March 2013 Legal Briefs

• ATR and QM
• Refinancing existing loans
• Safe harbors
• QM product features

ATR and QM

Background
Just what you wanted, right? Another set of acronyms to add to your regulatory vocabulary. The fact is, ATR and QM are two of the most fundamental concepts within Dodd-Frank and the new final rules, so it behooves you to become thoroughly familiar with what they are and how they will affect you.

ATR stands for Ability to Repay. QM stands for Qualified Mortgage. (One note of caution: QM is different from QRM, which standards for Qualified Residential Mortgage, another Dodd-Frank term that relates to the so-called “skin-in-the-game” risk retention requirement. Final rules on QRM matters have not been issued yet. Don’t confuse the two terms or their implications.)

Under new final rules that take effect January 10, 2014, a creditor is prohibited from making a loan that is a covered transaction unless the creditor makes a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms.

Coverage
As you see, not all loans are covered. The new rules amend Regulation Z. That means we know immediately that they pertain only to loans to consumers that are primarily for personal, family or household purposes. The actual scope, however, is even more narrow that that, because it applies only to “covered transactions” a term that is specifically defined in the new rule.

Under amended Reg Z, the term covered transaction means a consumer credit transaction that is secured by a dwelling, as defined in § 1026.2(a)(19), including any real property attached to a dwelling, other than a transaction exempt from coverage under paragraph (a) of this section.

The definition of dwelling under § 1026.2(a)(19) is the same as it has been in the past. It has not changed. Dwelling means a residential structure that contains one to four units, whether or not that structure is attached to real property. The term includes an individual condominium unit, cooperative unit, mobile home, and trailer, if it is used as a residence.

If the loan is not to a consumer and/or is not primarily for a personal, family or household purpose, and doesn’t have a dwelling as collateral, it’s not covered by this new rule. It’s driven by type of borrower, purpose of loan and collateral type. In addition, there are two other types of loans that are totally exempt from the ATR rule: l) home equity lines of credit covered by § 1026.40; and 2) loans secured by a time share.

Three types of loans are exempt from the ATR rules, except the prepayment penalty provisions and the anti-evasion section. The types of extensions of credit that are exempt are:

1. A reverse mortgage loan;
2. A temporary or “bridge” loan with a term of 12 months or less, such as a loan to finance the purchase of a new dwelling where the consumer plans to sell a current dwelling within 12 months or a loan to finance the initial construction of a dwelling; or
3. A construction phase of 12 months or less of a construction-to-permanent loan.

Thank heaven (or the CFPB) for small favors.

If you’re thinking we already had ability-to-repay requirements, you’re right, but they only applied to Higher-Priced Mortgage Loans (HPMLs – under Reg Z § 1026.35) and High Cost Mortgage Loans under the Homeowners Equity Protection Act (HOEPA) — under Reg Z § 1026.32. The new rule enhances the requirements, expands the scope to include all consumer credit transactions secured by a dwelling (other than HELOCs and time share loans), and puts some real teeth into the mandates by building in some expensive consequences for non-compliance.

Consequences for non-compliance
So, let’s talk about those “teeth.” I think doing so will make you a whole lot more interested in studying the ATR/QM requirements and making sure you’re in compliance with them.

First of all, Section 1416 of the Dodd-Frank Act amends Section 130(a) of the Truth in Lending Act (TILA) to give the borrower a right to sue the lender for damages for a violation of the ATR rule. The suit must be brought within 3 years of the violation. The statute allows the borrower to potentially recover:

• Actual damages;
• Special statutory damages equal to the sum of all finance charges and fees paid by the consumer. (The creditor can defend against this by showing that the failure to comply was not material);
• Statutory damages in an individual action or class action (and they’ve raised the civil liability limits. You can check them out in Section 1416 of Dodd-Frank if you want to see how bad they can be); plus
• Any court costs and attorney fees that would be available for violations of other TILA provisions.

In addition, under Section 1413 of Dodd-Frank, a new subsection (k) is added to Section 130 of TILA. Under it, if the creditor or someone acting on the creditor’s behalf initiates either a judicial or nonjudicial foreclosure of the residential mortgage loan, or any other action to collect the debt in connection with such loan, a consumer may assert a violation of the ATR rules as a matter of defense by way of recoupment or set off without regard for the time limit on a private action for damages under subsection (e) of Section 130 of TILA (discussed in the preceding paragraph). In other words, long after the expiration of the 3 year period in which a borrower could bring suit for damages for violation of the ATR rule, if there is a foreclosure of any sort, the violation of the ATR rule could rear its ugly head again and the borrower could assert the violation as a matter of defense by recoupment or setoff.

