New villain in battle over CFPB mortgage rule: Appendix Q
Mortgage lenders are urging the Consumer Financial Protection Bureau to overhaul a set of little-known guidelines for how they document a borrower’s creditworthiness.
As part of its ability-to-repay underwriting rule, the CFPB requires lenders to follow a list of technical requirements — known as Appendix Q — for how they document a mortgage applicant’s income and liabilities. The guidelines are a key factor in calculating a borrower’s debt-to-income ratio.
To date, Appendix Q has had little impact since loans backed by Fannie Mae and Freddie Mac are temporarily exempt from the 43% DTI limit for “qualified mortgages,” the class of safe loans with the strongest liability protection under the CFPB’s underwriting rule.
But with the CFPB planning to end Fannie and Freddie’s exemption in a rewrite of the underwriting rule, lenders say the bureau needs to revisit problems with Appendix Q, which the industry has complained about for years. Without changes, companies say, meeting the CFPB’s criteria will be difficult.
“We don’t have to go back to stated-income loans, but there are other methods for evaluating income that are not written into Appendix Q today,” said John Lynch, CEO and founder of PCMA Private Client Lending in Aliso Viejo, Calif.
The Appendix Q standards, which are adapted from income documentation standards used by the Federal Housing Administration, require that lenders verify employment history for a full two years. The guidelines deal with how underwriters include overtime and bonus income, part-time work, commissions and retirement income.
The standards also include requirements for documenting the earnings of self-employed consumers, alimony and child support, investments and trusts, and other forms of income.
Lynch said regulators need to find a better way for lenders to account for nontraditional income sources especially as more workers shift toward freelance work. He noted that under the QM criteria, borrowers who do not receive steady income but are still creditworthy could get penalized.
“Asset-rich retirees and a lot of the self-employed got pushed out of the market due to the ability-to-repay rule,” he said.
Last month, the CFPB released an advance notice of proposed rulemaking signaling that the agency planned changes to the QM rule. The notice included several questions for public comment dealing with Appendix Q.
They included whether the CFPB should require lenders “to continue using Appendix Q to calculate and verify debt and income” or whether Appendix Q should be replaced. “If the Bureau retains Appendix Q, how should it be changed or supplemented?” the notice asks.
Roughly 70% of the working population are W-2 employees with little variable income, but 30% have income that is hard to document, said Brad Blackwell, a former Wells Fargo executive and independent consultant at the National Association of Hispanic Real Estate Professionals.
Lenders criticized the CFPB when the agency established the separate Appendix Q standards as part of the 2013 underwriting rule, saying the standards would make it difficult for loans not backed by Fannie and Freddie to attain QM status. The industry has largely passed on making non-QM loans.
That concern will likely grow as Fannie and Freddie’s exemption from the CFPB rule — known as the QM “patch” — is set to expire in 2021, and the bureau has said it wants that exemption to end.
“There is virtually no non-QM business being done because lenders want the safe harbor,” Blackwell said. “Nothing is being made out there except for loans that meet QM and jumbo loans.”
The industry has also urged the CFPB to raise the 43% DTI limit in an overhaul of the underwriting rule.
"An expiration of the patch without any corresponding reforms to preserve access to credit would have a disruptive impact to the market," said Pete Mills, a senior vice president at the Mortgage Bankers Association. "We firmly believe this work should include important reforms that must first be made to the QM’s 43% debt-to-income standard."
Yet removing Appendix Q entirely could be a credit negative because the discipline of ability-to-repay has strengthened underwriting.
With interest rates at new lows and still-rising housing prices, many see the plan to revisit the ability-to-repay rule as another opportunity to rebalance the market.
“The ability-to-repay rules were created to protect borrowers, first and foremost,” said Matt Tomiak, a managing director at Redwood Trust. "At this point we don’t see a reason not to extend these protections for more consumers and level the playing field for public and private capital.”