CFPB’s latest underwriting revamp seen as boon to fintechs, GSEs

Lenders are hoping for a boost from a Consumer Financial Protection Bureau plan to make more loans eligible for "qualified mortgage" status, but consumer groups say the proposal violates Dodd-Frank Act protections.

The CFPB last month proposed a new category of "seasoned QM" loans that shield lenders from legal liability. Loans that initially are not QM can still gain that status if they remain on a lender's balance sheet for at least three years and satisfy other criteria.

The plan aims to help lenders such as fintechs that rely on alternative underwriting data whose loans are ineligible for QM at origination. Many also hope it will cushion the blow of Fannie Mae- and Freddie Mac-backed loans losing an exemption from CFPB underwriting rules.

“This could provide some positive impact for borrowers and the secondary market,” said Eamonn Moran, of counsel at the law firm Morgan Lewis & Bockius and a former counsel in the CFPB’s Office of Regulations. “What the CFPB said in the proposal is specifically that at least some creditors are relying on nontraditional sources of income during underwriting, and creditors who use that information may not be able to originate a QM loan under current rulemaking restrictions."

The agency said in its proposal that loans with three years of "seasoning" have enough payment history to be considered safe, and therefore worthy of QM's safe harbor.

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But Alys Cohen, a staff attorney at the National Consumer Law Center, said the CFPB’s plan undermines protections for consumers because Dodd-Frank allows homeowners to bring a claim against a lender at any time, not just in the first three years of the loan. She argued that expanding the safe harbor is unnecessary since borrowers rarely if ever take legal action claiming a mortgage lender has violated CFPB rules.

“The narrative is that only QM loans are safe to make because they offer a safe harbor that is airtight from liability, but that narrative is not based on fact,” Cohen said.

The Aug. 19 proposal says a loan could achieve QM status after the three years if it is secured as a first lien, has a fixed rate with fully amortizing payments and no balloon payments, does not exceed 30 years, and complies with CFPB restrictions for points and fees.

The plan is tied to a broader effort by the Trump administration to release the government-sponsored enterprises Fannie Mae and Freddie Mac from conservatorship. The bureau is also seeking to encourage lenders to originate mortgages for which lenders may use alternative data to verify a borrower’s ability to repay. Using alternative data means lenders often have to give up QM status, but some in the industry say that hurts borrowers' access to credit.

The CFPB’s "reasoning, in part, will help provide access to consumers — that’s a big part of it,” Moran said.

Meanwhile, a 2014-era policy that Fannie and Freddie loans are exempt from CFPB underwriting guidelines — including a 43% debt-to-income limit for QM loans — is set to expire as early as next year. The exemption is known as the GSE "patch."

The CFPB has already proposed redefining QM, including replacing the DTI limit with a pricing-based standard, but some in the mortgage market say that is not enough to ensure compliance for GSE-backed loans once the patch expires.

The bureau said it received 20 comment letters on the seasoning issue after requesting feedback in June on how to change the QM definition.

At issue is how a lender verifies a borrower’s ability to repay a home loan. Dodd-Frank amended the Truth in Lending Act to identify factors lenders must consider for a loan to be compliant. A creditor that violates the ability-to-repay requirements may be subject to government enforcement actions as well as lawsuits filed by consumers as a defense against foreclosure.

“The idea behind the ability-to-repay [rules] is that if it looks like the borrower has been underwritten properly, [the loan] should be a QM loan and if there is three years of seasoning it’s unlikely that the borrower would default from an underwriting error,” said Bose George, managing director at Keefe, Bruyette & Woods.

But Cohen said allowing lenders more options for attaining QM status will just make it harder for homeowners to seek liability for an unaffordable loan.

“Lenders want as many of their loans as possible to be safe-harbor, qualified mortgages so they are immune from liability, but before Dodd-Frank lenders did not have airtight arguments against liability and they made loans anyway,” she said.

The CFPB’s proposal does not include data on legal or compliance costs that would indicate how much lenders have paid out either to borrowers or regulators to explain why liability is such a threat, Cohen said.

But lenders are concerned that without recourse for loans subject to the GSE patch, a significant number of loans will not be eligible to be sold to the government-sponsored enterprises, which could have a massive impact on the now-booming mortgage market.

Supporters of the proposal also argue that the seasoning period is a good layer of protection for loans issued by fintech companies.

"There is a recognition by the CFPB leadership that to try to accommodate some of the fintech players and other creditors that are relying on alternative sources of income, 36 months is a good seasoning period to show whether somebody can repay a mortgage or not," Moran of Morgan Lewis said.

The CFPB's plan currently would apply only to non-QM loans originated after the proposed rule goes into effect. Since the loans have to be held on balance sheet for three years, the earliest time frame for loans to be reclassified would be 2024. But the CFPB specifically has asked for public comment on whether loans held on balance sheet before the rule goes into effect should be eligible.

"That is something that could potentially come into play if the CFPB gets enough comments," Moran said.

The 130-page proposal predicts the annual number of loans that meet all of the requirements of a seasoned QM loan based on Home Mortgage Disclosure Act data for first-lien, fixed-rate conventional mortgages that do not have disqualifying features. Its complicated analysis estimates that anywhere from 22,000 loans to as many as 927,000 could meet the seasoned QM definition based on various requirements.

The bureau said it issued the proposal "to introduce an alternative pathway to a QM safe harbor because it seeks to encourage safe and responsible innovation in the mortgage origination market, including for loans that may be originated as non-QM loans but meet certain underwriting conditions, product restrictions, and performance requirements.”

Lenders have lobbied heavily to get the CFPB to come up with an alternative to the GSE patch that would also give the loans QM status.

GSE-backed loans "go through Fannie and Freddie’s underwriting engines for approval,” said Bryan Filkey, executive vice president of credit and strategic initiatives at PCMA Private Client Lending, a nonbank mortgage lender in Irvine, Calif.

Filkey said the CFPB’s policies have had the opposite effect of what the agency originally intended when it created the QM rule. Lenders that originate non-QM loans, currently a small part of the market, have to follow a list of technical requirements to document a mortgage applicant’s income and liabilities as part of the CFPB’s ability-to-repay underwriting rule.

He supports the bureau's proposal and says most non-QM loans have strong underwriting.

“The standard for documentation of non-QM loans is infinitely higher than for loans sold to Fannie and Freddie where a lender logs into the system and the loan is sold almost immediately,” Filkey said. “Non-QM is a misnomer, because the loans have been vetted five times more than government loans. We have internal teams examining the loans and if I want to sell a loan, I have to go through third-party due diligence that scores and grades the loan.”