Confusion in regards to the CFPB drawing rule stays

There is confusion in the mortgage market over conflicting deadlines for loans backed by Fannie Mae and Freddie Mac to meet the qualifying mortgage standard.

Acting director of the Bureau of Consumer Financial Protection, Dave Uejio, announced last week a delay in mandatory compliance with a revised QM rule through October 2022 and that loans backed by government-sponsored companies would remain exempt until then.

However, this is in direct contradiction to a January agreement between the Federal Housing Finance Agency and the Treasury Department that governs Fannie and Freddie's conservatories. The pact states that the exemption – known as the GSE "patch" – ends in July and Fannie and Freddie are required to only buy QM credits.

"It's a very messy and surprising situation," said Stephen Ornstein, partner at Alston and Bird.

The QM drawing rule created after the financial crisis in 2008 established parameters that define loans as secure. It was revised last year by the CFPB, which replaced a debt-income limit of 43% with a price-based threshold as a key factor in credit compliance. Lenders who use such criteria are protected from legal liability.

But Uejio's decision has further upset the market. With the GSE patch, all mortgages supported by Fannie and Freddie were able to receive QM status in the last seven years, even those with high DTIs.

Many lenders, lawyers and political decision-makers regard the CFPB's decision as a forerunner for the agency's renewed revision of the QM framework concluded last year under the former CFPB director Kathy Kraninger, despite two years of rule-setting and public statements.

"There it was, from our point of view, we could finally give it a try, and then this proposed review by the acting director raised the question of what to do next," said Meg Burns, executive vice president of the Housing Policy Council. "What they really did is create insecurity."

Many lenders and proponents agreed to Kraninger's QM rule, which set the standard based on the pricing of a loan and was 150 basis points above the prime rate rather than the DTI limit of 43%. A coalition of stakeholders had for years pushed for what they believed to be a more effective underwriting standard that would keep the market from borrowing primarily that the GSEs would allow.

The CFPB's further expansion of the GSE patch means that Fannie and Freddie would effectively remain the arbitrators of the drawing standards. Many believe this will stifle the return of the private secondary market.

"Industry advocates and consumers agreed because we realized that the new QM rule finally allowed us to innovate to reach the underserved population," said Burns.

The Mortgage Bankers Association and non-QM lenders want Fannie and Freddie to cancel the GSE patch so that private lenders can fill the loophole. Although non-QM lending came to a standstill during the pandemic, the private market recovered dramatically in the first quarter due to persistently low interest rates and increasing competition.

"There is still a strong and re-emerging market for agency-less mortgage-backed securities," said Richard Gottlieb, partner at Manatt, Phelps & Phillips. "Without further action, the delay will be problematic for QM lenders."

The QM revision last year came after a five-year review where the CFPB's own research found the GSE patch, 43% DTI limit, and a number of underwriting criteria loathed by lenders and known as Appendix Q. are not working.

What made the situation even more uncertain was the July 1 deadline set in the FHFA agreement for the end of the GSE patch. If this deadline is met, according to Ornstein, lenders can take out QM loans in accordance with the revised price standard or the old QM rules, "but only with regard to underwriting in accordance with Appendix Q."

"Without a change of heart by the GSEs [and FHFA Director Mark Calabria], credits drawn under the QM patch cannot be acquired by Fannie Mae and Freddie Mac after July 1st and therefore cannot be QMs "said Ornstein.

The mortgage industry and consumer advocates have long marveled at subscription restrictions, arguing that they exclude minority borrowers. Many believe that flexible use of technology and appropriate best practices established by the industry would allow more borrowers, especially Black and Hispanic homeowners, to qualify for home loans.

"One of the main benefits of the new QM rule is that it aims to open up underwriting to reach more black and Hispanic borrowers," said Burns. "The fact that the CFPB may reconsider the new rule means that companies considering investing in the modeling and risk analysis required to establish new underwriting, new products and new practices must now decide whether to makes sense based on the final rule will be permanent or not.

Others suspect that the CFPB may plan to remove the QM rule entirely and start a new rule creation or revert to the 43% DTI limit, a standard that never fully came into effect due to the GSE patch. Although the CFPB's delay reportedly allows lenders an additional 15 months to borrow high-DTI loans under the GSE patch as well as loans that meet a price-based threshold, the FHFA will limit its purchases on July 1 to loans that The key interest rate is limited to 150 basis points above the maximum amount.

Although the GSEs will continue to be able to buy many of the same mortgages they would have bought under the "GSE patch," experts say the conflicting schedules in the mortgage market are causing confusion.

In a press release announcing the delay in the entry into force of the new QM rule, the CFPB noted that the GSE patch may be challenging for lenders after July 1.

"The availability of the GSE patch after July 1, 2021 may be restricted by the latest revisions of the purchase agreements for preferred shares concluded by the Ministry of Finance and the Federal Housing Agency," said a press release by the CFPB.

The PSPA agreements mandate government ownership of the GSEs, which were listed as a Historic Monument in 2008.

The stock agreement changes shouldn't affect a wide variety of lenders, as Fannie and Freddie can continue to buy high-debt-to-income loans as long as they meet the new QM standard. However, the other restrictions in the PSPAs could limit the number of "riskier" mortgages the GSEs can acquire that may have qualified as QM under either the patch or the new rule.

The PSPAs limited the GSE's purchase of high-risk single-family mortgages to 6% of their total book and high-risk refinancing to 3%. Under the new agreements, a loan is considered high risk if two of the following apply: it is more than 90% of the value of a home, the borrower's DTI is more than 45%, or if the borrower has an FICO value below 680.

The Community Home Lenders Association, a trading group for independent mortgage bankers, questioned the changes. In an April 22 letter to Fannie and Freddie, the group said that some lenders are now being given "caution" in lending through the GSEs' automated underwriting machines, even if borrower loans, loan terms and financial standing remain the same.

"We see no evidence that the tightening of credit boxes is currently warranted by the underlying credit risk, particularly given the continued profitability record of the GSEs," said CHLA.

While the FHFA cannot change these restrictions on its own, the Treasury Department could suspend the PSPA changes or prevent GSEs from being required to comply. The Treasury Department does not require approval from the FHFA to operate as it has a majority stake in the GSEs.

The MBA and the American Bankers Association asked the CFPB not to renew the GSE patch because the implementation of the final QM rule was delayed.

Mortgage lenders have made calls to discuss the issue with some suggesting continuing to use the GSE patch and tracking the delay in the QM compliance date by the CFPB, while others simply plan not to sell any loans to the GSEs.

"Lenders can adhere to the FHFA, but it destroys the CFPB's argument of optionality, making it a very delicate situation," Ornstein said. "You take away the near certainty of the patch and automated underwriting, and now lenders have to consider rates [thresholds]."

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