The Consumer Financial Protection Bureau on Monday proposed the elimination of debt-to-income limits for qualified mortgages processed through Fannie Mae and Freddie Mac, as the government-sponsored enterprises patch nears expiration in January 2021.
Instead of using DTI limits to predict a borrower’s creditworthiness, the CFPB is suggesting a price-based approach that considers annual and prime offer rates to bolster mortgage accessibility.
“The GSE Patch’s expiration will facilitate a more transparent, level playing field that ultimately benefits consumers through promoting more vigorous competition in mortgage markets,” CFPB Director Kathleen L. Kraninger said in a prepared statement. “The Bureau is proposing to replace the Patch with a price-based approach to QM loans to preserve consumer access to mortgage loans while also making sure consumers have the ability to repay them.”
“The Bureau is committed to ensuring a smooth and orderly mortgage market throughout its consideration of these issues and any resulting transition away from the GSE Patch,” Kraninger added.
To approve a qualified residential mortgage loan, lenders must use the Truth in Lending Act’s ability-to-repay requirements to calculate a borrower’s creditworthiness. Alongside the elimination of interest-only periods, negative amortization, balloon payments, and extended loan terms (30-plus years), TILA requires borrowers to have a debt-to-income ratio of less than 43 percent.
Under this rule, certain Fannie Mae and Freddie Mac guaranteed loans have been given temporary qualified mortgage status, even if the DTI surpasses 43 percent. According to the CFPB, temporary GSE QM loans “represent a large and persistent share of mortgage originations” and put nearly 1 million borrowers at risk when the patch expires in January.
“As noted above, the GSE Patch is scheduled to expire soon, and absent regulatory action the Bureau estimates that approximately 957,000 mortgage loans would be affected by the expiration of the GSE Patch,” CFBP’s announcement read. “The Bureau estimates that, after the Patch expires, many of these loans would either not be made or would be made but at a higher price.”
To maintain mortgage availability and affordability, the CFPB is proposing two amendments to Regulation Z, which requires lenders to provide written disclosures explaining interest rates, finance charges, and additional loan terms. It also requires lenders to answer borrowers’ billing questions and prohibits unfair lending practices.
The first amendment would eliminate DTI limits in favor of a price-based approval, which the CFPB said is a “more holistic and flexible” method of determining a borrower’s creditworthiness.
“The Bureau is proposing a price-based approach because it preliminarily concludes that a loan’s price, as measured by comparing a loan’s annual percentage rate to the average prime offer rate for a comparable transaction, is a strong indicator and more holistic and flexible measure of a consumer’s ability to repay than DTI alone,” the announcement read.
With this method, lenders will still be encouraged to “take into account a consumer’s income, debt, and DTI ratio or residual income and verify the consumer’s income and debts.”
The second amendment to Regulation Z addresses the GSE Patch expiration date. Instead of allowing the Patch to expire January 2021, the CFPB is asking for it to be extended until the first Regulation Z amendment is approved.
“The Bureau is proposing to take this action to ensure that responsible, affordable credit remains available to consumers who may be affected if the GSE Patch expires before the amendments take effect as defined in the first NPRM,” the amendment read.
“Under the CFPB’s proposed rule change, an easy-to-understand number would be replaced by lenders’ judgment. The risk is that, over time, borrowers and lenders would make increasingly reckless decisions under this proposed rule. After all, they have a track record of irresponsibility from about 2005 to 2008.
The National Association of Realtors supports CFPB’s proposals, with NAR President Vince Malta telling HousingWire the amendments would help homebuyers achieve their homeownership goals amid a coronavirus-induced market shift.
“America’s Realtors applaud the CFPB’s action to provide a temporary QM patch extension, and commend the bureau and Director Kraninger for acting on behalf of our nation’s consumers and homebuyers at a time when market stability is so critical,” Malta said. “Perhaps most importantly, we appreciate the Bureau’s decision to eliminate a hard DTI standard, and we look forward to more closely examining the proposed replacements and their impact on homebuyers over the coming months.”
However, some experts are concerned lenders will exploit the new more flexible requirements to approve high-rate loans for desperate homebuyers.
“Specifically, the proposal would get rid of a rule that legally protects loans with a debt-to-income ratio of 43 percent or less,” NerdWallet Home and Mortgage Expert Holden Lewis said in an emailed statement to Inman. “It would be replaced by a rule that says a lender is legally protected if the mortgage’s APR is less than two percentage points higher than the average APR that week for a prime mortgage.”
“The CFPB argues that this wouldn’t make a big change in mortgage risk or availability,” Holden added. “It would have to find a way to prevent lenders from gaming the system with high-rate loans that just barely fit within the guidelines.”