The CFPB recently issued a factsheet addressing how prepaid interest, also referred to as per diem interest, factors into the calculation of the annual percentage rate (APR) for certain adjustable rate mortgage (ARM) loans and step-rate loans for purposes of assessing qualified mortgage (QM) loan status under the revised general QM rule. The advice provided by the CFPB appears to be better suited for a rule than a factsheet.
As previously reported in December 2020 the CFPB issued a final rule to replace the original general QM based on a strict 43% debt-to-income (DTI) ratio with a revised general QM based on a pricing construct. For most mortgage loans, the loan qualifies as a QM under the revised general QM approach if it satisfies the product restrictions and applicable points and fees limit, and has an APR that does not exceed the average prime offer rate (a market-based interest rate) by 2.25 or more percentage points. (Higher thresholds apply for lower balance and junior lien loans.) The revised general QM basically substitutes the APR limit for the DTI limit. Also, as previously reported, the CFPB subsequently delayed the mandatory compliance date for the revised general QM from July 1, 2021 to October 1, 2022. For applications received before October 1, 2022, both the original general QM and revised general QM are available. For applications received on or after October 1, 2022, only the revised general QM remains available.
For an ARM loan or step-rate loan that provides for an increase in the interest rate during the five year period following the first scheduled payment due on the loan, the actual APR used for disclosure purposes is not used to determine if the APR on the loan is below the applicable threshold to qualify as a QM loan. Rather, the APR for such purposes must be calculated as if the highest interest rate that could apply during such five-year period is in effect for the entire loan term. In the factsheet, the CFPB addresses how prepaid interest is factored into the special APR calculation.
The CFPB notes in the factsheet that interest on mortgage loans is paid in arrears. For example, for a monthly mortgage loan payment due on November 1, the payment will include interest that accrued during October. The CFPB also addresses two approaches used in the industry to address interest that accrues during the month in which a loan is closed. Using an example of a loan that closes on September 20 with an initial payment due on November 1, the CFPB indicates that the consumer typically will pay at closing prepaid interest for the 11 days during the month of September in which interest will accrue. Conversely, using an example of a loan that closes on October 4 with an initial payment due on November 1, the CFPB indicates that the creditor typically will credit the consumer for three days of interest, addressing that the loan was not outstanding until October 4.
Whether the consumer pays prepaid interest, or the creditor provides the consumer with an interest credit, the payment or credit are included in the determination of the APR. In the factsheet, the CFPB addresses which rate of interest is used for the special APR calculation for an ARM loan or step-rate loan that provides for an increase in the interest rate during the five year period following the first scheduled payment due on the loan. The CFPB advises as follows:
For purposes of calculating the APR for the General QM ARMs special rule, the maximum interest rate that may apply during the five-year period after the date on which the first regular periodic payment will be due is used to calculate prepaid interest and negative prepaid interest. For example, if Ficus Bank is originating an ARM that has an interest rate of 2.5% in years 1-3 and 4.5% for the remainder of the loan term, Ficus Bank must use 4.5% as the interest rate when determining if the loan satisfies the price-based General QM definition, including for calculating
any prepaid interest or negative prepaid interest as part of the APR calculation. A creditor must use the maximum interest rate in the first five years for calculating the APR for purposes of the
special rule, even if the creditor will use a different rate for calculating prepaid interest due at consummation.
Thus, for the applicable ARM loans or step rate loans, for purposes of the special APR calculation used to determine QM status, the actual charge or credit for prepaid interest based on the initial interest rate is not used. Rather, the highest rate that can apply during the initial five-year period is used. The CFPB provided no explanation for using that rate and not the initial interest rate, which is the rate that is used to determine the actual prepaid interest charge or credit at closing. Further, as noted above, the guidance would appear to be more suited to a rulemaking than a factsheet.