-to-value (LTV) ratios based on the purchase price or appraised property value and the first-lien balance; and credit scores.

The Bureau proposes to use these data to tabulate volumes and performance of loans with varying characteristics and to perform other statistical analyses that may assist the Bureau in defining loans with characteristics that make it appropriate to presume that the lender complied with the ability-to-pay requirements or assist the Bureau in assessing the benefits and costs to consumers, including access to credit, and covered persons of, as well as the market share covered by, alternative definitions of a "qualified mortgage."

Riding the Horse Backwards

At a DC conference, dauntingly titled Mortgage Regulatory Forum, Barney Frank, the Congressman from Massachusetts whose name eponymously joins Dodd in the landmark Dodd-Frank Act, spoke about a "revolt" against the risk retention regulations embodied in the Qualified Residential Mortgage rules required by that Act.

We've heard about this risk retention requirement by its euphemistic cognate, rather barbarically described as to "keep skin in the game." I will be publishing a comprehensive article soon about the Act's provision regarding this "skin in the game" mandate. And I will see that you get a copy of the article. For the time being, though, maybe we should reflect a bit on Congressman Frank's worries.

But first, before speculating on Frank's musings about a revolution, let's begin with a story.

Snideley Whiplash and Dudley Do-Right

You might remember the cartoon character Dudley Do-Right of the "Dudley Do-Right of the Mounties" series, a part of the Rocky and Bullwinkle show. Dudley was forever saving Nell Fenwick, Mountie Inspector Fenwick's beautiful daughter, from the machinations of the evil Snideley Whiplash and Tuque, his equally nefarious sidekick. Whereas Dudley is garbed in the bold red uniform with shiny gold buttons of the Royal Canadian Mounted Police, Snidely wears black on black: suit, cape, stove pipe hat, boots - even a black, twisted, handlebar moustache.

Snidely was bent on doing naughty things to the hapless Nell, like tying her to a railroad track. And Snideley's arrogance was only exceeded by his sheer joy when conniving some evil exploit to be perpetrated on the innocent.

But Dudley would save Nell, usually just by dumb luck, free her from the railroad tracks, and boldly stand before her in a puffed-up, prideful "my hero" pose. And then Nell would thrillingly come running into Dudley's open arms, thanking him profusely for saving her!

Actually, no. Nell never did run into Dudley's arms. That just never happened. Not even once!

In fact, Nell would show her gratitude not to Dudley but to Dudley's horse, aptly named Horse, also dressed up like a Mountie. Dudley often rode Horse backwards, galloping boldly to the scenes of Snideley's pernicious schemes.

Even when Dudley had freed Nell from the chains holding her to the railroad tracks, she would hardly notice him. Instead, she gently stroked Horse's snout and elicited his big, charming, toothy smile. For the most part, Nell ignored Dudley, even when he saved her from Snideley's perilous plans.

Poor Dudley Do-Right! He really never did get the grateful recognition he thought he deserved. He never did win Nell's hand in romance. And yet Dudley never gave up on seeing himself as the bold hero responding with courageous alacrity to Nell's call of distress!

"Skin in the Game"

In a proposed rule issued by federal financial regulators, and pursuant to Dodd-Frank, there will soon be a requirement for sponsors of certain asset-backed securities to retain at least 5% of the credit risk of the assets underlying the securities. For "asset-backed securities" read mortgage securitizations. This is being referred to as "risk retention," or that "skin in the game" phrase I mentioned above.

According to those in favor of risk retention, the purpose of this rule is to coalesce underwriting guidelines into an incentivized alignment with securitizers and investors, through promoting a certain set of underwriting standards. The risk retention provision would exempt asset-backed securities that are collateralized exclusively by residential mortgages that are eligible as "qualified residential mortgages," now known, of course, as QRMs.

Many regulators have signed on to the QRM and risk retention provisions, since their view essentially is that "credit risk retention," the name given to the QRM concept, should be required because they believe it encourages prudent underwriting and securitization.

However, consider this: it is simply not known if 5% is even the appropriate amount of risk to be retained in order to align incentives! Indeed, there is scant statistical support for any such percentage whatsoever.

From a Distance

From a high altitude of consideration, the composite criteria of a QRM are the "plain vanilla" variety perfectly familiar to residential mortgage loan originators: 80% LTV; 20% down payment plus closing costs; 28% front-end ratio, and 36% back-end ratio.

