Community banks have a potential advantage over larger competitors under the Consumer Financial Protection Bureau’s ability-to-repay and Qualified Mortgage Rule, Melissa Blundell informed bankers at the BHCA’s Spring Seminar. The Seminar was conducted May 5-6 in Bloomington, Minn.
“When you compare a community bank to a large institution for its ability to serve a high-net-worth person or business owners with nonstandard documentation for income, the large banks are not as able to serve the customer under QM,” said Blundell, a mortgage consultant at Bankers Advisory, a division of CliftonLarsonAllen LLP, based in Belmont, Mass. “The small originator status gets you around a few of the requirements of the ability-to-repay rule.”
Under the rule, which took effect in January, small originators can write qualified mortgages under a looser set of guidelines than larger originators. The advantage is twofold, Blundell said.
Under the bureau’s rule, mortgages fall into two types: qualified mortgages and non-qualified mortgages. A bank can make a QM loan by considering and documenting the following eight facts about the borrower: income or assets, employment, credit history, monthly mortgage payment, other monthly payments associated with the property, other monthly obligations associated with the mortgage, and other debt. A bank must also consider borrowers’ debt-to-income (DTI) ratio, which must be 43 percent or less. The bank cannot charge more than 3 percent in points and fees; and the loan cannot have a special structure such as balloon payments, negative amortization, interest-only payments or terms beyond 30 years. If a lender doesn’t verify the borrower’s ability to repay, or if the loan doesn’t meet the DTI ratio and structural requirements, it is not a QM loan.
What Blundell called the “small originator status” refers to an exemption within the ability-to-repay rule for banks with fewer than $2 billion in assets and which make less than 500 mortgages per year. Banks that meet these requirements can make QM loans with a DTI ratio above 43 percent, Blundell said. “In fact, the exemption sets no specific threshold for DTI or residual income,” she said.
Under the ability-to-repay rule, a QM loan receives a legal “safe harbor” under which the borrower cannot challenge the bank’s decision to extend credit. Non-QM loans receive only a “rebuttable presumption” under which a court will assume the bank properly determined the borrower’s ability to repay unless the borrower can prove otherwise. When combined with the safe harbor of a QM loan, the effect of the small originator exemption is that small banks have less legal risk than larger banks when making the same loan. A large bank could make a mortgage loan with a 50 percent DTI ratio, but it would receive only a rebuttable presumption as legal protection. For the same loan, a community bank would get a safe harbor.
Even with the exemption, however, restrictions still apply on the type of QM loans community banks can make, Blundell said. “You must hold the loan in portfolio for three years, and the points and fees cap still applies,” she said. Nonetheless, the small originator exemption is a competitive advantage for community banks. “There is an opportunity for them to customize mortgages for high net worth individuals or business owners and charge a higher rate for the service,” she said, noting that banks would need to be careful not to charge a rate so high that the loan becomes a high-priced mortgage.
Still, Blundell hesitated to call the small originator exemption a competitive advantage because the CFPB’s mortgage rules are so burdensome. “These new rules from the CFPB are almost insurmountable challenges without these exemptions,” she said.
In addition to new compliance cost and burden, the Dodd-Frank Act that created the CFPB also changed fair lending laws to the borrower’s favor. “The law extended the period in which a consumer can bring a claim that the bank did not determine their ability to repay,” Blundell said. “The statute of limitation is now three years; it was one year before Dodd-Frank. And, if a consumer becomes involved in foreclosure, they can raise issues about ability-to-repay even though the three-year period has passed.”
Dodd-Frank also enhanced the possible penalties for failure to determine a borrower’s ability to repay, Blundell said. “These aren’t just regulatory penalties,” she said. “If a consumer claimed they were given a loan they couldn’t repay, a possible outcome is the refund of all finance charges paid.
“If a borrower is successful alleging the bank did not verify ability-to-repay, they could claim that they never would have gone through with the transaction,” she continued. “They may even be able to claim damages like the loss of a down payment. For now, all this is just theory, however; none of this has been tried in court. We do not know how successful challenges will be under the rule and we do not know how difficult it will be for banks to demonstrate that they did make a reasonable assessment of the borrower’s ability to repay.”
Banks also will want to be careful about deciding to only make QM loans, Blundell said. “It is a potential fair lending issue,” she said. “If you seek to mitigate your legal risk from mortgages by originating only QM loans, it may affect your ability to meet the needs of your community. The CFPB has said that the decision to originate QM only will not trigger a fair lending issue. They have said, however, that originating only QM loans is unwise because of disparate impact rules. We do not know how the CFPB will actually treat this,” she said.
Additional issues include changes to Fannie Mae’s and Freddie Mac’s loan review process. “Now they will assess performing loans, in addition to nonperforming loans, to determine if they were originated in adherence to the ability-to-repay rule,” Blundell said.
If Fannie or Freddie finds that the loan was not originated within ability-to-repay guidelines, they can return the loan to the bank for three years. “Once the loan is returned to the bank it can be past due for 30 days only once and then Fannie or Freddie will take it back,” she said. “This means you need to have a more robust quality control on all your performing loans.”
Community bank servicers
Community banks also have received favorable treatment in the CFPB’s mortgage servicing rules, Blundell said. The exemption is fortunate for community banks because “there has been a deluge of new rules in this area in recent years,” she said. “Now the rules are numerous and complex.”
For the purposes of the exemption, a small servicer is a bank that, together with its affiliates, originates 5,000 or fewer loans a year. It also only services loans originated by the bank or an affiliate of the bank.
While Blundell did not present the specific advantages of the exemption, she said that banks in the small servicer category are exempt from certain provisions for periodic statements, early intervention in nonperforming loans, servicing policies and even from the prohibition on force-placed insurance restrictions.