It’s been several months since the Consumer Financial Protection Bureau enacted the Ability-to-Repay and Qualified Mortgage Rule (ATR/QM), but many banks remain concerned and somewhat confused about what constitutes a QM loan and about the potential risks are of writing non-QM loans.
“Some answers about ATR/QM won’t come for years,” said Tyler Gilday, vice- president, and director of retail lending at Lake Sunapee Bank, Newport, N.H., during a panel discussion at the recent 2014 ABA Real Estate Lending Conference. “Unfortunately, we don’t have the time to wait until all the facts are known.”
“Banks are nervous about QM,” agreed John Battaglia, president, Cambridge Mortgage Group in Hingham, Mass., a subsidiary of $1 billion-assets South Shore Bank, Weymouth. “There is no right answer. Banks need to document what they do in both QM and non-QM lending and be ready for the regulators.”
Risk of unpleasant surprises
Some banks have been outspoken that they will not lend outside the narrow ATR/QM “box” because they fear litigation. But even those banks choosing to write only QM loans may be at risk. A bank may think it is originating a QM loan when it isn’t.
For example, a loan with a debt-to-income (DTI) ratio of 42.5% may squeak by under the 43% DTI requirement for a QM loan—but wind up at 43.2% DTI at closing due to higher-than-anticipated homeowners insurance or flood insurance requirements.
“There’s a lot of pressure to know what truly is a QM loan and what isn’t,” said Leonard Chanin, partner, Morrison & Foerster, and a former CFPB and Federal Reserve official. “You can’t go back. Once you originate a non-QM loan, it’s always a non-QM loan.”
In addition to a DTI of less than 43%, QM loan points and fees are limited to 3% of the entire loan amount (for loans in excess of $100,000). Negative amortization, interest only, balloon, no documentation, and loans with terms longer than 30 years do not qualify as QM.
QM loans do offer several advantages for lenders. First, QM loans can be readily sold. Because a secondary market for non-QM loans does not yet exist, banks must be willing to keep non-QM loans in their portfolio. QM loans also provide safe harbor legal protection against borrowers who default and claim that the bank should have known that the borrower did not have the ability to repay the loan.
These claims can be “a substantial windfall for consumers,” Chanin stated.
Know thy customer and loan history
Lake Sunapee Bank, a $1.4 billion federal savings institution, is among the lenders that have decided to continue to originate non-QM loans. This decision, as is frequently the case, is based on customer population and past mortgage lending experience.
Gilday noted that the bank’s borrowers include a large number of self-employed business owners, first-time homebuyers, and medical professionals just starting their careers, all of whom may have difficulty meeting the 43% requirement. For example, a recent medical school graduate with a large student loan repayment may have a DTI above 43%, but their residual income allows them to comfortably take on the debt.
The bank wanted to continue to lend to these customer segments. “Lake Sunapee Bank has a history of offering products to meet the needs of our community,” Gilday explained.
To make the QM/non-QM decision, Lake Sunapee Bank analyzed five years of mortgage loans and found that those loans that would have fallen outside QM guidelines were in fact high quality loans that performed within the bank’s risk tolerance. The few loans that did default were due to factors not measured by underwriting models, such as death, divorce, job loss, or medical costs.
The bank then weighed the potential lost revenue from not making non-QM loans against the potential liabilities and loss from a default and determined that the bank was comfortable continuing to lend outside of QM.
While the bank will continue to originate non-QM loans, it has made several changes to address the potential liabilities of writing loans that are not protected by the Dodd-Frank Act’s safe harbor, noted Gilday. First, the bank secured its board’s approval to originate non-QM loans subject to production limits. Second, the bank regularly reports to the board on the status of non-QM loans, including early payment default. Third, all non-QM loans require dual approval.
Lake Sunapee Bank also has safeguards in place to ensure that it is not unintentionally violating fair-lending rules by documenting the reasons for making a non-QM loan, including factors such as the assets of the borrower, income stability, and residual income.
Potential backlash on consumers
Cambridge Mortgage’s Battaglia expressed concern that ATR/QM rules will stunt the innovation of new mortgage products that can help consumers such as 40-year loans for first-time homebuyers. He told attendees he worries that lenders may need to hire additional staff to comply with the rules, stressing already thin margins.
Those banks electing to stick with only QM loans face another dilemma, explained Battaglia: What lending decision does the bank make when the child of a long-term (and profitable) commercial customer applies for a mortgage and does not meet QM requirements?
Does the bank risk a fair-lending violation or potential lawsuit and originate the loan as a non-QM mortgage on a one-off basis? Does the bank decline the loan and potentially risk losing a profitable commercial client?
Each bank will provide its own answer to the situation. But no matter what they decide, all banks must diligently document why they made the lending decision they did, said Battaglia.