In a recoupment, the borrower would be allowed to deduct from the plaintiff’s (the lender’s) recovery the amounts that this new provision would allow to be deducted.

Section 1413 of Dodd-Frank addresses the amount of recoupment or set off by saying the amount of recoupment or setoff shall equal the amount to which the consumer would be entitled under subsection (a) for damages for a valid claim brought in an original action against the creditor, plus the costs to the consumer of the action, including a reasonable attorney’s fee. (In other words, it is limited to what the borrower could have gotten if he filed a private suit within the timeframe – damages computed up to the day preceding the expiration of the application time limit. But there is no time limit on when the defense itself may be used.)

The borrower’s right to sue for damages and the borrower’s defense to foreclosure provide powerful incentives for a lender to ensure that any “covered transaction” is made in conformity with the ability to repay requirements. Now that we’ve made that clear, let’s examine how to comply.

Underwriting
As noted earlier, the rule prohibits a creditor from making a loan that is a covered transaction unless the creditor makes a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms. In so doing, a creditor is not required to follow particular underwriting models, but must, at a minimum, consider eight factors articulated by the regulation.

The eight factors that must always be considered by the creditor in a covered transaction are:

(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;
(6) current debt obligations, alimony, and child support;
(7) the monthly debt-to-income ratio or residual income; and
(8) credit history.

It is not sufficient to merely obtain the information directly from the consumer. The information must be verified through reasonably reliable third-party records

When determining whether the applicant will be able to repay the covered transaction’s monthly payments, the monthly payments must be calculated by assuming that the loan is repaid in substantially equal monthly payments during its term. If the loan is an Adjustable Rate Mortgage (ARM) loan, the monthly payment must be calculated using the fully indexed rate or an introductory rate, whichever is higher.

Sometimes, a borrower will obtain an 80/20 or 90/10 loan, where there’s one loan for the bulk of the purchase price and a different loan for the balance. Hard to imagine that we’re going to see such 100% financings anymore, but, just in case, the rule says if the creditor knows, or has reason to know, that 1 or more covered loans secured by the same dwelling will be made to the same consumer, the creditor is required to make a reasonable and good faith determination, based on verified and documented information, that the consumer has a reasonable ability to repay the combined payments of all loans on the same dwelling according to the terms of the loans and all applicable taxes, insurance and assessments. It’s a holistic view of the borrower’s financial situation. It doesn’t matter if the borrower is able to afford to make the payments on his first mortgage if he can’t cough up the cash necessary to keep the property insured, satisfy the tax man, and pay the subordinate lienholder.
 

Refinancing existing loans

At the time the new rule becomes effective, lenders will undoubtedly have many loans on the books that would be covered transactions that will not meet the ATR/QM standards. That’s fine – the rule only applies to loans for which applications are received on or after the effective date. But when it’s time to refinance an existing loan, the requirements would be triggered. The rule provides an important exemption from the ATR requirements for refinancing into what the rule terms “standard mortgages.”

Under the exemption, the ATR requirements don’t apply when a creditor is refinancing non-standard mortgages into standard mortgages l) if the creditor has considered whether the standard mortgage likely will prevent a default by the consumer on the non-standard mortgage once the loan is recast, AND 2) if the following six conditions are met.

(i) The creditor for the standard mortgage is the current holder of the existing nonstandard mortgage or the servicer acting on behalf of the current holder;
(ii) The monthly payment for the standard mortgage is materially lower than the monthly payment for the non-standard mortgage, as calculated under paragraph (d)(5) of this section.
(iii) The creditor receives the consumer’s written application for the standard mortgage no later than two months after the non-standard mortgage has recast.
(iv) The consumer has made no more than one payment more than 30 days late on the non-standard mortgage during the 12 months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage.
(v) The consumer has made no payments more than 30 days late during the six months immediately preceding the creditor’s receipt of the consumer’s written application for the standard mortgage; and
(vi) If the non-standard mortgage was consummated on or after January 10, 2014, the non-standard mortgage was made in accordance with paragraph (c) or (e) of this section, as applicable.

