CFPB Says Patch is Going Away but Asks "What Next?"

The Consumer Financial Protection Bureau (CFPB) has issued an Advance Notice of Proposed Rulemaking (ANPR) regarding the expiration of the so-called GSE Patch.  The provision is scheduled to expire no later than January 10, 2021.

As background, the Dodd-Frank Consumer Protection and Wall Street Reform Act amended the Truth in Lending Act (TILA) to establish, among other things, ability-to-repay (ATR) requirements in connection with the origination of most residential mortgage loans.  TILA identifies the factors a creditor must consider in making a reasonable and good faith assessment of that ability including the consumer's credit history, current and expected income, current obligations, debt-to-income (DTI) ratio, employment status, and other financial resources.  A lender, however, may not be certain if its ATR determination is reasonable in a particular case, making it liable for penalties if a court or a regulator later concludes that it was not.    

TILA addresses this uncertainty by defining a category of loans-called qualified mortgages (QMs)-for which a creditor "may presume that the loan has met" the ATR requirements. These requirements are set forth in the ATR/QM Rule adopted in 2013 which prohibits certain types of loans such as those with a balloon payment. The rule also includes a condition that that DTI ratio may not exceed 43 percent.  The calculation of DTI is determined by Appendix Q of the Rule.

Under the Rule, a creditor that makes a QM loan is protected from liability presumptively or conclusively, depending on whether or not the loan is "higher priced," as defined by the Rule. A creditor making a loan that is not higher priced is entitled to a conclusive presumption that it has complied with the Rule and receives a safe harbor while a creditor that makes a higher priced QM loan is entitled to a rebuttable presumption of compliance, i.e. one than can be challenged by courts or the borrower.

A second category of QM loans carries the Rule's prohibitions on certain loan features, its underwriting requirements and limitations on points and fees but, instead of prescribing a DTI limit, requires these loans must be eligible for purchase or guarantee by one of the government sponsored enterprises (GSEs) Fannie Mae or Freddie Mac. This is the GSE Patch.  

At the time the patch was created the mortgage market was still recovering from the Great Recession and CFPB believed that, with further recovery, the GSEs and government guaranteed lenders would be able to reduce their market share and the percentage of loans requiring the patch would decline.  The market would instead shift toward General QM loans and non-QM loans above a 43 percent DTI ratio, a sector that would be supported by the private market. However, private lenders are still largely absent from the market.

Dodd-Frank requires that CFPB assess each of its significant rules and orders and publish a report of each assessment after five years. CFPB conducted an assessment of the ATR/QM Rule through requests for information in 2017 and 2018 and received hundreds of comments from creditors, industry and consumer advocacy groups, and individuals. Many comments called Appendix Q outdated or cumbersome and some called for raising or eliminating the DTI requirement entirely. Comments specifically addressing the patch generally agreed that it had been helpful but disagreed about how CFPB should address its expiration.  Suggestions included eliminating it, extending it, and making it permanent.   

The assessment report, published early this year, included a number of findings about the effects of the Rule on the mortgage market generally and specifically about the Patch.  It found that loans with higher DTI levels are historically associated with higher levels of delinquency within two years of origination, which can serve as a proxy for measuring whether a consumer had the ability to repay at the time the mortgage loan was consummated.  The Report also found that the rule has not decreased access to credit for borrowers with DTI ratios above 43 percent who qualify for loans eligible for GSE purchase or guarantee but has eliminated between 63 and 70 percent of high DTI, non-GSE eligible home purchase loans.  CFPB also found that loans made under the patch represent a "large and persistent" share of originations in the conforming segment of the mortgage market and noted that for loans destined for the secondary market, creditors generally offer a Temporary GSE QM loan even when a General QM loan could be originated.

CFPB estimates there were approximately 6.01 million closed-end first-lien residential mortgage originations in the United States in 2018 and the GSEs purchased or guaranteed 52 percent or roughly 3.12 million of them.  Thirty-one percent, approximately 957,000 loans- had DTI ratios greater than 43 percent.  This means that approximately 16 percent of all mortgage originations made that year fell under the patch but not the General QM loan definition.

The Bureau has identified several ways that borrowers may respond to the expiration of the Patch.  First it seems likely that many who would have obtained loans under it will instead obtain FHA-guaranteed loans since FHA currently has a maximum DTI of 57 percent. The FHA loan limit puts an outer bound on the share of loans that could move to FHA.

Second, it is possible that some borrowers who would have sought High-DTI GSE loans will be able to obtain loans in the private market.  The number would likely depend, in part, on whether actors in the private market are willing to assume the credit risk associated with funding these loans as non-QM loans or small-creditor portfolio QM loans and, if so, whether actors in the private market would offer more competitive pricing or terms. 

Third, if FHA and actors in the private market together do not guarantee or make all of the High-DTI GSE loans, some borrowers who would have sought High-DTI GSE loans might adapt to changing options and make different choices such as adjusting their borrowing to lower their DTI. Other borrowers might not obtain mortgages at all.

According to the ANPR, CFPB currently intends to allow the GSE Patch to expire either on schedule in January 2021 or with a short extension to facilitate a smooth and orderly transition if necessary.  It states it does not intend to make the provision permanent.

CFPB is soliciting comments on possible amendments to the ATR/QM Rule, including whether to revise Regulation Z's definition of a qualified mortgage in light of the Patch expiration.  It also seeks information and comment on whether QM definition should retain a direct measure of a consumer's personal finances (for example, debt-to-income ratio), and whether the definition should include an alternative method for assessing financial capacity.