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Copyright © 2013 by K&L Gates LLP. All rights reserved. Ability-to-Repay, QM, and Points & Fees What You Really Need to Know K&L Gates Webinar Series DC.

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Presentation on theme: "Copyright © 2013 by K&L Gates LLP. All rights reserved. Ability-to-Repay, QM, and Points & Fees What You Really Need to Know K&L Gates Webinar Series DC."— Presentation transcript:

1 Copyright © 2013 by K&L Gates LLP. All rights reserved. Ability-to-Repay, QM, and Points & Fees What You Really Need to Know K&L Gates Webinar Series DC v2 N. Akilah Green Jonathan Jaffe, Esq. Kris D. Kully, Esq. K&L Gates LLP K&L Gates LLP K&L Gates LLP Phillip L. Schulman, Esq. David T. Tallman, Esq. K&L Gates LLP K&L Gates LLP January 30, 2013

2 2 I.INTRODUCTION A.Background  Laissez-Faire Attitude  Anything Goes – Up & Went  Congress Steps In = Dodd-Frank Act  attempts to control risk  clean up Wall Street  protect consumers

3 3 B.CFPB Mandated to Address Mortgage Processes  Every aspect of origination and servicing being examined  Objectives  timely, understandable information  eliminate deceptive practices  enforce consumer laws 3.Regulations flying off the presses  combined TILA-RESPA forms  LO compensation  servicing standards  appraisal requirements for high-priced mortgage loans  final HOEPA rules  expanded escrow periods

4 4 C.Today We Address ATR and QM  Congress and CFPB concerned that too many consumers placed in loans they could not repay  View that lenders approved borrowers without considering ATR  failure to verify consumer income and debts  loans based on teaser rates 3.Section 1411 of the Dodd-Frank Act  requires creditors to make reasonable good  faith determination of consumer’s ability to repay  based upon verified documented information  January 10, 2013  CFPB issues final ATR Rule  effective January 10, 2014

5 5 D. Covered Transactions 1.Covered Transactions are consumer credit transactions secured by a dwelling  first lien  subordinate lien 2.Higher-Priced Covered Transactions  1.5% or more above APOR for first lien loans  3.5% or more above APOR for subordinate liens 3.Excluded Transactions  HELOC  construction loans  time share plans  temporary bridge loans  reverse mortgages  business purpose loans

6 6 II. SUMMARY OF ABILITY TO REPAY RULE A. General Requirements  Creditor must make 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  Creditor must verify consumers’ ATR using reasonably reliable third-party records  Bureau does not dictate a particular underwriting model

7 7 B. Basis for Determination At a minimum creditors must consider 8 underwriting factors:  Current or reasonably expected income or assets  Current employment status  Monthly payment on covered transaction  Monthly payment on simultaneous loan  Monthly payment for mortgage-related obligations  Current debt obligations, alimony, child support  Monthly debt-to-income ratio or residual income  Credit history

8 8 C.Standard vs. Non-standard Loans 1.Standard loan means covered transaction  with regular periodic payments  in which principal balance does not increase  no deferral of principal (no I/O)  no balloon payments  prescribed points and fees  term does not exceed 40 years  fixed interest rate for first 5 years  proceeds used to pay off non-standard loan or for closing and settlement charges 2.Non-standard loan means covered transaction that is  ARM loan with introductory fixed rate for a year or more  interest only  negative amortization

9 9 A. Presumption of ATR 1.Conclusive (safe harbor) vs. Rebuttable Presumption  FRB 2011 proposed rule contemplated either/or  CFPB Rule provides for both  Safe harbor for non-higher priced covered transactions (prime loans)  Rebuttable presumption for higher priced covered transactions III.QUALIFIED MORTGAGE

10 10 B. QM Defined 1.Regular substantially equal periodic payments except for prescribed adjustable-rate increases that do not include  negative amortization  interest only  balloon payment  Term does not exceed 30 years  Total points and fees do not exceed 3% (for loans of $100,000 or more)  Monthly payment calculated based on highest payment that applies in first 5 years  Consider current or reasonably expected income, debt obligations, alimony, child support  Total debt-to-income ratio does not exceed 43%

