Community Bankers of Iowa Monthly Banker Update May 2014 | Page 10

Ability to Repay and Qualified Mortgage Risks: Part 1 of 3 Written By: R. Jeff Andersen - Attorney, Dickinson Law Introduction The ability-to-repay rules effective January 10, 2014 add a new cause of action available to consumers, which raises new risks for community banks. Banks have two primary ways to comply with the rule and defend against this new action – the qualified mortgage (“QM”) and ability-to-repay (“ATR”) standards. The qualified mortgage standard involves more stringent product and underwriting criteria. For example, points and fees cannot exceed 3% of the total loan amount for loans over $100,000, the DTI cannot exceed 43%, and the detail-oriented Appendix Q must be used to underwrite the loan. The benefit of getting qualified mortgage protection is that you will get safe harbor protection from a consumer action under the new rule. As discussed in this 3-part series, a safe harbor means that if you prove you meet the qualified mortgage criteria, you will have an absolute defense. With qualified mortgages you have higher standards to comply with in exchange for higher legal protection. categories. Below is a high-level summary of which closed-end mortgages will get a safe harbor and which will get a rebuttable presumption: • Small Creditor QM Loans: Loans made by a ‘small creditor’ as defined in 1026.35 and generally retained in portfolio for 3 years – qualified mortgage : safe harbor • Eligible QM Loans: Loans eligible for purchase by Fannie or Freddie – qualified mortgage : safe harbor • Standard Track QM: Loans underwritten in accordance with Appendix Q and meeting the QM product restrictions, including 43% DTI and the points and fees cap – qualified mortgage : safe harbor • Higher-Priced QMs: Loans that are HPMLs under 1026.35 but meet one of the three QM standards above – qualified mortgage : rebuttable presumption [Note that the HPML threshold for ‘small creditors’ under this rule is 3.5 as opposed to the usual 1.5 over APOR] • Ability-to-Repay Loans: Loans underwritten in accordance with the ability-to-repay standard – ability-torepay : rebuttable presumption The ability-to-repay standard has less restrictive underwriting requirements and does not have the product and pricing restrictions present in the qualified mortgage standard (such as the points and fees and DTI cap). The ability to repay standard instead requires the bank to consider eight underwriting factors. Unlike qualified mortgages that underwrite in accordance with Appendix Q, the ability-to-repay standard does not mandate specific underwriting criteria – banks are still free to develop its own underwriting standards. Because it is less restrictive, you get a lesser legal protection – instead of a safe harbor, you get a rebuttable presumption. A rebuttable presumption means that if you prove you considered and documented the eight factors required under the ability-to-repay standard, you are presumed to be compliant with the rule, but the consumer has the opportunity to rebut that presumption and present evidence that you did not properly consider his or her ability to repay. There is a lot more detail to each of these standards, but this should provide the general foundation needed to discuss the risks associated with the rule. This new rule requires the bank to make numerous business decisions and to assess the risks attendant to such decisions. Although the rule is already effective, the risk assessment should continue as the market adjusts to the new rules and the risks begin to crystallize. The decisions your bank made leading up to January 2014 should be re-visited as information is made available at your bank, in your community, and in the mortgage marketplace. Discussed in this 3-part are some of the key risks brought about by the ability-to-repay rule. Note that these are just opinions and your individual risk assessment may vary considerably. Which Loans are Qualified Mortgages and Ability-to-Repay Loans? The threshold issue in discussing the risks inherent in the ability-to-repay rule is the type of loans that are covered. For purposes of compliance with the ability-to-repay rule, the universe of loans can generally be broken down into 5 10 CBI BANKER UPDATE | MAY 2014 Liability for Ability to Repay Violations Violating the ability-to-repay rule could bring liability from multiple fronts. First, the bank would have potential liability under the existing Truth-in-Lending Act section that provides for actual damages, statutory damages, and attorneys’ fees and costs. In addition to that, there are new ability-to-repay statutory damages that can include a refund of certain finance charges and fees paid by the borrower. Lastly, in a foreclosure action, the borrower can assert an ability-to-repay violation and seek recoupment or setoff. These potential damages could add up and could give attorneys for borrowers a significant bargaining chip in foreclosures and other litigation. In addition, as discussed below, the legal costs of defending ability-torepay violations could themselves be a significant cost. The landscape of potential damages will become clearer as we start to see courts address ability-to-repay claims. Banks and their counsel should monitor these cases closely and evaluate whether the results change any decisions the bank has made or policies and procedures the bank has adopted. Part 2 will discuss how the safe harbor and rebuttable presumption can protect against these potential liabilities. Stay Tuned Next Month for Part 2: Litigation Risk – Safe Harbor v. Rebuttable Presumption Jeff Andersen is an attorney with Dickinson, Mackaman, Tyler & Hagen, PC. He can be reached at 515.246.4515 or via email at [email protected].