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New CRL Report Outlines Two Proposals to Replace the GSE QM Patch

Monday, July 8, 2019
Tom Feltner
Michael Calhoun

WASHINGTON, D.C. – Today, the Center for Responsible Lending (CRL) released A Smarter Qualified Mortgage Can Benefit Borrowers, Taxpayers, and the Economy, a report urging the Consumer Financial Protection Bureau (CFPB) to take timely steps to ensure widespread access to safe and sustainable loans. Unless the CFPB revises its mortgage rule under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), an expiring provision will cause a significant number of mortgages to face new legal liability, and these loans likely would not be originated at all or would have higher costs and riskier terms.

After the passage of the Dodd–Frank Act, Congress required lenders to make a reasonable and good faith determination that the borrower has the ability to repay a mortgage loan (ATR) before the loan is made. It also created a category of loans that are presumed to comply with the ATR requirement, called Qualified Mortgages or QM. The product protections for a loan to be considered a QM are outlined in Dodd-Frank, and the credit characteristics are left to the CFPB to determine.

In setting the borrower credit characteristics, CFPB established a debt-to-income ratio (DTI) limit of 43% for QM loans and also provided a number of exceptions to permit lenders to obtain QM status while making loans above 43% when other underwriting factors suggested that the borrower could reasonably repay the loan.

Loans eligible for purchase or guarantee by Fannie Mae or Freddie Mac (the GSEs) were included in these exemptions for seven years or until the GSEs cease to be in conservatorship. In the absence of this exemption, called the GSE Patch, almost 19% of the loans guaranteed by the GSEs over the last five years—3.3 million loans—would not have been QM. Letting the Patch expire on schedule in January 2021 and subjecting these loans to a flat 43% DTI limit would thus have a dramatic impact on mortgage lending in the country. CRL’s report finds that such disruption would not be justified because statistical analysis demonstrates that, on its own, DTI is only minimally predictive of risk for near-prime loans.

“Once the Patch expires, many borrowers who today qualify for a QM loan would find themselves ineligible due to the 43% DTI limit. CFPB should amend its rule to accommodate the significant number of sustainable loans over 43% DTI so that that these borrowers will not be forced out of the mortgage market altogether or into more expensive and riskier products,” said Eric Stein and Mike Calhoun, authors of the report. “While DTI is an important factor to consider in underwriting loans, CFPB should choose an approach for near-prime loans that permits lenders to use compensating factors rather than relying solely on DTI.”

Once the QM Patch expires, CRL’s report suggests that the CFPB should choose an approach that will ensure that QM serves its goals of protecting mortgage borrowers while making access to affordable credit widely available. The report suggests two alternatives:

  • Allow lenders to use compensating factors for near-prime loans. The first proposal is for CFPB to keep its 43% DTI QM limit and replace the exception for GSE loans with an exception for near-prime loans. Thus, fully documented near-prime loans that meet the QM product protections, just like GSE loans under the Patch and community bank portfolio loans today, are QM without an explicit DTI limit. But higher-rate loans, which suggest higher delinquency risk and greater borrower dangers, are subject to the 43% limit.
  • Validated model approach. The second alternative is the same as the first, but near-prime loans over 43% DTI cannot be considered QM unless the lender uses a validated underwriting model with statistically-predictive compensating factors, including DTI or residual income, to distinguish which higher DTI loans to make.