The FRB issued for comment a proposed rule under Regulation Z that would require creditors to determine a consumer’s ability to repay a mortgage before making the loan and would establish minimum mortgage underwriting standards. The proposal is being made pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The proposal would apply to all consumer mortgages, except home equity lines of credit, timeshare plans, reverse mortgages, or temporary loans.
Four Compliance Options
The proposal provides four options for complying with the ability-to-repay requirement.
1. General Ability-to-Repay Standard
A creditor can meet the general ability-to-repay standard by:
- Considering and verifying the following eight underwriting factors:
- Income or assets relied upon in making the ability-to-repay determination;
- Current employment status;
- The monthly payment on the mortgage;
- The monthly payment on any simultaneous mortgage;
- The monthly payment for mortgage-related obligations;
- Current debt obligations;
- The monthly debt-to-income ratio, or residual income; and
- Credit history.
- Underwriting the payment for an adjustable-rate mortgage based on the fully indexed rate.
2. Qualified Mortgage
A creditor can originate a “qualified mortgage,” which provides special protection from liability. The FRB is soliciting comment on two alternative definitions of a “qualified mortgage.”
a. Alternative 1
Alternative 1 would operate as a legal safe harbor and define a “qualified mortgage” as a mortgage for which:
- The loan does not contain negative amortization, interest-only payments, or a balloon payment, or a loan term exceeding 30 years;
- The total points and fees do not exceed three percent of the total loan amount;
- The income or assets relied upon in making the ability-to-repay determination are considered and verified; and
- The underwriting of the mortgage (i) is based on the maximum interest rate that may apply in the first five years, (ii) uses a payment scheduled that fully amortizes the loan over the loan term, and (iii) takes into account any mortgage-related obligations.
b. Alternative 2
Alternative 2 would provide a rebuttable presumption of compliance and would define a “qualified mortgage” as including the criteria listed under Alternative 1 as well as additional underwriting requirements from the general ability-to-repay standard. Thus, under Alternative 2, the creditor would also have to consider and verify:
- The consumer’s employment status;
- The monthly payment for any simultaneous mortgage;
- The consumer’s current debt obligations;
- The monthly debt-to-income ratio or residual income; and
- The consumer’s credit history.
3. Balloon-Payment Qualified Mortgage
A creditor operating predominantly in rural or underserved areas can originate a balloon payment qualified mortgage. This option is meant to preserve access to credit for consumers located in rural or underserved areas where creditors may originate balloon loans to hedge against interest rate risk for loans held in portfolio.
Under this option, a creditor can make a balloon-payment qualified mortgage with a loan term of five years or more by:
- Complying with the requirements for a qualified mortgage; and
- Underwriting the mortgage based on the scheduled payment, except for the balloon payment.
4. Refinancing of a Non-Standard Mortgage
A creditor can refinance a “non-standard mortgage” with “risky” features into a more stable “standard mortgage.” This option is meant to preserve consumers’ access to streamlined refinancings that materially lower their payments.
Under this option, a creditor complies by:
- Refinancing the consumer into a “standard mortgage” that has limits on loan fees and that does not contain certain features such as negative amortization, interest-only payments, or a balloon payment;
- Considering and verifying the underwriting factors listed in the general ability-to-repay standard, except the requirement to consider and verify the consumer’s income or assets; and
- Underwriting the “standard mortgage” based on the maximum interest rate that can apply in the first five years.
The proposal would also:
- Implement the Dodd-Frank Act’s limits on prepayment penalties;
- Lengthen the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions, and
- Prohibit evasion of the rule by structuring a closed-end extension of credit as an open-end plan.
Comments on the proposal must be received by July 22, 2011. Click here for the proposal.