11 11 C. Temporary QMs 1.Loans that have regular substantially equal periodic payments, term does not exceed 30 years, points and fees do not exceed 3% AND 2.Loan is eligible to be  guaranteed/purchased Fannie Mae (while under conservatorship)  guaranteed/purchased Freddie Mac (while under conservatorship)  insured by FHA or RHS  guaranteed by VA or Dept. of Agriculture For 7 years or until agencies publish their own QM rules

12 12 D. Additional Alternatives to Assuring ATR  Rural balloon payment QMs  Refinancing a non-standard loan into a standard loan  Concurrent proposal under consideration to add additional exemptions  credit extended to Housing Finance Agency  credit extended to certain non-profit creditors  credit extended under the EESA  credit extended by certain small creditors  credit extended by small creditors making balloon loans

13 13 Ability to Repay: Why Care?

14 14 Ability to Repay General Rule  For loans subject to the ATR, creditors must make “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.”  Can meet that requirement in one of four ways:  ATR  QM  Refinancing a non-standard mortgage into a standard mortgage  By making a qualifying balloon mortgage in a rural or underserved area, if the creditor is small and services primarily rural or underserved areas

15 15 Ability to Repay, cont. Why Care About ATR?  Common wisdom is that everyone will follow the QM  Remains to be seen whether the MBS market will tolerate the risk  Portfolio lenders might accept the risk to serve customers  If fail to meet QM test, might be able to prove met ATR test

16 16 Ability to Repay, cont. Covered Loans to Which ATR (and Therefore the QM) Applies  The ATR – and the QM – applies to all consumer- purpose, closed-end loans secured by a dwelling  First and junior lien, home-purchase, refinance and home equity loans  Do not apply to:  Business-purpose loans, even if secured by a dwelling (TILA applies only to consumer loans)  Open-end credit, e.g., HELOCS (no structuring as open-end to evade ATR) – CFPB intends to monitor the HELOC exemption

17 17 Ability to Repay, cont. Covered Loans  ATR and QM do not apply to:  Timeshare loans  Reverse mortgages  Bridge or temporary loans with terms of 12 months or less  Loans to finance the initial construction of a dwelling or to finance the purchase of a new dwelling where the consumer plans to sell a current dwelling within 12 months  The construction phase of a construction-to-perm loan, provided the construction phase is 12 months or less  Loan mods (unless the mod is a refinancing)

18 18 Ability to Repay, cont. Two Things a Creditor Must Do  Follow underwriting requirements and verify what they rely on in making credit decisions  No limits on points and fees or most product features  Lots of underwriting and verification requirements, but unlike QM, there isn’t much detail  E.g., doesn’t specify income needed to support debt or how credit history should be weighed against other factors  Creditors may develop their own standards and make changes over time in response to empirical information and changing economic and other conditions

19 19 Ability to Repay, cont. Two Things a Creditor Must Do  So have some flexibility, but with flexibility comes potential regulatory risk  Many of the requirements impose “reasonableness” or “good faith“ standard on creditor  The ATR notes that a creditor may refer to GSE guidance

20 20 Ability to Repay, cont. Eight Underwriting Factors  Creditor must consider eight underwriting factors 1. Current or reasonably expected income or assets (other than the value of the collateral)  May consider only assets, and only the income and assets needed to determine that the consumer can repay the loan 2.The consumer’s current employment status, to the extent the creditor relies on employment income

21 21 Ability to Repay, cont. Eight Underwriting Factors 3. The monthly loan payment on the covered transaction  For fixed and ARMs, the payments must be monthly, substantially equal and sufficient to fully amortize the loan over its term  For ARMs, the payments must be based on the higher of the fully indexed rate or introductory rate

22 22 Ability to Repay, cont. Eight Underwriting Factors 4.The monthly payment on any “simultaneous loan” that the creditor “knows or has reason to know” will be made  E.g., Piggyback loans (even HELOCs and loans closed by another creditor) secured by the same property  Not required to investigate, but likely to turn up in underwriting or closing

