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CFPB Issues Final Ability-To-Repay and Qualified Mortgage Rule

Today the Consumer Financial Protection Bureau (“CFPB”) released its final rule on the definition of a “qualified mortgage” and the ability-to-repay requirements mandated by the Truth-in-Lending Act §129C, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act §§1411-1412 (“Dodd-Frank”). The CFPB has structured the rule as a safe harbor for lenders originating prime “qualified mortgages” and as a rebuttable presumption for lenders originating higher-priced “qualified mortgages.” The rule is set to take effect January 10, 2014.

The Truth-in-Lending Act (“TILA”), as amended by Dodd-Frank, prohibits lenders from originating residential mortgage loans without first making a “good faith determination based on verified and documented information [that] the consumer has a reasonable ability to repay the loan.” 15 USC §1639c(a). The statute requires that creditors consider several factors when making the ability-to-repay determination, including the mortgage payment amount, borrower income, borrower assets, employment status, other debt obligations, credit history and the borrower’s debt-to-income ratio (“DTI”). 15 USC §1639c(a)(3). “Qualified mortgages” are presumed to satisfy the ability-to-repay requirements. The statute does not specify whether this presumption is conclusive or rebuttable. 15 USC §1639c(b).

The final rule resolves the ambiguity by providing a safe harbor for qualified mortgages that are not “higher-priced” as defined under the Federal Reserve’s 2008 ability-to-repay regulation (73 FR 44522, July 30, 2008; 12 CFR §1026.35(a)). In other words, compliance with the ability-to-repay requirements is conclusively presumed for prime loans that meet the definition of “qualified mortgage.” Conversely, “higher-priced” loans that are qualified mortgages are entitled only to a rebuttable presumption of compliance with the ability-to-repay rules. Borrowers of such loans may rebut this presumption by showing that, at the time the loan was originated, the borrower’s income and debt obligations left insufficient residual income or assets to meet living expenses. However, guidance accompanying the rule explains that the longer the borrower makes timely payments, thus demonstrating an actual ability to repay, the more difficult it will become to rebut the presumption.

The final rule implements statutory criteria as to what constitutes a “qualified mortgage,” including that:

1. the loan does not feature negative amortization, interest-only payments, balloon payments, or a term exceeding 30 years;
2. the total points and fees do not exceed three percent of the total loan amount for loans over $100,000 (with provision for a sliding scale of acceptable caps on fees for lesser loan amounts); and
3. the borrower’s income or assets are verified and documented.

The final rule additionally establishes a maximum DTI ratio for qualified mortgages. With certain exceptions noted below, the rule requires that the borrower’s resulting (or “back-end”) DTI ratio be less than or equal to 43 percent. The monthly payment is to be calculated based on the highest interest rate that will apply in the first five years of the loan rather than any lower introductory rate.

Exempt from the final rule’s DTI ratio requirement during a transitional period are otherwise qualifying loans that are eligible to be purchased, guaranteed, or insured by the Department of Housing and Urban Development, the Department of Veterans Affairs, the Department of Agricultural, the Rural Housing Service, or the Federal National Mortgage Association or Federal Home Loan Mortgage Corporation (the Government Sponsored Enterprises, or “GSEs”) while the latter operate under Federal conservatorship. This temporary provision will expire at the earlier of (i) seven years after the rule’s effective date or (ii) the issuance by the Federal agencies of their own qualified mortgage rules.

In addition, exempt from the prohibition against balloon payment features are loans originated and held by small creditors operating predominantly in rural or underserved areas. Such loans would still be considered “qualified mortgages.”

The final rule appears to represent an attempt by the CFPB to harmonize the positions of industry groups and consumer advocates. Industry groups had urged a safe harbor definition, citing the need for certainty as to what constitutes a “qualified mortgage” and to minimize the risk of litigation, while consumer groups had advocated for a rebuttable presumption, arguing that the threat of consumer litigation encourages compliance. The CFPB’s bifurcated approach, whereby prime loans would be subject to a safe harbor and higher-priced loans to the rebuttable presumption, can be characterized as a middle ground between the two. Similarly, the CFPB explicitly stated that it put in place the temporary DTI ratio requirement exceptions for government-backed and GSE loans due to its concern that “creditors may initially be reluctant to make loans that are not qualified mortgages, even though they are responsibly underwritten.” The Mortgage Bankers Association and the American Bankers Association have applauded the CFPB decision to provide a safe harbor, but cautioned that the rule’s pricing restrictions could curb competition, increase costs and tighten credit availability for borrowers. Borrowers with low income or low credit scores are most likely to be affected by any resultant decrease in access to credit.

The full text of the final rule is available here. Our previous alert on the qualified mortgage and ability-to-repay rule can be found here.

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This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Elizabeth McKeen, an O'Melveny partner licensed to practice law in California, Trevor Lain, an O'Melveny counsel licensed to practice law in New York and California, Dixie Noonan, an O'Melveny counsel licensed to practice law in California, New York, and the District of Columbia, and Ashley Pavel, an O'Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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