There are several terms used in the list of six conditions that are new to all of us. To understand the requirements, you have to understand the definitions of those terms:

Recast means:

(i) For an adjustable-rate mortgage, as defined in § 1026.18(s)(7)(i), the expiration of the period during which payments based on the introductory fixed interest rate are permitted under the terms of the legal obligation;
(ii) For an interest-only loan, as defined in § 1026.18(s)(7)(iv), the expiration of the period during which interest-only payments are permitted under the terms of the legal obligation; and
(iii) For a negative amortization loan, as defined in § 1026.18(s)(7)(v), the expiration of the period during which negatively amortizing payments are permitted under the terms of the legal obligation.

The term non-standard mortgage means a covered transaction that is:

(A) An adjustable-rate mortgage, as defined in § 1026.18(s)(7)(i), with an introductory fixed interest rate for a period of one year or longer;
(B) An interest-only loan, as defined in § 1026.18(s)(7)(iv); or (C) A negative amortization loan, as defined in § 1026.18(s)(7)(v).

The term standard mortgage means a covered transaction:

(A) That provides for regular periodic payments that do not:
     (1) Cause the principal balance to increase;
     (2) Allow the consumer to defer repayment of principal; or
     (3) Result in a balloon payment, as defined in § 1026.18(s)(5)(i);
(B) For which the total points and fees payable in connection with the transaction do not exceed the amounts specified in paragraph (e)(3) of this section;
(C) For which the term does not exceed 40 years;
(D) For which the interest rate is fixed for at least the first five years after consummation; and
(E) For which the proceeds from the loan are used solely for the following purposes:
     (1) To pay off the outstanding principal balance on the non-standard mortgage; and
     (2) To pay closing or settlement charges required to be disclosed under the Real EstateSettlement Procedures Act, 12 U.S.C. 2601 et seq.

Safe Harbors

How will you know when you’ve done enough to satisfy the ability-to-repay requirements and can rest easy? There is a rebuttable presumption that you’ve done so on some loans. Even better, on others, there is a conclusive presumption that you’ve done so. The conclusive presumption is termed a “safe harbor.”

The rule builds in a safe harbor for loans that meet the definition of “Qualified Mortgage” (as to product feature prerequisites and affordability underwriting requirements) and are not higher-priced mortgage loans. (As to HPMLs, it is possible, if the loan meets certain criteria (discussed later in this article), to fall within a rebuttable presumption of compliance with the ATR requirements.)

There is a transitional rule that will help many lenders. It provides a temporary category of Qualified Mortgages for loans that both 1) satisfy the product feature prerequisites and also 2) would be eligible to be purchased, guaranteed or insured by either l) the GSEs while under conservatorship/receivership by the federal government (Fannie and Freddie), or 2) HUD, the VA, or the Department or Agriculture or Rural Housing Service. The maximum length of this transitional type of QM is 7 years. The time period can be shortened by further rulemaking.

What about where it’s a balloon payment loan? Eesh. Bad news. In most situations, you aren’t going to be able to comply with the ATR/QM rules with a balloon payment loan. Since many community banks make balloon loans, it was hoped there would be some kind of exemption for them. Well, there is, but it is limited due to limiting language in the Dodd-Frank Act itself, so it only comes into play if the loan has certain characteristics, the lender meets tests relating to asset size and number of originations of covered transactions, the lender meets certain requirements relating to holding the loans in portfolio for a period of time, AND – here’s the kicker – the majority of the lender’s first lien covered transactions are made in rural or underserved counties.

Here are the particulars. The rule provides a special Qualified Mortgage status to a type of loans known as “Rural Balloon Payment Qualified Mortgages.” To be considered Rural Balloon Payment Qualified Mortgages (and therefore to be considered QMs), those loans must:

• Have a term of at least five years
• Have a fixed interest rate;
• Meet certain basic underwriting standards;
• Have taken into consideration debt-to-income ratios (although these special QMs are not subject to the 43% general requirement that we’ll describe in a minute.)
• Be made by a creditor who originates at least 50% of its first-lien covered mortgages in counties that are rural or underserved, has less than $2 billion in assets, and (along with its affiliates) originates no more than 500 first-lien covered mortgages per year
• Be held in the creditor’s portfolio for 3 years in order to maintain their qualified mortgage status.