23 23 Ability to Repay, cont. Eight Underwriting Factors 5.Monthly payment for “mortgage-related obligations,” i.e., insurance premiums if insurance is required by the creditor, obligations to community governance associations (e.g., HOA assessments), property taxes, ground rent, and lease payments 6.Current debt obligations, alimony and child support  Some flexibility based on facts and circumstances, e.g., likelihood that obligation will be paid off shortly after consummation

24 24 Ability to Repay, cont. Eight Underwriting Factors 7.Monthly DTI ratio or residual income  Again, purports to offer a great deal of flexibility in determining what is debt and income  For example, creditors may consider compensating factors in addition to the DTI or residual income in assessing a consumer’s repayment ability (reasonable and good faith standard)

25 25 Ability to Repay, cont. Eight Underwriting Factors 8.Credit history, but a credit report not required  Again, purports to offer flexibility by permitting creditor to “give various aspects of a consumer’s credit history as much or as little weight as is appropriate to reach a reasonable, good faith determination of ability to repay,” but subject to reasonable, good faith consideration

26 26 Ability to Repay, cont. Verification  Creditors must make a reasonable and good faith determination, based on “verified and documented information,” that a consumer has a reasonable ability to repay the covered transaction  Differs from HOEPA’s existing requirement to verify consumer’s income or assets  For most part, creditors are to use third-party records  A document or other record prepared or reviewed by an appropriate person other than the consumer, the creditor, or the mortgage broker or an agent of the creditor or mortgage broker

27 27 Ability to Repay, cont. Verification  Third-party records may come from the consumer, provided they are reasonably reliable and specific to the individual consumer, e.g., payroll statements from the consumer  Examples  Credit history, but a credit report not required  Again, purports to offer flexibility by permitting creditor to “give various aspects of a consumer’s credit history as much or as little weight as is appropriate to reach a reasonable, good faith determination of ability to repay,” but subject to reasonable, good faith consideration

28 28 Ability to Repay, cont. Verification  Examples  Credit report, including the information in it, the existence and amount of a debt – but only if noted on the report, and can’t rely if knows or has reason to know it’s inaccurate  Copy of a tax return filed with the taxing authority, such as the IRS  Record from a government agency of the amount of any benefit payments or awards, e.g., “proof of income letter” issued by the Social Security Administration

29 29 Ability to Repay, cont. Verification  Examples  Homeowners association billing statements provided by the seller  What isn’t a third-party record?  Using average incomes in the consumer’s geographic location or average wages paid by the consumer’s employer

30 30 Qualified Mortgages: What are they good for?

31 31 Qualified Mortgages Dodd-Frank Act: A creditor/assignee “may presume” that a loan has met the ability-to-repay requirements if the loan is a Qualified Mortgage.  Dodd-Frank Act established core criteria:  Regular periodic payments – no negative amortization, balloon payments only in limited circumstances  Borrower’s income and financial resources must be verified and documented  Underwriting must be based on a fully amortizing payment schedule and take into account taxes, insurance, and assessments

32 32 Qualified Mortgages  Dodd-Frank Act established core criteria (cont.):  Total points and fees (as redefined) do not exceed 3% of the total loan amount  Loan term does not exceed 30 years (with limited exception)  Board/CFPB may establish debt-to-income ratios or alternative measures of ability to pay regular expenses after payment of total monthly debt

33 33 Qualified Mortgages Safe Harbor – QMs that are not higher priced are deemed to comply with the ability-to-repay requirements Rebuttable Presumption – QMs that are higher priced are presumed to comply with ability-to-repay requirements  First Liens: APR 1.5 over APOR  Second Liens: APR 3.5 over APOR  To rebut presumption: Borrower must prove that creditor did not make reasonable, good faith determination of repayment ability, because consumer’s income, debt, alimony, child support, and monthly payments would leave consumer with insufficient residual income or assets to meet living expenses of which the creditor was aware

34 34 Qualified Mortgages Final Rule: Regulation Z Section (e)(2) defines Qualified Mortgage:  Provides for safe harbor, but rebuttable presumption for higher APR loans  Adds a maximum DTI ratio  Interprets “points and fees” broadly  Temporarily carves out Fannie/Freddie/FHA eligible loans  Proposes other exemptions and QM definitions