Underwriting to the QRM guidelines means that securities backed by QRMs will not require securitizers to retain credit risk. Of course, there's far more to what constitutes a QRM and how it is structured. 

Recently, I spoke with a supervising prudential regulator, an old friend, and asked if QRM will crowd out the development of other products that could serve the consumer. His view was that the QRM criteria allow for innovation and, in any event, if they adversely affect a consumer's access to credit, then QRM standards may need to be changed. I must admit, I do not find that response very satisfying.

Markets are active, not passive. Much too often, though, regulatory requirements tend to be reactive, rather than responsive, mostly due to politicians catering to their constituencies and lobbyists. Since when did politicians and regulators so fully replace market action or override underwriting models that lenders undertake as part of making a market, pricing in risk, and developing loan products that respond to consumer needs?

"Revolt"

Congressman Frank seems to have concluded that the recent economic meltdown was largely caused by the housing bubble - presumably, that would be the housing bubble that he declared would never take place. So, "credit risk retention" is now being advanced as a policy that can help to avoid another housing bubble.

Here's the prevailing narrative: in 2008 and 2009, we went into the Great Recession, and now we're experiencing high unemployment and weak growth. Was the housing bubble the ultimate cause?

Most people seem to think so. They believe that the housing bubble burst in 2006 and led to a severe financial crisis in 2008, intensifying a recession that had begun in December 2007. And the Fed did what it could, through targeting inflation to prevent the crash, but could not stem the tide.

Here's another narrative, one actually supported by facts: the housing crash did not lead directly to a recession or high unemployment, although it seems to have been a proximate cause.

More than two-thirds of the decline in housing construction happened between January 2006 and April 2008. During that period, though, the unemployment rate rose only slightly, from 4.7% to just 4.9%. And statistics demonstrate that most of the workers who lost jobs in housing construction were subsequently reemployed in other fields. It wasn't until October 2009 that unemployment soared to 10.1%, with job losses spread out across almost all sectors of the economy.

Indeed, the financial crisis did have its roots in the housing bubble, and there were consequent systemic failures of financial institutions, yet for some odd reason this situation did not set off alarm bells at the Fed until much too late.

There is a world of difference between a proximate cause and the ultimate cause.

Bottom Line: monetary policy failed to predict the problem and the Fed did not respond soon enough.

Fallacy of the "Blame Game"

The assumptions of the first narrative have dominated politics and have led to the QRM remedy.

Thus it is that we have this statement from Mr. Frank:

"I am disappointed at this revolt against risk retention that was so clearly at the center of this."

"All the other problems we had ... they all centered on the system for selling to other people loans that shouldn't have been made in the first place."

"It's simply not possible with any conceivable number of regulators to monitor every loan. If the people making the loans do not have an incentive not to lend to people who can't repay, there is no way we will prevent those kinds of loans from being made." (My emphasis.)

That sweeping statement is certainly not supported by the facts. I have discussed this fallacy of the "blame game" in detail elsewhere, for instance in my three-part series on the Dodd-Frank legislation.

Yet the "revolt" is not just coming from lenders. Consumer advocacy groups want to ensure homeownership for qualified borrowers among low and middle income families, without having to be turned away due to a market that has been deincentivized from lending to them.

Nell and the Horse

Maybe there was a really good reason why Nell preferred to show her gratitude to the Horse, rather than to drape herself around Dudley Do-Right's neck in gleeful appreciation and unbounded thanks.

I wonder if you could suggest what Nell's reason might have been.

What do you think?

Please feel free to comment!

Jonathan Foxx is the President and Managing Director of Lenders Compliance Group.

Ability-to-Repay: The Basics and a Chart

Commentary By: Jonathan Foxx
President and Managing Director of Lenders Compliance Group

On May 11, 2011, the Federal Reserve Board (FRB) issued a proposed rule (Rule) to implement ability-to-repay requirements for closed-end residential loans.[i] The Rule implements Section 1411, Section 1412, and part of Section 1414 of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010 (Dodd-Frank).[ii] Comments on the Rule are to be received by no later than July 22, 2011.[iii] Having published the proposed Rule, the FRB retired from its involvement in this matter and handed over its rulemaking authority in the subject statute to the Consumer Financial Protection Bureau (CFPB) on July 21, 2011.[iv]

As a revision to Regulation Z (the implementing regulation of the Truth in Lending Act), the Rule requires creditors to determine a consumer’s ability to repay a mortgage before making the loan and would also establish minimum mortgage underwriting standards. The Rule applies to any consumer credit transaction secured by a dwelling, except an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan or ‘‘bridge’’ loan with a term of 12 months or less. [v] It appears that the Rule applies to purchase money and refinances, but not modifications of existing mortgages. There is a prohibition on prepayment penalties unless the mortgage is a prime, fixed rate, qualified mortgage - and unless the amount of the prepayment penalty is limited.

