As QM Goes Into Effect, Uncertainty Is the Only Sure Thing

WASHINGTON — A sweeping set of mortgage rules that primarily target underwriting standards is due to take effect on Friday, but lenders, regulators and market experts remain unsure exactly what their impact will be.

The biggest question is whether the rules, which include the creation of a new class of loans known as "qualified mortgages," will spark a credit crunch.

While it may be months before hard data tackling that question is released, there are other concerns as well, namely whether lenders are ready for the new rules — and how investors will react to them.

In the months leading up to the Jan. 10 effective date, banks have scrambled to get systems in place and updated, while ensuring staff are adequately trained for the new regulations. Some said they are ready, but will tread cautiously in distributing credit.

"I don't have a sense for where it's all going to land" but "we're going to absolutely adhere to the CFPB's guidelines and document the ability-to-repay and try to be precisely within the QM guidelines just because there's a big unknown outside of that," said David Bryles, executive vice president of IberiaBank Mortgage in Little Rock, Ark.

Investors, meanwhile, also seem to still be grappling with what loans they will buy. Even a day before implementation, observers said investors were all over the place about their own guidelines, including what types of QM loans they would purchase. Also up in the air is how investors will treat loans that don't qualify for QM status but which comply with rules that require lenders to ensure borrowers have the ability to repay a loan.

"It's just one of those last minute things where you get your own systems in place and think you know how the rules work and all of sudden, you get what the investors think — who are the buyers of your loans — and it's different," said Pete Mills, senior vice president of residential policy and member services at the Mortgage Bankers Association. "There's a lot of last-minute scurrying on that front, so obviously, that scurrying at the end of the day will take some fine-tuning post-Jan. 10."

Still, there has been a gradual shift in many lenders' attitude toward the new rules. When they were first finalized, some banks said they would never make non-QM loans once the regulations were in place.

But as they've gained a better understanding of the rules — and the Consumer Financial Protection Bureau has made several changes — institutions like Bank of America (BAC), JPMorgan Chase (JPM), Wells Fargo (WFC) and Bank of the West have made it clear there is at least a market for interest-only loans, which are non-QM.

"Our banks have gone more toward begin willing to do non-QM loans than they had earlier" last year, said Richard Hunt, president of the Consumer Bankers Association. "But you better believe those non-QM loans will be as pristine as you can get."

Most banks, however, are expected to ease into the non-QM space throughout this year, while some might wait even longer for the new market to shake out.

Under the rules, QM loans have greater legal protections from lawsuits by consumers while lenders making non-QM loans must ensure borrowers have the ability to repay. Many banks plan to wait and see how the new rules will be tested in a court of law and whether more lawsuits may result from them.

"I think we'll have people get more comfortable and ease back [into non-QM loans] but you've got to look out a few years and see whether there is going to be lawsuits" filed by borrowers, said Drew Breakspear, commissioner of the Florida Office of Financial Regulation. "If that happens, that will make banks even more leery."

Bryles of IberiaBank agreed, adding that the litigation risk has becoming a critical factor in the ability to make and sell a loan.

"From a business perspective, I don't think a business person can take that [non-QM loan] risk until the ability-to-repay rule has been litigated," Bryles said. "You can't take that sort of risk in a low margin business."

The rules are also likely to change. The CFPB has vowed to revisit certain issues as they see the rule take effect.

"The CFPB has clarified a lot of its rules verbally, particularly in October when it hosted webinars on the rules with the industry so you have to assume some of that advice will appear formally in a rule at some point in time," said Richard Andreano, the practice leader of Ballard Spahr's mortgage banking group. "Even though the rules go into effect Friday, the dust won't settle for another few years."

Lenders are also pressing the CFPB for more detail in certain places.

Under the rules, loans must meet certain debt-to-income requirements and comply with a 3% points-and-fees cap to qualify as a QM loans.

But bankers are still seeking clarification on the 3% cap. Many are confused about what the CFPB will consider a so-called bona fide discount that is excluded from the points-and-fees cap calculation. For example, a "bona fide discount" would be when a borrower buys down the interest rate of a loan upfront. But the specific requirements for what CFPB considers such a discount are complex and have raised questions from lenders.

"When I explain to my staff what a bona fide discount is, it becomes very difficult and it does bring up a lot of questions," Bryles said. "Until we can put it through the software and the staff can physically test it, they're not going to truly grasp it."

CFPB officials have repeatedly said they want to continue hearing from lenders and will assess the markets after the rules take effect to see whether any changes are warranted.

"We will be sensitive to considering whether we got the line right, whether we should put it in a different place," said CFPB Director Richard Cordray before the National Association of Realtors on Tuesday. "Let's see how they're working. ... And if we see something that's dramatically out of balance with what we expect in this market, we want to hear it from the Realtors, we want to hear it from the community bankers, the credit unions, anybody who has a line of sight on this market in order to think about what that means."

The CFPB is predicting that roughly 95% of the current mortgage market would meet QM status due to a provision that temporarily includes all loans approved for purchase by Fannie Mae and Freddie Mac.

Observers said those who tend to fall outside the DTI and other requirements in the QM rule are typically first-time homebuyers or wealthier borrowers like business owners who show atypical income flows but have strong credit history.

Still, even if it affects a smaller slice of the mortgage market, it could have a significant impact overall, some said.

The potential effect on small-business owners "is one of the outcomes of the rule that I think people haven't anticipated but it will, in fact, occur. And that's where we're going to see potential backlash to the rule is if that happens to any significant extent," Andreano said. "Because the small-business owner who is trying to get a home loan will call up their local Congressman and ask: 'What did you do to protect me?' And if that happens to a significant extent, I think policymakers are going to have to revisit the rule."