Confusion over CFPB underwriting rule persists

Confusion is building in the mortgage market about conflicting deadlines for loans backed by Fannie Mae and Freddie Mac to be in compliance with the Qualified Mortgage standard.

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

But that is in direct conflict with a January agreement between the Federal Housing Finance Agency and Treasury Department governing Fannie and Freddie's conservatorships. The pact states that the exemption — known as the GSE "patch" — will end in July, requiring Fannie and Freddie to start purchasing only QM loans.

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

The QM underwriting rule created after the 2008 financial crisis set parameters that defined loans as safe. It was overhauled last year by the CFPB, which replaced a 43% debt-to-income limit with a price-based threshold as the key factor determining loans in compliance. Lenders using such criteria are protected from legal liability.

But Uejio's decision has thrown the market into further turmoil. The GSE patch has allowed all mortgages backed by Fannie and Freddie to get QM status for the past seven years, even those with high DTIs.

Many lenders, advocates and policymakers view the CFPB's decision as a precursor to the agency's yet again overhauling the QM framework finalized last year under former CFPB Director Kathy Kraninger, despite two years of rulemaking and public comment.

"There it was, within our sights; we could finally taste it and then, this proposed reconsideration by the acting director called into question how to proceed," said Meg Burns, executive vice president of the Housing Policy Council. "What they’ve really done is to create uncertainty."

Many lenders and advocates sided with Kraninger's QM rule that set the standard based on a loan's pricing, capped at 150 basis points above the prime rate, rather than the 43% DTI limit. A coalition of stakeholders had pushed for years for what they considered a more effective underwriting standard that would pry the market away from primarily originating loans that the GSEs would allow.

The CFPB's further extension of the GSE patch means Fannie and Freddie would effectively remain the arbiters of underwriting standards. Many believe that will stifle the return of the private, secondary market.

"The industry and consumer advocates were on the same page because we recognized that with the new QM rule, we could finally achieve the opportunity to innovate to reach the underserved population," said Burns.

The Mortgage Bankers Association and lenders that originate non-QM loans want Fannie and Freddie weaned off the GSE patch to allow private lenders to pick up the slack. Though non-QM loans came to a grinding halt during the pandemic, the private market rebounded dramatically in the first quarter thanks to persistently low interest rates and increased competition.

“There remains a strong and rebuilding market for non-agency mortgage-backed securities,” said Richard Gottlieb, a partner at Manatt, Phelps & Phillips. “For QM lenders, the delay will be problematic without further action.”

The QM overhaul last year came after a five-year look-back review in which the CFPB's own research found that the GSE patch, the 43% DTI limit and a set of underwriting criteria detested by lenders, known as Appendix Q, were not working.

What makes the situation even more uncertain was the July 1 deadline established in the FHFA agreement for the GSE patch to end. If that deadline is upheld, Ornstein said, lenders will be able to originate QM loans under the revised pricing standard or under the legacy QM rules, "but only with respect to underwriting under Appendix Q."

"Absent a change of heart by the GSEs [and FHFA Director Mark Calabria], after July 1, loans underwritten under the QM Patch will no longer be eligible for purchase by Fannie Mae and Freddie Mac, and hence cannot be QMs," Ornstein said.

The mortgage industry and consumer advocates have long chafed at underwriting restrictions, arguing that they shut out minority borrowers. Many believe that flexible use of technology and appropriate best practices set by the industry would allow more borrowers, particularly Black and Hispanic homeowners, to qualify for home loans.

"One of the primary benefits of the new QM rule is that is it designed to open up underwriting to reach more Black and Hispanic borrowers," said Burns. "The fact the CFPB might reconsider the new rule means companies that were considering investing in modeling work and risk analysis needed to set up new underwriting, new products, new practices, now have to determine whether this makes sense, based on whether the final rule will be permanent or not.

Others suspect the CFPB could be planning to scrap the QM rule altogether and begin a new rulemaking or return to the 43% DTI limit, a standard that never fully went into effect because of the GSE patch. Though the CFPB’s delay ostensibly gives lenders another 15 months to originate high-DTI loans under the GSE patch as well as loans that meet a price-based threshold, starting July 1 the FHFA will use the revised definition for QM.

Although the GSEs will still be able to purchase many of the same mortgages that they would have purchased under the “GSE patch,” experts say the conflicting timelines are creating confusion in the mortgage market.

In a release announcing the delay of the effective date of the new QM rule, the CFPB noted that the GSE patch might become challenging for lenders to use after July 1.

“The availability of the GSE Patch after July 1, 2021 may be limited by recent revisions to the Preferred Stock Purchase Agreements entered into by the Department of the Treasury and the Federal Housing Finance Agency,” the CFPB said in a press release.

The PSPA agreements dictate the government's ownership of the GSEs, which were placed in conservatorship in 2008.

The changes to the stock agreements shouldn’t impact a wide swath of lenders, because Fannie and Freddie will still be able to purchase loans with high debt-to-income ratios, so long as they meet the new QM standard. But the other restrictions in the PSPAs could limit the amount of “riskier” mortgages the GSEs can purchase that might have qualified as QM under either the patch or the new rule.

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

The Community Home Lenders Association, a trade group for independent mortgage bankers, questioned the changes. In an April 22 letter to Fannie and Freddie, the group said some lenders are now receiving "caution” notices when running loans through the GSEs’ automated underwriting engines, even when borrower credit, loan terms and financial capacity remain the same.

“We see no evidence that credit box tightening is warranted at this time by the underlying loan risk, particularly in light of the GSEs’ continued record of profitability,” CHLA said.

While the FHFA cannot alter those restrictions on its own, the Treasury Department could suspend the PSPA amendments or keep the GSEs from being required to comply. Treasury does not need approval from the FHFA to act since it is the majority stakeholder in the GSEs.

The Mortgage Bankers Association along with the American Bankers Association urged the CFPB against extending the GSE patch by virtue of delaying the implementation of the final QM rule.

Mortgage lenders have held calls to discuss the issue with some suggesting they would continue to use the GSE patch and follow the CFPB’s delay of the QM compliance date, while others simply plan not to sell loans to the GSEs.

“Lenders can comply with FHFA, but it destroys the optionality argument of the CFPB. So it’s a very ticklish situation,” said Ornstein. “You take away the almost certainty of the patch and automated underwriting, and now lenders have the pricing [threshold] to consider.”