The Rule sets forth limits on prepayment penalties, the lengthening of the time creditors must retain records evidencing compliance with the ability-to-repay and prepayment penalty provisions, a prohibition to evading the Rule by structuring a closed-end extension of credit as an open-end plan, the delineation of new terms, procedures, and their resulting implications, and, very importantly, the means by which the Rule claims to offer tools to prevent likely default and mitigate risk for creditors and others who arrange, negotiate, or obtain an extension of mortgage credit for a consumer in return for compensation or other monetary gain.

Complying with the requirements of the ability-to-repay Rule is essential, because borrowers in a foreclosure proceeding will likely claim that the creditor failed to comply with the Rule as a defense by way of recoupment or set off, without regard to the normal statute of limitations under the Truth-in-Lending Act (TILA).[vi] A violation of the Rule subjects the creditor to the TILA civil monetary penalties, plus the same enhanced civil remedies that apply to violations of TILA’s high-cost loan rules,[vii] and TILA also would authorize state attorneys general to bring actions for violations of the Rule for a period of up to three years.[viii]

A loan that is a covered transaction must qualify, among other things, as a “qualified mortgage” if the creditor wishes to include a prepayment penalty in the loan.

The Rule provides a presumption of compliance with the ability-to-repay requirements if the mortgage loan is a ‘‘qualified mortgage,’’ which does not contain certain risky features and limits points and fees on the loan. Furthermore, one feature of a higher-risk mortgage loan (i.e., subject to enhanced appraisal requirements under Dodd-Frank § 1471) is the loan may not be a qualified mortgage.[ix]

There are four (4) options to the determination of compliance with the Rule. The Rule refers to these origination options as “methods” and equips each method with a description of (1) limits on the loan features or term, (2) limits on points and fees, (3) underwriting requirements, and (4) payment calculations.

Option # 1: General Ability-to-Repay Standard

A creditor can meet the general ability-to-repay standard or test by:

• Considering and verifying the following eight (8) underwriting factors:

1. Income or assets relied upon in making the ability-to-repay determination;

2. Current employment status;

3. The monthly payment on the mortgage;

4. The monthly payment on any simultaneous mortgage;

5. The monthly payment for mortgage-related obligations;

6. Current debt obligations;

7. The monthly debt-to-income ratio, or residual income; and

8. Credit history.

• Underwriting the payment for an adjustable-rate mortgage based on the fully indexed rate.

Comment: This is an option that will be carefully reviewed by plaintiff’s counsel in an action to challenge a creditor’s compliance with the Rule. Consequently, enforcing compliance with the Rule will require fully vetted, tested, and continually updated, written procedures to govern every aspect of the application and underwriting process. Without clear and unambiguous policies and internal enforcement of appropriate policies and procedures, the creditor is allowing exposure to such a challenge. This option contains rigorous underwriting criteria and requires unmitigated, fact-based evaluations. Option # 1- the ability-to-repay test - is somewhat unstable (due to the invariant rigors of procedural compliance) though a relatively favorable methodology for the creditor, even if the loan flow process leaves very little room for error.

Option # 2: Qualified Mortgage (QM)

A creditor can originate a “qualified mortgage,” which provides special protection from liability. Two alternative definitions of a “qualified mortgage” are being considered by the CFPB:

Alternative # 1: Provides a legal safe harbor and defines a “qualified mortgage” as a mortgage for which:

· The loan does not contain negative amortization, interest-only payments, or a balloon payment, or a loan term exceeding 30 years;

· The total points and fees do not exceed three (3%) percent of the total loan amount;

· The income or assets relied upon in making the ability-to-repay determination are considered and verified;[x] and,

· The underwriting of the mortgage (a) is based on the maximum interest rate that may apply in the first five years, (b) uses a payment scheduled that fully amortizes the loan over the loan term, and (c) takes into account any mortgage-related obligations.

