Back in 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in order to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail,’ to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.” In the realm of mortgage lending, the Dodd-Frank Act protects lenders from lawsuits instigated by borrowers. But a provision of that act, called the GSE Patch, was included to extend protection to borrowers as well.
Due to the Patch, lenders are given incentives to lend to borrowers who, although not quite meeting the strictest of qualifying standards, are still deemed a safe credit risk, relatively speaking. The GSE Patch was set to expire on January 10, 2021, however, under new parameters (called Regulation Z or the General QM Final Rule) an extension of its benefits will stay in effect until July 2021 for those that qualify.
Replacement of the 43% DTI Ratio
Under the Frank-Dodd Act, a borrower received protection if the mortgage was issued based on a debt-to-income ratio (DTI) of up to 43%, and lenders could not exceed this ratio and still expect to be protected. However, under the General QM Final Rule, the 43% DTI has been replaced with price-based thresholds (the difference between a loan’s annual proportion ratio [APR] and the average prime offer rate [APOR] for a similar loan), apparently to “facilitate a smooth and orderly transition” after the expiry of the GSE patch.
As to the benefits of this change, Kathleen L. Kraninger, Director of the Consumer Financial Protection Bureau (CFPB), says that it “will facilitate a more transparent, level playing field that ultimately benefits consumers through promoting more vigorous competition in mortgage markets.”
Disadvantages of the Price-Based Approach
If a bank sets its interest rates low, consumers view their loans as “affordable” since most view low-interest rates as synonymous with low-risk lending. The worry to consumers, however, is that a price-based approach gives more advantage to the lender, and it creates an environment where incentives can gradually become more perverse. For example, rates may be lowered just enough for the lender to qualify for protection from liability for a questionable loan, thereby making an “affordable” loan a hidden risk.
Ability to Repay Requirements
Under Regulation Z, creditors must determine to a reasonable degree, and in good faith, the ability of a consumer to pay back loans (ability to repay [ATR]) that comply with the requirements set forth for “qualified mortgages” (QMs) in order to obtain liability protection. However, who determines what is ‘reasonable and in good faith’? Herein lies the risk of the ATR requirement which necessitates familiarity with the new rules. Indeed, there are now several categories of QMs that can qualify for purchase by GSEs, including a new category called Seasoned QMs. The main objective of regulation Z is to make sure that consumers can access responsible and affordable mortgage options.
Strategies for 2021
With interest rates still relatively low and the expiry of the GSE Patch, the climate is favorable for both lenders and borrowers provided they have a thorough knowledge of the ways that Regulation Z has modified the mortgage market going into 2021. Quality control, compliance services, and expert opinions from professional consultants can help financial institutions provide a product that attracts consumers while still protecting their organization from liability—successfully navigating today’s mortgage market.