35 35 Qualified Mortgages A covered transaction with following characteristics:  Regular periodic payments (i.e., substantially equal – no neg am, deferral of principal repayments, or balloons, with limited exceptions)  Loan term not over 30 years  Total points and fees do not exceed 3% (different thresholds for loans under $100,000)  Must consider monthly payments for property taxes; premiums for insurance required by the creditor; fees and special assessments  Must consider maximum rate during the first 5 years after the first regular periodic payment will be due  Must consider periodic payments of principal and interest that will repay the loan amount over the loan term (or the outstanding principal balance over the remaining term once the rate adjusts to its maximum)

36 36 Qualified Mortgages  Must consider and verify, in accordance with Appendix Q:  Current or reasonably expected income or assets  Current debt obligations, alimony, child support  Verification = reasonably reliable third-party records (rule provides examples)  Monthly DTI at consummation does not exceed 43% (using App. Q)  Must include monthly mortgage-related obligations and simultaneous loans about which creditor knows/has reason to know

37 37 Qualified Mortgages Total Points and Fees – 3%  For loans $60K to less than $100K: $3000  For loans $20K to less than $60K: 5%  For loans $12.5K to less than $20K: $1000  For loans less than $12.5K: 8%  Amounts will be adjusted annually for inflation Definition of Points and Fees  Same definition for QM and HOEPA Loans (different thresholds)  Revised/expanded definition (generally includes direct and indirect loan originator compensation, LLPAs, affiliate fees)

38 38 Same-Creditor Refinancing of Non-Standard Loans  “Non-Standard” – ARMs with introductory fixed rate period, IOs, Neg Ams  “Standard” – Regular periodic amortizing payments, with no balloon, 3% points and fees, terms not exceeding 40 years, fixed rate for first 5 years, no cash out  Exempt from Ability to Repay if:  Same creditor (creditor for the new mortgage is the current holder or servicer acting on behalf of current holder)  New monthly payments materially lower  Creditor receives application no later than two months after the non- standard mortgage has recast  Consumer has no more than one 30-day late during preceding 12 months; no 30-day lates during the preceding 6 months  Creditor must consider whether standard mortgage likely to prevent a default on non-standard mortgage once the loan is recast

39 39 Points and Fees

40 40 A.What is included in “points and fees”? The following, if “known at or before consummation”: 1.Items in TILA finance charge, other than interest 2.Loan originator compensation paid by the consumer or creditor, whenever payable, if attributable to the transaction and known at the time the interest rate is set 3.Real estate related fees (1026.4(c)(7)), other than bona fide and reasonable enumerated charges not paid to the creditor, originator, or an affiliate (see exclusions) 4.Credit insurance, debt cancellation premiums, etc. payable at or before consummation 5.Prepayment penalties:  Maximum amount under the new mortgage  Total penalty under existing mortgage if the new mortgage is a refinance of a loan with the current holder or servicer, or an affiliate of either Points and Fees

41 41 B.What counts as “loan originator compensation”? 1.Compensation payable to a loan originator by creditor or consumer for the specific transaction (whenever payable), if known at time rate is set:  Includes broker and individual LO compensation  Includes bonus, commission, yield spread premium, award of merchandise, services, trips, or similar prizes, or hourly pay for the actual number of hours worked on a particular transaction 2.Excludes compensation not attributable to particular transaction at origination, such as base salary or compensation based on the performance or overall quality of originated loans 3.Issues include need to track individual LO compensation, double-counting (“additive” effect)  Bureau recognizes issues, but finalized rule “without qualifying the statutory result.” Concurrent proposed rule seeks comments on potential resolutions

42 42 C.What is excluded from “points and fees”? 1.Interest and time-price differential 2.Gov’t mortgage insurance/guaranty fees; PMI payable after consummation; PMI payable at or before consummation not in excess of FHA standards if refundable on pro rata basis 3.Bona fide and reasonable real estate related fees not paid to the creditor, originator, or an affiliate for title, document preparation, notary, credit report, appraisal, inspection, pest removal, or flood hazard determination services 4.Bona fide third-party charges not retained by the creditor, originator, or an affiliate (except otherwise included mortgage/credit insurance premiums and real estate related fees)  Exclusion does not cover LLPAs 5.Bona fide discount points, limited to:  2 points if undiscounted rate does not exceed the APOR by more than 1 point  1 point if undiscounted rate does not exceed APOR by more than 2 points  Use average Title I rate if secured by personal property

