QM and Non-QM Are Going to Get Along Just Fine

Savvy entrepreneurs or established organizations have little to fear from the new qualified mortgage (QM) and Ability-to-Repay (ATR) regulations about to come into effect a new white paper from CoreLogic says. They will find a way to deliver qualified and non-qualified mortgages in a way that meets all the regulations, incorporates sound lending and consumer protections, and makes a profit.

The paper, ATR/QM Standards:  Foundation for a Sound Housing Market, written by Faith A. Schwartz, CoreLogic's manager of government business and former director of HOPE NOW and Margarita S. Brose, a former director in Barclay Bank's Operational Risk Management Group, is upbeat about the mortgage market, its regulatory environment, and the opportunities it presents.

They point to the current environment as resulting from President Obama's goals for a new housing finance system; that private capital will be at its center, but it must maintain affordability and access to homeownership.  The Dodd-Frank Act (DFA) required lenders to assess the borrower's ability to repay a mortgage loan and the Consumer Financial Protection Bureau's (CFPB) regulations have formulated the rules to guide this. 

CFPB's QM and ATR provide the eight factors a lender must evaluate; current income or assets, current employment, monthly payment on the subject loan, payments on other loans secured by the property, payments for taxes and insurance, current debt obligations, debt-to-income ratio, and credit history.   The rules also provide thresholds for QM which, when met and depending on the APR create a "safe harbor" or presumption of compliance.  These protections, the authors say, fulfill the vision of Elizabeth Warren in her 2007 article Unsafe at Any Rate in which she proposed a regulated marketplace where the consumer would get the same protections as the purchaser of a toaster. 

Access to homeownership became increasingly common before the financial crisis, in part because the mortgage industry was willing to underwrite and sell loans with limited documentation coupled with additional risk layering.  This led to a "breathtaking" $3 trillion annual market for purchase and refinance mortgages in the pre-crisis period.

As the market continues to heal from the aftereffects of these loans there are, the authors say, a number of opportunities to ensure the creation of a sound lending process that works for all parties.  Achieving this will require transparency, accountability, and traceability.

In addition to presuming compliance with ATR a QM loan must meet limits on points and fees and specific underwriting requirements.   Loans are automatically considered QM (even if they do not require verification of income or meet other underwriting requirements) as long as they are eligible for guarantee or purchase by one of the agencies (Fannie, Freddie, FHA, VA), meet point/fee requirements, and requirements regarding "risky features." 

If some of the thresholds are not met there is still a presumption for a QM loan that ATR provisions have been met but a consumer can rebut this by providing evidence about his inability to repay the loan.  He can specify the "risky features" that disqualify a loan from this designation including negative amortization, interest only, balloon payment features, and amortization exceeding 30 years. 

Lenders who lend beyond the QM scope do have some litigation risk.  While this is a concern, it is hoped that the market an still serve homeowners who fall outside of the QM rules because of high DIT ratios, high points and fees and/or interest rates  and other QM criteria. 

Another concern is how much appetite investors will have for non-QM loans.  By not including a downpayment threshold CFPB preserved the opportunity for higher LTV loans to remain QMs when possible.  One area of focus is how to meet the demand of the changing demographics of first time homebuyers, some with low wealth but less risky credits scores, who may have limited options among first time programs offered by the government.  There is also a concern that lenders may limit or eliminate non-qualified products.

The authors see many opportunities under the ATR and QM rules for private capital to flow into the housing finance system.  It does not make sense to write a mortgage which the borrower cannot repay and the rules will require lenders to review their existing processes and procedures, data validation, and counterparty tracking and surveillance.  Traceable documentation of the eight ATR factors and the QM fee minimums will need to be retained.  CFPB has issued a list of the required documentation and will review it during their examinations.  Companies who are not used to reviews are apprehensive but a measured approach to implementing new processes and procedures should address any anxiety about audits.

Much of the concern defaults to common sense when thinking about systems and compliance.  How does a lender validate the way information was verified during underwriting?  How does an investor establish a clear audit trail?  When these issues are resolved markets will have confidence that the information and processes established to make a sound loan are likely to result in sound loan performance over the life of the loan.

The authors say that it is almost a certainty that pre-crisis lending will not return and that there will be few if any no-doc loans and loans with DTI above the QM thresholds will not be easy to get.  The Mortgage Bankers Association estimates approximately $1 trillion in mortgages will be originated in 2014, one third of the pre-crisis level.   Still, the new market has many opportunities.

"Many in the hedge fund world will tell you that there is an unlimited market for those who do not need the ordinary protections afforded the unsophisticated buyer," the Schwartz and Brose say.  In the new ATR and QM world lenders will still be able to offer mortgages to housing investors using ordinary contractual conditions.  Lenders will market mortgages for multi-family dwellings and commercial properties to purchasers who evidence an ability to pay but outside of the CFPB guidelines.

While the QM rule provides regulatory safeguard for ordinary home buyers, it does not prevent a lender from making a non-QM loan, assuming it adheres to the broader ability to pay requirements.  But it does require those lenders to make a sound risk assessment and have the documentation to support it.