WASHINGTON — The Consumer Financial Protection Bureau's willingness to extend a special regulatory exemption for Fannie Mae and Freddie Mac is welcome news for the mortgage market. But the agency is also signaling longer-term changes to its underwriting rule that will affect all mortgage lenders.
CFPB Director Kathy Kraninger told Congress in a recent letter that Fannie and Freddie will prolong the "qualified mortgage" patch beyond its expiration in January 2021. The agency had already indicated in July that it was planning a soft landing to eliminate the patch.
But she also confirmed that the bureau is planning to replace the 43% debt-to-income limit for QM loans based on industry comment letters.
Kraninger's letter sends an early message to Wall Street that there is time to prepare for a smooth transition to a truly competitive mortgage market.
"The Bureau has decided to propose an amendment to the Rule which would move away from DTI and instead include an alternative," Kraninger wrote. "The proposed alternative would be intended to better ensure that responsible, affordable mortgage credit remains available to consumers."
Here are four key questions about the future of the patch and the QM rule.
Is the CFPB preserving the QM patch?
The short answer is: no. This is just a short-term extension. But drilling down deeper, the answer is more complicated.
The QM rule became effective in 2014. It implemented a requirement in the Dodd-Frank Act that lenders verify a borrower's ability to repay a loan. But the CFPB gave the GSEs an exemption, known as the patch, that was supposed to be temporary because the mortgage market was still in recovery at the time. This means that GSE-backed loans can have DTIs above 43% and still be in compliance.
Kraninger is still set on eventually letting the QM patch expire. But banks and mortgage lenders have lobbied for some time to maintain GSEs' exemption while also lobbying for more flexible standards for meeting the DTI requirement.
A longer delay in ending the QM patch potentially increases the riskiness of loans sold to the GSEs.
What is unclear going forward is how Kraninger plans to redefine QM. The industry has pushed for replacing the current QM definition with different thresholds and compensating factors for higher-risk mortgages.
An extension of the patch gives the CFPB more running room to revamp the QM rule — and the industry more time to adopt the changes — without disrupting the mortgage market.
Changes by the CFPB will have a broad effect on the housing market.
Eliminating the patch could potentially shift volume from Fannie and Freddie to the Federal Housing Administration, and potentially, private lenders. Currently, the FHA guarantees mortgages with DTIs of up 57%. Yet such a shift could be preempted by other changes to the QM rule.
What does Kraninger's letter mean for the long-term future of the QM rule?
Kraninger told lawmakers that the CFPB intended to phase out using DTI ratios to evaluate a borrower’s ability to repay a loan. She said the agency will likely propose a rule to replace the DTI limit with some sort of an alternative metric to assess creditworthiness.
Kraninger said that the alternative metric could be a pricing threshold — the difference between the loan's annual percentage rate and the average prime offer rate.
The agency plans to issue a notice of proposed rulemaking no later than May to solicit feedback on any revisions it plans to make to the QM rule.
The CFPB also plans to add a “seasoning” framework that would provide a legal safe harbor to loans after a borrower has made payments for a certain period of time, Kraninger said. That would be proposed through a separate rulemaking process.
If the DTI ratio is eliminated from the QM rule, it could also mean that a set of criteria called Appendix Q would be eliminated, said Jaret Seiberg, an analyst with Cowen Washington Research Group, in a note.
Appendix Q, adapted from the FHA, set standards for documenting income to determine whether a loan qualifies for QM, and consists of eight criteria used to calculate a borrower’s DTI.
Some have argued that the criteria in Appendix Q are too restrictive, resulting in some self-employed borrowers, small business owners and borrowers with assets but no income being unable to qualify for a QM loan. In essence, the mortgage industry has been trying to get rid of Appendix Q for years.
"There is no need for exhaustive rules on when a lender can count income and when it cannot count income, " said Seiberg. "This is especially true as the gig economy leaves many borrowers with multiple sources of additional income."
Why is the CFPB telling Congress now that it will delay the end of the patch?
Kraninger is signaling a year ahead of the elimination of the patch that lenders need time to start preparing.
Mark Calabria, the director of the Federal Housing Finance Agency, has stated that a core reason for eliminating the patch is to transition or jump-start the private market to originate standard QM or non-QM loans without government backing.
Calabria had said last year that he hoped to get a new set of rules in place before the patch expires in 2021.
"If we had to extend the QM patch, I would consider that to be a failure on the part of Washington regulators," he told American Banker in April.
But at the same time, he committed to minimizing market disruption in July when the CFPB asked for public feedback on the future of QM.
Ending the QM patch is "a critical component of moving toward a competitive mortgage finance system," he said at the time, adding that he didn’t believe ending the exemption for Fannie and Freddie would affect the GSEs' market share.
How would an alternative QM metric affect the GSE-backed market?
Because nearly a third of GSE-backed loans currently enjoy the benefits of the QM exemption, ending the patch without adjusting the current methods used to evaluate a borrower’s ability to repay could constrain Fannie and Freddie’s business.
But replacing DTI with an alternative metric and incorporating a seasoning framework would likely preserve mortgage credit availability and ease the transition away from the patch, said Isaac Boltansky, a policy analyst at Compass Point Research & Trading, in a note to clients.
"There are still hundreds of pages of comments and untold billable hours between here and a final rule, but all signals suggest that policymakers remain focused on fostering a level playing field without materially disrupting mortgage markets," he said.
Boltansky said there are still some unknowns, like how or if the CFPB will address Appendix Q, or how a pricing threshold or seasoning framework would be constructed, among other things.
