By Anthony Grasso & Mission Global
In the past, loose underwriting practices included failure to verify consumers’ income or debts or using such income to calculate the borrower’s ability to afford the payments based on adjustable rate mortgage lower “teaser” interest rates. Not surprisingly, when the scheduled monthly mortgage interest rate adjustments occurred thereafter, payments would jump to unaffordable levels, a major mortgage crisis contributing factor. Regulators initial response to the skyrocketing mortgage delinquency rate was to adopt a rule under the Truth in Lending Act in 2009 prohibiting creditors from making higher-priced mortgage loans without assessing consumers’ “ability to repay” the loans.
This rule was followed by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), when Congress adopted similar Ability-to-Repay (ATR) requirements for virtually all closed-end residential mortgage loans. The Dodd-Frank Act also provided a presumption of compliance with ATR requirements, and protections from legal liability, for a certain category of mortgages, called Qualified Mortgages (QM). The Consumer Finance Protection Bureau (CFPB) implemented the ATR and QM provisions for covered mortgage loan products (Conforming/FHA/VA/USDA) with new loan applications taken on or after 01/10/2014.
Under the ATR rule, there are the eight underwriting factors that must be considered to meet the requirements of the rule:
- Current, or reasonably expected income or assets (other than the value of the property that secures the loan) that the consumer will rely on to repay the loan.
- Current employment status (if the employment income was relied upon when assessing the consumer’s ability to repay).
- Monthly mortgage payment for this loan.
- Monthly payment on any simultaneous loans secured by the same property.
- Monthly payments for property taxes and insurance that the consumer is required to buy, and certain other costs related to the property such as homeowner’s association fees or ground rent.
- Other debt obligations including but not limited to alimony, and child-support obligations.
- Monthly debt-to-income ratio, or residual income, calculated using the total of all the mortgage and non-mortgage obligations listed above as a ratio of gross monthly income.
- Credit history.
The QM requirements generally focus on prohibiting certain risky features and practices, such as negative amortization, interest-only periods, or loan terms longer than 30 years. In addition, points and fees generally may not exceed 3 percent of the total loan amount, although higher thresholds are provided for loans below $100,000. There for four categories of QM mortgages: General QM, Temporary QM, Small Creditor QM and Balloon-payment QM. For simplicity purposes, we will review the General QM requirements below:
In order for the loan to be a General QM, a lender must:
- Underwrite based on a fully amortizing schedule, using the maximum rate permitted during the first five years after the date of the first periodic payment adjustment.
- Consider and verify the borrower’s income or assets, current debt obligations, alimony, and child-support obligations.
- Determine that the member’s total monthly debt-to-income ratio (DTI) is no more than 43 percent.
- Points and fees are less than or equal to 3% of the loan amount (higher thresholds allowed for loans less than $100,000)
The presumption of compliance for a QM loan depends on whether it is higher-priced or not. Higher priced, according to the CFPB, means that a first lien mortgage’s APR is greater than 1.5% higher than AOPR (the Average Prime Offer Rate), which is based on the average terms offered to highly qualified borrowers (2.5% higher on jumbo loans).
- If a loan is not higher-priced, and meets the QM criteria, a court will conclusively presume that the creditor complied with the ATR rule and the lender is said to have a safe harbor.
- If a loan is higher-priced, and meets the QM criteria, a court will presume it complies with the ATR requirements. However, higher priced QM loans that are presumed to comply with the ATR requirements have conditions allowing borrowers to rebut that presumption (referred to as QM rebuttable presumption loans).
Many lenders have considered the significant potential liability and litigation expenses for an ATR violation and have limited themselves to making only QM safe harbor loans (where the borrower’s claim ends when the lender proves it has made a QM). The lenders that offer non-QM loans charge higher rates to offset the potential legal and compliance risk, although those risks are relatively small. The current ATR QM rule was a giant step in the right direction although we support work with policymakers to support future enhancements.
The following is a link to a compliance guide published by the CFPB:
http://files.consumerfinance.gov/f/201603_cfpb_atr-qm_small-entity-compliance-guide.pdf
Mission Global delivers custom solutions to our clients for QM/ATR Underwriting reviews by leveraging our deep transactional experience, proprietary technology, subject matter expertise and best-in-class talent. Click here to learn more.
FAQs
The Ability-to-Repay/Qualified Mortgage Rule (ATR/QM Rule) requires a creditor to make a reasonable, good faith determination of a consumer's ability to repay a residential mortgage loan according to its terms.
