Financing for Homes and Small Businesses

Qualified Mortgages QM | Ability to Repay

Qualified Mortgages are a type of loan that has known, stable features that help make it more likely that you’ll be able to afford your mortgage.

Qualified Mortgages

The Mortgage Reform and Anti-Predatory Lending Act provides that a creditor may presume the ability of a borrower to repay exists if the loan is a “qualified mortgage.”  A qualified mortgage is a residential mortgage loan that meets the following characteristics:

  • The periodic payments will not result in an increase in the principal balance
  • There are no balloon payments (although the law provides that the Board can pass regulations that allow balloon payments in limited circumstances)
  • Verification and documentation of the income and financial resources of those who are obligated to repay the loan are complete
  • Underwriting will analyze a payment schedule that fully amortizes the loan over the loan term if the loan has a fixed rate
  • Underwriting decisions are based on the maximum interest rate permitted during the first five years of the loan term and on a payment schedule that fully amortizes the loan over the loan term if the loan has a variable rate
  • The loan complies with guidelines, initially established by the private banking organization, the Board of Governors of the Federal Reserve, for debt-to-income ratios or with other measures of ability to pay that now, the Consumer Financial Protection Bureau establishes
  • The total points and fees for the loan do not exceed 3% of the total loan amount
  • The term of the loan does not exceed 30 years, with some exceptions allowed

If a residential mortgage loan meets these characteristics, it is a qualified mortgage, and the creditor can assume that the borrower will have the ability to repay the loan.

(H.R. 4173 Section 1412)

Prohibited Practices for Qualified Mortgages

The Mortgage Reform and Anti-Predatory Lending Act prohibits certain compensation practices.  Like the rule on loan originator compensation, the prohibitions include:

Compensation Based on Loan Terms:  No mortgage originator can accept remuneration, and no person can pay compensation based on the terms of a loan other than the amount of the principal.

Unlike other licensed professionals, mortgage originators can no longer be compensated based on the work involved in the successful completion of the borrower’s loan request.

Double Compensation:  No mortgage originator can accept an origination fee or a charge, and no person can pay an origination fee or charge to a mortgage originator who has already received direct compensation from a borrower.

Steering:  The law also prohibits steering, stating that mortgage originators cannot steer borrowers to:

  • Loans that the borrower cannot reasonably repay
  • Loans with predatory characteristics

The law also prohibits the practice of steering borrowers away from a qualified mortgage for which the borrower qualifies.

Unfair Lending Practices:  The law also prohibits abusive or unfair lending practices including:

  • Lending practices that discriminate by race, ethnicity, gender, or age
  • Mischaracterizing the credit history of a loan applicant or the residential mortgage loan available to the loan applicant
  • Mischaracterizing the appraised value of the property securing the loan

The law directs the regulators to draft regulations to implement these prohibited practices. (H.R. 4173 Section 1403)

Borrower’s Ability to Repay:  Potential Scenarios

Othello Thomas has owned a home improvement company for 20 years.  His services include roofing, siding, windows, remodeling, additions, and decks.  Well known in the community, he stays very busy working strictly from referrals from former clients.  Three years ago, Othello refinanced two properties and used cash from the transactions to build a new office, update his office equipment, and purchase a new Bobcat for his business.  Both cash-out loans were done using stated income mortgage products, and offered low initial ARM payments, not to mention an interest-only feature.

Now, both loans are within six months of an initial adjustment, and Othello’s business, while still doing well, isn’t nearly as profitable as it was in the boom market.  At this point, Othello is concerned he may have to sell his investment property and may struggle as well to find affordable financing for his primary residence due to tightening constraints on income documentation and credit scoring.

Under the Mortgage Reform and Anti-Predatory Lending Act, a creditor is required to base their lending decisions on a reasonable good faith determination of an ability to repay the loan.  A borrower’s tax returns can be used to determine qualification for the payments on an ARM.

Filed tax returns are a part of the documentation collected for a self-employed borrower, but under the new legislation, a borrower is required to qualify using the fully-amortized payment, or the worst case example for an ARM.

Income verification, according to the new law, is required to be confirmed through the use of reliable evidence.  Three forms of reliable documentation evidence can include:

  • W-2s
  • tax returns
  • payroll receipts
  • bank records, and
  • reliable third party documents (such as verification of employment, or verification of deposit).

Othello, a self employed business owner has several issues, among them:

  • a decreased income
  • tightening qualification factors, and
  • an existing mortgages on the verge of adjustment.

These original loans were closed, funded and recorded.  What can be done now to prevent situations like Othello finds himself in today?  The following is a quote from a state approved continuing education course in 2014:

“While loan programs allowed for less than responsible underwriting years ago, it could be argued that it was unethical for the originator of the two ARM loans Othello is struggling with now because no effort was apparently made to guarantee he could afford the loan.”

Personally, I find this irresponsible, silly and laughable.  The only mention of responsibility is with the originator.  Not the

  • Lender:  who underwrote and funded the loan
  • Wall Street:  who had responsibility for buying such loans and repackaging them and selling under false pretenses in collusion with the rating agencies.
  • The Borrower:  ultimately, it’s the borrower’s responsibility to look out for themselves.  Caveat emptor!  Current law in most jurisdictions do not allow for borrower representation.  Virginia does not allow agency for borrowers.

Qualified Mortgage Liability

The Mortgage Reform and Anti-Predatory Lending Act includes retribution provisions  applicable to mortgage originators that violate the prohibitions related to originator compensation.  The law provides that the maximum penalty a mortgage originator must pay for violations of the restrictions on compensation is:

  • The greater of actual damages or three times the total amount of direct or indirect compensation or gain, which the mortgage originator has earned in connection with the loan involved in the violation
  • The borrower costs expended to bring the action including reasonable attorney’s fees

(H.R. 4173 Section 1404)

 

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