Alternative # 2: Provides a rebuttable presumption of compliance and would define a “qualified mortgage” as including the criteria listed under Alternative # 1 (above) as well as additional underwriting requirements from the general ability-to-repay standard (see Option # 1). In any event, under Alternative # 2, the creditor would also have to consider and verify:

· The consumer’s employment status;

· The monthly payment for any simultaneous mortgage;

· The consumer’s current debt obligations;

· The monthly debt-to-income ratio or residual income; and

· The consumer’s credit history.

Comment: Two alternatives are given: in Alternative # 1, to obtain a legal safe harbor, the creditor must consider and verify the borrower’s current or reasonably expected income or assets to determine the borrower’s repayment ability; and, in Alternative # 2, to obtain a rebuttable presumption of compliance, the creditor must consider and verify the borrower’s current or reasonably expected income or assets (i.e., other than the value of the dwelling in question), the borrower’s current employment status (assuming the creditor relies on employment income), the borrower’s monthly payment on any simultaneous loan, the borrower’s current debt obligations, the borrower’s monthly DTI or residual income, and the borrower’s credit history. It should be noted that the second alternative is for the most part similar to the ability-to-repay test.

Ability-to-Repay: Regulating or Underwriting? Part II

Jonathan Foxx is the President and Managing Director of Lenders Compliance Group.

Click below to download my article:

ABILITY-TO-REPAY:

REGULATING OR UNDERWRITING?

Part II

It has been published in the National Mortgage Professional Magazine - July 2011.

I am providing this article to you as a courtesy, for your personal use. I hope you enjoy it.

Please feel free to contact me at any time.

EXCERPT # 1

It seems to me that the imposition of an ability-to-repay requirement as a regulatory mandate is an admission that market forces cannot discipline lenders or incentivize lenders to act in their own self-interest. 

This is an obvious shift in liabilities, because this mandate shifts the burden of compliance to the lenders in order to assure that their contractually bound borrowers can pay back their loans. Parties to any contract can become adversaries! 

In other words, the relationship between the creditor and the borrower is innately affected and extensively undermined by this Rule, inasmuch as it imposes a new kind of theory for a regulatory framework and, in my estimation, infantilizes lenders by making them comply with a regulator's ad hoc way of rationing the extension of credit.

ABILITY-TO-REPAY:

REGULATING OR UNDERWRITING?

Part II

EXCERPT # 2

If the rationing of credit is meted out through this regulatory construct, it can be legitimately asserted as well that lenders are not arms-length, contractual counterparties; that is, lenders now will have a duty to assess a prospective borrower's ability to repay, irrespective of collateral value and securitization.

This change in the dynamics between and the inherent, due diligence tension among the parties to a residential mortgage transaction raise serious issues about the systemic consequences soon to be engendered.

ABILITY-TO-REPAY:

REGULATING OR UNDERWRITING?

Part II

Ability-to-Repay: Regulating or Underwriting? (Magazine Article)

COMMENTARY: by JONATHAN FOXX

Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is President and Managing Director of Lenders Compliance Group, the nation’s first full-service, mortgage risk management firm in the country.

I think you may be interested in reading my article in the June 2011 edition of National Mortgage Professional Magazine, entitled:

Ability-to-Repay: Regulating or Underwriting?

The article is Part I of a two-part magazine series.

As you may know, on May 11, 2011, the Federal Reserve Board (FRB) issued a proposed rule (Rule) to implement ability-to-repay requirements for closed-end residential loans.

The Rule implements Section 1411, Section 1412, and part of Section 1414 of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010.  Comments on the Rule are to be received by no later than July 22, 2011. 

But, having published the proposed Rule, the FRB will soon retire from its involvement in this matter, because it will hand over its rulemaking authority in the subject statute to the Consumer Financial Protection Bureau (CFPB) on July 21, 2011.

Thus, the promulgation of the final Rule will be under the aegis of the CFPB.

In this article, I explore some of the salient features of this Rule, noting particularly that, as a revision to Regulation Z (the implementing regulation of the Truth in Lending Act), it requires creditors to determine a consumer's ability to repay a mortgage before making the loan and would also establish minimum mortgage underwriting standards.

