No One-Size Fits All Solution to Mortgage Rule
The law that just keeps on giving, the Dodd-Frank Wall Street Reform and Consumer Protection Act, created the Consumer Financial Protection Bureau (CFPB) to draft and implement regulations on banks. In January of 2013, the CFPB issued several final rules concerning mortgage markets in the United States. The regulations, well-intended as they may be, have resulted in heartburn and expense for bank management, and additional hurdles for borrowers. One rule in particular, the Ability-to-Repay and Qualified Mortgage Rule, demands the attention of compliance officers and bank directors everywhere.
The Ability-to-Repay and Qualified Mortgage Rule, or ATR/QM, requires creditors originating a loan secured by a dwelling to make a reasonable and good faith determination that the consumer will have the ability to repay the loan. This sounds logical. The kicker is that ATR requires the creditor to not only consider eight specific factors but also verify the consumer’s repayment ability with reliable third-party records. Non-compliance with ATR could result in monetary damages for banks.
Like most regulations, ATR has a safe harbor – Qualified Mortgages. A Qualified Mortgage, or QM, is a mortgage for a borrower with a debt to income ratio of 43% or less that does not have certain characteristics typically seen in sub-prime mortgages. In very broad terms, QMs are your better mortgage loans. Based on certain thresholds and the interest rate, a QM may establish the bank complied with ATR or provide a presumption that it complied. For QMs that are not higher-priced (typically those with a lower interest rate), the bank is deemed to have complied with ATR. This is the rule’s safe harbor.
For higher-priced QMs, there is a rebuttable presumption that the bank complied with ATR. The presumption can be rebutted by the borrower demonstrating that the lender was aware the borrower had insufficient residual income or assets at the loan’s consummation. The ATR/QM Rule also provides exemptions and exceptions for certain classes of loans and lenders.
The ATR/QM Rule took effect January 10, 2014. Banks are hopefully prepared and have adopted policies to comply with the rule. Senior management must evaluate the bank’s products to determine whether to offer Qualified Mortgages and develop a procedure for making the Ability-to-Repay determinations. Management should then supply the board of directors with as much information as possible before the board adopts the policies. When challenged by a borrower or regulator, the bank’s best defense is the business judgment rule: the directors acted on an informed basis, in good faith, and in the best interests of the bank.
Some banks have hired compliance and legal consultants to review the policy and discuss practical and legal implications surrounding the ATR/QM Rule with the board of directors. At a minimum, bank management should document its efforts in educating itself and the board about the ATR/QM Rule, the steps it took in developing the policy, and the considerations the board discussed in adopting it.
Adopting the policy is only half the battle. The next steps are training the bank’s staff on the policy, implementing the procedures, and complying with the policy. Like so many other safety mechanisms, they are only effective if consistently used. Banks should periodically monitor developments from the CFPB, because if history is any indication, the Bureau will be clarifying the rule for months to come.
Although CFPB director Richard Cordray recently suggested that the Bureau’s oversight may be more relaxed for the first few months after the effective date, don’t think that borrowers won’t be looking to challenge banks’ ATR practices when borrowers default. Legal analysts believe that banks have the biggest liability risk with borrowers raising ATR issues as a defense to foreclosure. If the borrower is successful, the bank’s exposure could be up to three years of finance charges and fees, as well as the borrower’s attorney’s fees.
Unfortunately for bank management teams and boards of directors, there is not a one-size fits all solution. Each institution must evaluate its market, its mortgage originations, and the level of risk it is willing to bear when tailoring a product offering and ATR policy that works for it.
Erin Brogdon's practice focuses on public and corporate finance, regulatory and government relations, local government, utilities and health care.
Wright Lindsey Jennings and the Arkansas Bankers Association will host Hot Topics in Lending, a half-day lending conference focused on practical methods and solution-based legal information, on May 21 from 9 a.m. to 12:15 p.m. at the Embassy Suites in Little Rock. A networking lunch will immediately follow the final session.