I wish the exemption was broader, but it’s not. Look to the CFPB.gov website to see which counties in Oklahoma are being designated rural or underserved, and remember that it’s not where your bank’s office is physically located – it’s where your covered transactions are. If you think you might possibly meet the various tests, go through and look at which of your mortgage loans are of the type we’re talking about – to a consumer, primarily for a personal, family, or household purpose, secured by a dwelling. For purposes of the “more than 50%” test (but not for purposes of determining whether a loan is a covered transaction for other purposes), you just count the covered transactions that are first-lien loans.

QM product features

The Qualified Mortgage (QM) standards are found in a new section of Reg Z — 12 CFR 1026.43 Minimum standards for transactions secured by a dwelling. There is also a new Appendix Q to Regulation Z. Plus, revisions were also made to 12 CFR 1026.32 Requirements for high-cost mortgages.

In order for a loan to be treated as a qualified mortgage the product features must conform to the standards and the lender must meet certain criteria.

To satisfy the requirements for a qualified mortgage under § 1026.43(e)(2), the ratio of the consumer’s total monthly debt to total monthly income at the time of consummation cannot exceed 43 percent. (Remember, that 43% DTI ratio doesn’t apply if it is a Rural Balloon Payment Qualified Mortgage.)

Section 1026.43(e)(2)(vi)(A) requires the creditor to calculate the ratio of the consumer’s total monthly debt to total monthly income using the standards in Appendix Q, with additional requirements for calculating debt and income appearing in § 1026.43(e)(2)(vi)(B). If you haven’t looked at Appendix Q yet, get on the Alphabet Soup section of BankersOnline and take a gander. The level of specificity and detail is fairly astonishing.

In terms of product features, a qualified mortgage:

• Cannot have negative amortization;
• Cannot have interest-only payments;
• Generally cannot have balloon payments (although see the information above about the Rural/Underserved exception to the balloon payment prohibition);
• Cannot have a term that exceeds 30 years;
• Cannot have points and fees paid by the consumer that exceed a certain percentage of the total loan amount. (Generally, it can’t exceed 3% of the total loan amount, but it’s actually tiered, so it’s 3% if the loan amount is greater than or equal to $100,000, and it goes up to 8% for a loan amount less than $12,500. There are gradations in between.)

When it comes to figuring out whether your points and fees are going to be a problem, the first thing to understand is that what counts as points and fees is being changed. The QM standards refer to points and fees under the Reg Z HOEPA rule, in 1026.32(b)(1). Look at the amended version of Section 1026.32(b)(1) in the Alphabet Soup section of BankersOnline to see exactly what will be covered in points and fees under the revised test. Pay particular attention to what is included in (ii), (iii), and (iv).

Getting protected
As noted earlier, Qualified mortgages that are not higher-priced fall within a safe harbor of conclusively presumptive compliance with the ATR requirements. That means that, in addition to satisfying the other QM tests, the loan’s APR must be no more than 1.5% over the APOR for a first lien loan, or no more than 3.5% over the APOR for a subordinate lien loan.

What that means is that if the QM falls within the safe harbor, the rule reduces the borrower’s right of action under the rule and the possible defense to foreclosure. Instead of having the full range of legal options under the ATR rule, the borrower would be limited to arguing that the loan wasn’t a QM with a rate that qualified it for safe harbor status.

Qualified mortgages that are higher-priced mortgage loans fall within a rebuttable presumption of compliance with the ATR requirements. That means a borrower can try to show that the lender was aware at the time of origination of the loan that the borrower would not have the ability to repay. The longer the borrower makes the payments in the correct amount on a timely basis, the more difficult it will be for the borrower to rebut the presumption that the creditor complied with the ATR rule.

Another wrinkle
You may remember hearing about something called a “higher-risk mortgage loan” when Dodd-Frank first came out. If you will recall, those loans were going to entail special appraisal requirements. Even if they had a transaction value under the FIRREA trigger, an appraisal would have to be performed by a certified or licensed appraiser and it would have to involve a physical inspection of the interior of the property. In addition, if the higher-risk mortgage was a “flip” type loan, an additional appraisal would have to be performed by a different appraiser, at no cost to the applicant/borrower, and it would have to address changes in market conditions, improvements to the property, and other factors that might have a bearing on the increase in price.