The Rule applies to any consumer credit transaction secured by a dwelling, except an open-end credit plan,  timeshare plan, reverse mortgage, or temporary loan or ''bridge'' loan with a term of 12 months or less. It includes a closed-end home improvement loan on a vacation residence.

It appears that the Rule applies to purchase money and refinances, but not modifications of existing mortgages.

There is a prohibition on prepayment penalties unless the mortgage is a prime, fixed rate, qualified mortgage, and unless the amount of the prepayment penalty is limited.

As a courtesy, I am sharing this magazine article with you. I hope you enjoy reading it! 

Excerpt # 1

Complying with the requirements of the ability-to-repay Rule is essential, because borrowers in a foreclosure proceeding will likely claim that the creditor failed to comply with the Rule as a defense by way of recoupment or set off, without regard to the normal statute of limitations under the Truth-in-Lending Act (TILA). 

A violation of the Rule subjects the creditor to the TILA civil monetary penalties, plus the same enhanced civil remedies that apply to violations of TILA's high-cost loan rules, and TILA also would authorize state attorneys general to bring actions for violations of the Rule for a period of up to three years.

Excerpt # 2

A loan that is a covered transaction must qualify, among other things, as a "qualified mortgage" (QM) if the creditor wishes to include a prepayment penalty in the loan.

The Rule provides a presumption of compliance with the ability-to-repay requirements if the mortgage loan is a ''qualified mortgage,'' which does not contain certain risky features and limits points and fees on the loan.

Furthermore, one feature of a higher-risk mortgage loan (i.e., subject to enhanced appraisal requirements under Dodd-Frank § 1471) is the loan may not be a QM.  (Under Dodd-Frank § 941, a "qualified residential mortgage" may not be broader in scope than a QM as defined in the Rule.) 

Ability-to-Repay: Review and Discussion

COMMENTARY: by JONATHAN FOXX

Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is President and Managing Director of Lenders Compliance Group, the nation’s first full-service, mortgage risk management firm in the country.

On Thursday of this week (6/23/11), I will be speaking at the Empire State Mortgage Bankers Association.

Topic

Ability-to-Repay: 

Regulating or Underwriting?

Time and Venue

This speaking engagement will coincide with the publication of my forthcoming article on this subject in the National Mortgage Professional Magazine.

On May 11, 2011, the FRB issued a proposed rule (Rule) intended to implement ability-to-repay requirements for closed-end residential loans.

The Rule implements Section 1411, Section 1412, and part of Section 1414 of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010. Comments on the Rule are to be received by no later than July 22, 2011.

We notified you recently about this proposed Rule here, here, and here.

In my remarks, I will explore some of the salient features of the Rule, noting particularly that, as a revision to Regulation Z, it requires creditors to determine a consumer's ability to repay a mortgage before making the loan and would also establish certain minimum mortgage underwriting standards.

We will review how violations of the Rule would be incurred, the exposure to regulatory risk, and the ways by which a loan originator may be deemed or presumed to be in compliance with the Rule. I will also discuss how Qualified Mortgages (QMs) offer a safe harbor.

Attendants will receive:

• Ability-to-Repay Chart
• Magazine Article
• Complete June Edition 

I look forward to seeing you soon!

Ability to Repay - Additional Analysis

In our Tuesday (4/19/11) newsletter and also in our post we notified you of the FRB's proposed amendments to Regulation Z that would set out how residential mortgage lenders would be required to determine a consumer's ability to repay a mortgage (Proposal). 

The Proposal would define what are termed "qualified mortgages" and also set minimum underwriting standards for many mortgages.

The proposed amendments, which are required by the Dodd-Frank Act (DFA), also would implement limits on prepayment penalties and attempt to prevent lenders from evading the rules.

In today's review, we will provide further analysis of the Proposal.

Comment Period: Until July 22, 2011.

Because the Consumer Financial Protection Bureau (CFPB) will take over Regulation Z rulemaking authority on July 21, 2011, the FRB has said that it will not be taking final action on the proposal and that the comments it receives will be transferred to the CFPB.

Loan Products

The Proposal would apply the ability-to-repay requirement to nearly any consumer credit plan secured by a dwelling, but it would exclude open-end credit plans, reverse mortgages, construction or other temporary loans with terms of 12 months or less, and timeshare plans. 