43 43 D.What is a “bona fide discount point”? 1.Knowingly paid by the borrower for the purpose of reducing the interest rate 2.Actually results in a bona fide reduction of the interest rate 3.Reduction must be consistent with established industry practices for determining the amount of rate reduction 4.Final rule does not require a relationship between the amount of interest rate reduction purchased by a discount point and the value of the transaction in the secondary market 5.Use of APOR thresholds without adjustment may cause problems for jumbo loans, second homes, etc.

44 44 E.Timing Considerations 1.Private mortgage insurance and credit insurance premiums etc. are included if they are “payable at or before closing” 2.All other charges are included if they are “known at or before consummation” 3.Potential fees for servicing-related actions, including modification fees, are not included as “points and fees”

45 45 Other Types of Qualified Mortgages

46 46 Alternative/Temporary Qualified Mortgage  Fannie Mae or Freddie Mac: Loans eligible to be purchased or guaranteed by GSEs while under conservatorship or receivership (or limited life successor entity)  Desktop Underwriter “Approve/Eligible”  Loan Prospector “Accept and Eligible to Purchase”  Conformity with Single-Family Selling Guides  FHA, VA, USDA, RHS: Loans eligible to be insured or guaranteed by agencies, until agencies issue their own QM rules

47 47 Alternative/Temporary Qualified Mortgage  Fannie Mae/Freddie Mac/FHA/VA/USDA/RHS QMs:  Also must have regular, substantially equal periodic payments (allowing for payment changes on ARMs or step-rates)  No negative amortization  No deferment of repayment of principal (limited exception)  No balloon (limited exception)  Loan term does not exceed 30 years  Total points and fees do not exceed 3% (or different threshold for smaller loans)  Sunset: January 10, 2021 (if not sooner)  CFPB must analyze impact of QM rule after 5 years, and may allow the temporary provision to expire prior to sunset.

48 48 Small Creditor Balloon Qualified Mortgage  Standard definition of QM generally excludes loans with balloon payments  Special Small Creditor Balloon QM:  Only by small (portfolio) creditors in rural/underserved areas  Less than $2B in assets, originated more than 50% of transactions in rural or underserved transactions, but fewer than 500 total (along with affiliates)  Loan not subject to forward commitment; if creditor sells, assigns, or otherwise transfers loan it could immediately lose its Balloon QM status  No neg am  Loan term does not exceed 30 years (but at least 5 years)  Total points and fees do not exceed 3% (or different threshold for smaller loans)  Must consider and verify current or reasonably expected income/assets; current debt obligations, alimony, and child support; but without regard to App. Q  Determine consumer can make all scheduled payments and mortgage- related obligations excluding the balloon payment  Consider DTI/residual income, excluding balloon (but no specific limits/standards)  Must otherwise have substantially equal scheduled payments calculated based on amortization period that does not exceed 30 years  Fixed rate

49 49 Break Concurrent ATR/QM Proposed Rule

50 50 Concurrent Proposed Rule, cont. Exemptions for HFA programs, nonprofit creditors, EESA programs (Hardest Hit, etc.)  Credit made pursuant to a program administered by a housing finance agency (HFA)  ATR requirements may undermine the underwriting requirements of these programs, e.g., may require consideration of underwriting factors that are not required under HFA programs, such as the consumer’s credit history  Also concerned that complying with the ATR requirements could result in a severe curtailment of the credit offered under these programs