What are the underwriting factors for ability to repay? ›
At a minimum, creditors generally must consider eight underwriting factors: (1) current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; ...
Are HELOCs subject to ability to repay? ›
The rule applies to most closed-end mortgages. Most first mortgages on a home are closed-end because they have a specific pay-off date. Open-ended mortgage loans like home equity lines of credit (HELOCs) aren't covered by the ATR rules.
Which of the following loans is excluded from the ability to repay rule requirements? ›
pursuant to certain programs, certain nonprofit creditors, and mortgage loans made in connection with certain Federal emergency economic stabilization programs are exempt from ability to repay requirements.
What loans does the QM rule apply to? ›
Any loan that meets the product feature requirements and is eligible for purchase, guarantee, or insurance by a GSE, FHA, VA, or USDA is QM regardless of the debt-to-income ratio (this QM category applies for GSE loans as long as the GSEs are in FHFA conservatorship and for federal agency loans until an agency issues ...
How do you determine your ability to repay? ›
Under the rule, lenders must generally find out, consider, and document a borrower's income, assets, employment, credit history, and monthly expenses. Lenders cannot just use an introductory or “teaser” rate to figure out if a borrower can repay a loan.
What are the 5 C's of underwriting? ›
The Underwriting Process of a Loan Application
One of the first things all lenders learn and use to make loan decisions are the “Five C's of Credit": Character, Conditions, Capital, Capacity, and Collateral. These are the criteria your prospective lender uses to determine whether to make you a loan (and on what terms).
What are the three C's of underwriting? ›
What Are The 3 C's Of Underwriting? The 3 C's of underwriting are Capacity, Character, and Collateral, fundamental factors assessed by underwriters to determine a borrower's creditworthiness and risk level.
What are the 7 C's of underwriting? ›
The 7Cs credit appraisal model: character, capacity, collateral, contribution, control, condition and common sense has elements that comprehensively cover the entire areas that affect risk assessment and credit evaluation.
What is the 3% rule for QM? ›
Points and fees are less than or equal to 3% of the loan amount (for loan amounts less than $100k, higher percentage thresholds are allowed); No risky features like negative amortization, interest-only, or balloon loans (BUT NOTE: Balloon loans originated until Jan.
The TILA-RESPA integrated disclosure rules and forms do not apply to HELOCs. Lenders are not required to provide the good faith estimate (HUD-1) described in Regulation X. Instead HELOCs are only subject to the special HELOC requirements in Regulation Z, which are substantially less consumer-friendly.
Do HELOCs require a closing disclosure? ›
If you are applying for a HELOC, a manufactured housing loan that is not secured by real estate, or a loan through certain types of homebuyer assistance programs, you will not receive a HUD-1 or a Closing Disclosure, but you should receive a Truth-in-Lending disclosure.
What is the qualified mortgage ability to repay? ›
ATR stands for “ability to repay.” QM stands for “qualified mortgage.” A QM is a mortgage that meets certain requirements, established by the Consumer Financial Protection Bureau (CFPB). These requirements make it more likely that you'll get a mortgage with repayment terms that are fair to you.
What are the 8 borrower considerations according to the ability to repay standards? ›
At a minimum, creditors generally must consider eight underwriting factors: (1) Current or reasonably expected income or assets; (2) current employment status; (3) the monthly payment on the covered transaction; (4) the monthly payment on any simultaneous loan; (5) the monthly payment for mortgage-related obligations; ...
What are the four types of qualified mortgages? ›
There are four types of QMs – General, Temporary, Small Creditor, and Balloon-Payment. Of the four types of QMs, two types – General and Temporary QMs – can be originated by all creditors. The other two types – Small Creditor and Balloon-Payment QMs – can only be originated by small creditors.
What is the mortgage qualification rule? ›
Employment record: The requirements vary by lender, but typically, you'll need to provide evidence of steady employment from the past two years. Credit score: For a conventional loan, you'll need at least a 620 FICO score. If you don't qualify, you might consider an FHA loan, which allows scores as low as 580.
Can a qualified mortgage have a prepayment penalty? ›
Prepayment penalties are allowed on these non-higher- priced loans only if the penalties satisfy certain restrictions and are permitted under law and if the creditor has offered the consumer an alternative loan without such penalties.
What is the repayment ability score? ›
Repayment ability rating (RAR) is a measure of an individual's repayment ability, calculated as a percentage of their available borrowing capacity. This score is used by lenders to assess an applicant's creditworthiness before granting a loan.