The FRB claims that the proposed requirements are similar to those it adopted for higher-priced mortgages in July 2008 under the Home Ownership and Equity Protection Act (HOEPA), but they would apply to mortgages that are not higher-priced and those that are not secured by the consumer's principal dwelling.

Ability to Repay

The DFA prohibits a lender from making a mortgage loan unless it has made "a reasonable and good faith determination, based on verified and documented information, that the consumer will have a reasonable ability to repay the loan, including any mortgage-related obligations." Examples of "mortgage-related obligations" are property taxes and homeowners' association assessments.

8 Criteria

A consumer's individual ability to repay uses 8 criteria:

1. the income or assets the lender is relying on in making its decision;
2. the consumer's current employment status;
3. the mortgage's monthly payment;
4. the monthly payment on any other mortgages on the property, such as home equity lines of credit;
5. the monthly payment for all mortgage-related obligations;
6. the consumer's other current debt obligations;
7. the consumer's monthly debt-to-income ratio or residual income; and
8. the consumer's credit history.

Special Features

If the mortgage includes an adjustable interest rate, it must be underwritten based on the fully indexed interest rate, or based on the introductory rate if that is higher than the fully indexed rate.

Features such as balloon payments, interest-only payments and negative amortization would not be prohibited. However, there would be strict underwriting standards.

Refinancing: "Nonstandard" into a "Standard" Mortgage

The lender is required to consider and verify the consumer's income and assets, if the lender is refinancing a mortgage loan and also adding certain features to the loan, such as a balloon payment, negative amortization, or interest-only payments. Notwithstanding this requirement, all the other aforementioned criteria must be considered.

The consumer must qualify for the loan based on the highest interest rate that could be imposed in the first five years after consummation, rather than over the life of the loan. There would be a requirement to satisfy limits on points and fees and the loan must materially reduce the consumer's monthly payments. Importantly, the refinancing option would be available only if the consumer is not delinquent under the existing mortgage.

Qualified Balloon Loan - Rural or Underserved Area

Some balloon loans would be considered to be qualified mortgages in rural and underserved areas. These loans would not only comply with all of the other criteria for a qualified mortgage but also would need to be underwritten based on scheduled payments other than the balloon.

Prepayment Penalties

The DFA provides limits on prepayment penalties. A prepayment penalty would be permitted only in the case of a prime, fixed-rate mortgage that meets the criteria for being a qualified mortgage.

The amount of the permitted penalty would decrease with the passage of time; for instance, a 3% penalty would be permitted in the first year of the loan, a 2% penalty in the second year, and a 1% penalty in the third year.

No penalty would be permitted more than three years after the loan was consummated. A lender that offers a consumer a loan with a prepayment penalty would also be required to offer a loan without that feature.

Safe Harbor or Rebuttable Presumption

Meeting the requirements of the "qualified mortgage" would provide the lender with some protection from liability. However, the DFA is actually not clear as to whether the consequent protection was intended to be a safe harbor from liability or only a means to provide a rebuttable presumption that the lender had complied with the ability to repay mandates.

Thus, the Proposal offers these two "alternatives" toward resolving the uncertainty vis-a-vis a "qualified mortgage:"

1. Safe Harbor Alternative: The loan would not permit negative amortization, interest-only payments, or balloon payments; the loan term would not exceed 30 years; the points and fees would not exceed 3 percent of the total loan amount; the consumer's income and assets would be documented and verified; and, the loan would be underwritten based on the maximum interest rate in the first five years, using a fully-amortizing payment schedule and considering any mortgage-related obligations.

2. Rebuttable Presumption Alternative: Includes the Safe Harbor Alternative and adds a requirement for the lender to consider and verify the monthly payment of any simultaneous mortgage and the consumer's employment, other current debt obligations, debt-to-income ratio or residual income, and credit history.

Lender Liability

The DFA provides that violations of the ability to repay requirements face tripartite penalties: (1) damages consisting of the sum of all finance charges and fees paid by the consumer, (2) the consumer's actual damages, and (3) described statutory damages.

A consumer could file a claim at any time within three years of the violation, although the consumer could assert the violation as a set-off or recoupment in a foreclosure suit at any time.

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FRB: Ability-to-Repay, Proposed Rule - Notice
April 18, 2011

FRB: Proposes Rule - Ability to Repay

Today, the Federal Reserve Board (FRB) requested public comment on a proposed rule under Regulation Z that would require creditors to determine a consumer's ability to repay a mortgage before making the loan and would establish minimum mortgage underwriting standards.