So why talk about that in the context of an article totally devoted to ATR/QM? Because when they came out with the final rules on these new special appraisal requirements, they decided to toss out the term “higher-risk mortgage loan” and instead make these appraisal requirements applicable to HPMLs – with an important exception. If the loan is an HPML, but it satisfies the tests for being a QM, it is exempt from the new appraisal requirements. Yea! Not ALL HPML QMs are exempt, however. Rural Balloon Payment Qualified Mortgages are not exempt from the special appraisal rules, so if you have a RBPQM that is an HPML, it will still fall under the new appraisal provisions. We’ll write about the new appraisal requirements in greater depth in a future edition.

Additional definitions
One of the most dangerous things you can do in compliance is assume you know the definition of a word or phrase without checking to see if the term or phrase has been specifically defined in the context of the law or rule you’re dealing with. In addition to the terms defined above (standard mortgage, non-standard mortgage, and recast), the rule provides definitions for nearly a dozen other terms. The terms points and fees and prepayment penalty, for purposes of the ATR/QM rule, have the same definitions as they do under § 1026.32(b)(6).

Other important terms are defined as follows

Maximum loan amount means the loan amount plus any increase in principal balance that results from negative amortization, as defined in § 1026.18(s)(7)(v), based on the terms of the legal obligation assuming:

(i) The consumer makes only the minimum periodic payments for the maximum possible time, until the consumer must begin making fully amortizing payments; and
(ii) The maximum interest rate is reached at the earliest possible time.

Mortgage-related obligations mean property taxes; premiums and similar charges identified in § 1026.4(b)(5), (7), (8), and (10) that are required by the creditor; fees and special assessments imposed by a condominium, cooperative, or homeowners association; ground rent; and leasehold payments.

Simultaneous loan means another covered transaction or home equity line of credit subject to § 1026.40 that will be secured by the same dwelling and made to the same consumer at or before consummation of the covered transaction or, if to be made after consummation, will cover closing costs of the first covered transaction.

Third-party record means:

(i) A document or other record prepared or reviewed by an appropriate person other than the consumer, the creditor, or the mortgage broker, as defined in § 1026.36(a)(2), or an agent of the creditor or mortgage broker;
(ii) A copy of a tax return filed with the Internal Revenue Service or a State taxing authority;
(iii) A record the creditor maintains for an account of the consumer held by the creditor; or
(iv) If the consumer is an employee of the creditor or the mortgage broker, a document or other record maintained by the creditor or mortgage broker regarding the consumer’s employment status or employment income.

Possible changes
The comment deadline passed on February 25, 2013 on proposed amendments to the ATR/QM rule. OBA President & CEO Roger Beverage authored a comment letter on behalf of the Association. The CFPB has stated that if it makes changes, it will do so in time for them to take effect at the same time the ATR/QM rule was scheduled to go into effect, January 10, 2014.

The most important part of the new proposal would create a fourth category of QM for certain loans originated by small creditors. In order to be considered a QM under this part of the proposal, both the loan and the creditor would have to meet certain criteria.

The creditor would need to:

• Have total assets of $2 billion or less at the end of the previous calendar year; and
• Together with all affiliates, have originated 500 or fewer first-lien covered transactions during the previous calendar year.

This new category of QMs, if adopted, would include only loans held in portfolio by these creditors, but would provide an exception that would allow forward commitments to sell to a creditor that also meets the limits on asset size and number of first-lien covered transactions. To prevent evasion, a loan in the proposed new category would lose its status as a qualified mortgage if it is held in portfolio for less than three years after consummation, with certain exceptions.

In addition, the loan would have to conform to all of the requirements under the general definition of a qualified mortgage, as described above, except the 43 percent limit on monthly debt-to-income ratio.

When underwriting the loan the creditor would NOT have to use Appendix Q to calculate the debt-to-income ratio (Once you review Appendix Q, you’ll realize what a big deal that is!), but the creditor would have to consider and verify the consumer’s income and assets and base the underwriting on a monthly payment calculated using the maximum interest rate that may apply during the first five years of the loan and that is fully amortizing. The creditor would also be required to consider the consumer’s debt-to-income ratio or residual income and verify the underlying information.

A loan with a consumer debt-to-income ratio higher than 43 percent could be a qualified mortgage if all other criteria are met.

Safe harbor: A qualified mortgage in this proposed new category would be conclusively presumed to comply if the annual percentage rate is equal to or less than the average prime offer rate plus 3.5 percentage points for both first-lien and subordinate-lien loans.