51 51 Concurrent Proposed Rule, cont. Exemptions for HFA programs, nonprofit creditors, EESA programs (Hardest Hit, etc.)  Creditors designated by Treasury as Community Development Financial Institutions or by HUD as Community Housing Development Organizations or Downpayment Assistance Providers of Secondary Financing  501(c)(3) nonprofits, provided (a) the credit is to a consumer with income that does not exceed the qualifying limit for moderate income families as established pursuant to section 8 of the United States Housing Act of 1937, (b) during the preceding calendar year the creditor extended credit no more than 100 times and only to consumers with income that did not exceed the above qualifying limit, and (c) the creditor determines, in accordance with written procedures, that the consumer has a reasonable ability to repay the extension of credit

52 52 Concurrent Proposed Rule, cont. Exemptions for HFA programs, nonprofit creditors, EESA programs  Loans made pursuant to an Emergency Economic Stabilization Act program, e.g., loans under a State Hardest Hit Fund program. If had to comply with ATR would:  Make it more difficult for consumers to qualify for assistance and increase the cost of credit for those who do, impacting the availability of credit for at-risk consumers  Disrupt the financial market for consumers at risk of foreclosure or default

53 53 Concurrent Proposed Rule, cont. Proposed Exemption from Ability-to-Repay Requirement for FHA/VA Refinancings  Refinancings eligible to be insured, guaranteed, or made pursuant to a program administered by the FHA, VA, or USDA  Same-creditor or third-party refi  Temporary: Only until the respective federal agency prescribes exemption rules

54 54 Concurrent Proposed Rule, cont. QM for Small Portfolio Lenders and Small Creditors in Rural/Underserved Counties  Considering loans made by certain small creditors and held in portfolio  Must have total assets of $2 billion or less as of the end of the preceding calendar year; and  May not have originated more than 500 first-lien loans covered by the ATR in the prior calendar year (aggregated with affiliates)  Can avoid following Appendix Q or the 43% DTI limit in underwriting the loan, but must satisfy the other QM requirements

55 55 Concurrent Proposed Rule, cont. QM for Small Portfolio Lenders and Small Creditors in Rural/Underserved Counties  Small creditors operating predominantly in rural or underserved areas may originate balloon- payment safe harbor QMs with APRs up to 3.5% above the APOR  Must originate 500 or than 50% of their total first lien, covered transactions on properties in rural or underserved counties (as defined)

56 56 Break Prepayment Penalty Restrictions

57 57 RESTRICTIONS ON PREPAYMENT PENALTIES (PP) A.Covered Transaction Cannot Include PP Unless  Penalty otherwise permitted by law  APR cannot increase after consummation  Loan is a QM (regular, temporary or balloon)  Loan is not a “higher-priced covered transaction”  Penalty cannot apply after third year following consummation  Must not exceed 2% of outstanding loan balance prepaid during first 2 years after consummation  Must not exceed 1% during third year after consummation

58 58 B.Alternative Offer Required  If lender offers loan product with PP  Must also offer borrower an alternative with similar features that does not contain a PP  May not structure loan as open-end credit to circumvent PP requirements

59 59 Record Retention

60 60 Record Retention  Expands required record retention period from two years from consummation to three, to match extended SOL for civil liability  Agencies have discretion to require longer retention  Bureau believes that responsible creditors will retain records beyond three years because of risk of defensive claims  Actual paper records not required, as long as records can be reproduced  No need to document compliance with the requirement to offer an alternative transaction without a prepayment penalty when a consumer does not choose a transaction with a prepayment penalty or if the covered transaction is not consummated

61 61 Liability/Penalties

62 62 Liability / Penalties  CFPB - Authority to issue cease and desist orders and impose civil monetary penalties  Private Right of Action – Affirmative action for actual damages, statutory damages (individual and class actions), costs and attorney fees, and special damages equal to all finance charges and fees (unless failure not material)  3 year statute of limitations  No arbitration  Foreclosure defense - By recoupment or set off  No 3 year statute of limitations  TILA damages, but special statutory damages limited to no more than 3 years of finance charges and fees  Applies to assignees

63 63 Political Dynamics

64 64 POLITICAL DYNAMICS  A Balanced Approach?: Stakeholder Reception  Next Up: Pivoting to the QRM  Policy Makers: The Current Political Environment  CFPB Director Cordray: Constitutional Concerns

65 65 Introducing our Blog For news and developments related to consumer financial products and services, please visit our blog at and subscribe to receive updates.


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