The FRB notice was issued on April 18, 2011.

The revisions to the regulation, which implements the Truth in Lending Act (TILA), are being made pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA).

The proposal would apply to all consumer mortgages (except home equity lines of credit, timeshare plans, reverse mortgages, or temporary loans).

The proposal would also implement the Dodd-Frank Act's limits on prepayment penalties.

Comment Period: Until July 22, 2011.

Because the general rulemaking authority for TILA is scheduled to transfer to the Consumer Financial Protection Bureau on July 21, 2011. 

Accordingly, this rulemaking will not be finalized by the FRB.

Four Compliance Options

Consistent with the DFA, the proposal would provide four options for complying with the ability-to-repay requirement.

General Ability-to-Repay Standard - Option # 1

First, a creditor can meet the general ability-to-repay standard by considering and verifying specified underwriting factors, such as the consumer's income or assets.

Considering and verifying the following eight underwriting factors:

• Income or assets relied upon in making the ability-to-repay determination

• Current employment status

• The monthly payment on the mortgage

• The monthly payment on any simultaneous mortgage

• The monthly payment for mortgage-related obligations

• Current debt obligations

• The monthly debt-to-income ratio, or residual income

• Credit history

Additionally, the underwriting of the payment for an adjustable-rate mortgage would be based on the fully indexed rate.

Qualified Mortgage - Option # 2

Second, a creditor can make a "qualified mortgage," which provides the creditor with special protection from liability provided the loan does not have certain features, such as negative amortization; the fees are within specified limits; and the creditor underwrites the mortgage payment using the maximum interest rate in the first five years. 

The FRB seeks comments on two alternative approaches for defining a "qualified mortgage."

Two alternative definitions of a "qualified mortgage."

Alternative 1

Alternative 1 would operate as a legal safe harbor and define a "qualified mortgage" as a mortgage for which:

• The loan does not contain negative amortization, interest-only payments, or a balloon payment, or a loan term exceeding 30 years;

• The total points and fees do not exceed 3 percent of the total loan amount;

• The income or assets relied upon in making the ability-to-repay determination are considered and verified; and

• The underwriting of the mortgage (1) is based on the maximum interest rate that may apply in the first five years, (2) uses a payment scheduled that fully amortizes the loan over the loan term, and (3) takes into account any mortgage-related obligations.

Alternative 2

Alternative 2 would provide a rebuttable presumption of compliance and would define a "qualified mortgage" as including the criteria listed under Alternative 1 as well as additional underwriting requirements from the general ability-to-repay standard.

The creditor would also have to consider and verify:

• The consumer's employment status,

• The monthly payment for any simultaneous mortgage,

• The consumer's current debt obligations,

• The monthly debt-to-income ratio or residual income, and
• The consumer's credit history.

Balloon-Payment Qualified Mortgage - Option # 3

Third, a creditor operating predominantly in rural or underserved areas can make a balloon-payment qualified mortgage. This option is meant to preserve access to credit for consumers located in rural or underserved areas where banks originate balloon loans to hedge against interest rate risk for loans held in portfolio.

Under this option, a creditor can make a balloon-payment qualified mortgage with a loan term of five years or more by:

• Complying with the requirements for a qualified mortgage; and
• Underwriting the mortgage based on the scheduled payment, except for the balloon payment.

Refinancing of a Non-Standard Mortgage - Option # 4

Fourth, a creditor can refinance a "non-standard mortgage" with risky features into a more stable "standard mortgage" with a lower monthly payment. This option is meant to preserve access to streamlined refinancings.

Under this option, a creditor complies by:

• Refinancing the consumer into a "standard mortgage" that has limits on loan fees and that does not contain certain features such as negative amortization, interest-only payments, or a balloon payment;

• Considering and verifying the underwriting factors listed in the general ability-to-repay standard, except the requirement to consider and verify the consumer's income or assets; and
• Underwriting the "standard mortgage" based on the maximum interest rate that can apply in the first five years.

Other Rule Proposals

• Implement the Dodd-Frank Act's limits on prepayment penalties

• Lengthen the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions
• Prohibit evasion of the rule by structuring a closed-end extension of credit as an open-end plan

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FRB: Ability-to-Repay, Proposed Rule - Notice
April 18, 2011