ability to repay

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It will take a while to digest the CFPB’s nearly 1,700-page release on payday, title and high-rate installment lending but, naturally, I have a number of preliminary observations:

  1. It remains highly uncertain that the Rule will ever go into effect.  Once Director Cordray leaves office, his successor may have very different views on the costs and benefits of these products and may, at a minimum, want to assure himself or herself that there is a strong basis for the Rule.  The CFPB has never established, as it must, a strong empirical case that any consumer injury associated with these loans outweighs off-setting consumer benefits.  The industry will surely litigate this issue and has a good chance of succeeding.  As we have previously speculated in our blog on numerous occasions, we expect that Director Cordray soon will resign to run for governor of Ohio, and, given that his term expires in July of next year regardless, there will be a new director or acting Director at least a year before the rule becomes effective as a result.  His successor may feel that he or she has better things to do with the initial period in office than to defend a badly flawed Rule. Of course, Director Cordray will not need to defend the Rule in industry lawsuits.
  2. The CFPB’s decision to carve longer-term high-rate (>36% APR) loans out of the Rule’s ability-to-repay (ATR) requirements is a big win for the industry.  It undoubtedly reflects the CFPB’s recognition, as reflected in two comment letters we submitted on the proposal, that: (a) the CFPB’s study of installment lending, as opposed to short-term payday and title loans, was particularly weak; and (b) the combination of the Rule’s 36% rate trigger and onerous requirements for longer-term loans effectively established a usury limit, in violation of a provision of Dodd-Frank that explicitly denies the CFPB the power to set usury limits.
  3. While the CFPB made a sensible decision to exclude longer-term loans from the Rule’s ability-to-repay requirements, this prudence was not matched by its treatment of card payments in the Rule’s so-called “penalty-fee prevention” provisions. These provisions apply to both short-term and to longer-term loans with APRs exceeding 36%.  The CFPB professes to impose these requirements to protect consumers against excessive bank NSF charges and account closures yet it applies the requirements not only to ACHs and check transactions but also to debit and prepaid card payments.  This makes no sense since card transactions, by their very nature cannot give rise to bank NSF fees and/or account closures.  Either a card transaction is authorized or it is declined, and no fee is associated with a decline.  To my mind, the application of penalty-fee prevention provisions to card payments is arbitrary and capricious and, accordingly, in violation of the Administrative Procedure Act.
  4. The 21-month deferred effective date, up from 15 months in the proposal, is a win for the industry.
  5. The Rule appears to be good news for lenders focused on providing longer-term title loans, which fall entirely outside the coverage of the Rule.
  6. The Rule, coupled with the OCC’s action withdrawing its prior deposit advance guidance, also appears to be good news for banks interested in providing deposit advance products.  Notably, longer-term deposit advance products will fall entirely outside the Rule (including its penalty-fee prevention provisions, provided that the bank offering the product ensures that its borrowers are never charged overdraft or NSF fees in connection with such loans. We will have additional blog updates on this topic in the coming days.

On November 9, 2017, from 12 p.m. to 1 p.m. ET, Ballard Spahr attorneys will hold a webinar, “First Takes on the CFPB Small Dollar Rule: What It Means for You.” The webinar registration form is available here.

On March 13, 2014, HUD published a proposal to eliminate the requirement that an FHA loan borrower be required to pay interest after the loan is prepaid.  The move is needed because the requirement would effectively cause FHA loans to be prohibited under CFPB rules starting in January 2015.  Comments on the proposal are due by May 12, 2014.

Based on the use of monthly interest accrual amortization with FHA loans, if an FHA loan is prepaid on a date that is not a regular payment due date the borrower must pay interest through the end of the month even though the loan has been paid off.  In connection with the adoption of the Regulation Z ability to repay rule and modifications to the Regulation Z high-cost loan provisions that became effective in January 2014, the CFPB revised the definition of “prepayment penalty” to provide that interest charged consistent with the monthly interest accrual amortization method is not a prepayment penalty for FHA loans consummated before January 21, 2015, but is a prepayment penalty for loans consummated on or after such date.

The revised definition of “prepayment penalty” restored the application to FHA loans of a prior Fed position on such penalties.  Shortly before the higher-priced mortgage loan provisions became effective in October 2009, the prior position was clarified to exclude FHA loans to avoid an unintended consequence that would have prohibited the making of any FHA loan if it would be a higher-priced mortgage loan.

The ability to repay rule also imposes significant limits on when a loan may be subject to a prepayment penalty, and prohibits a penalty that could be imposed more than 36 months after consummation or that would exceed certain amounts.  Also, the modifications to the high-cost loan provisions include (1) a new prepayment penalty trigger under which the provisions apply to a loan if a prepayment penalty could be imposed more than 36 months after consummation or could exceed a certain amount, and (2) a complete prohibition against a high-cost loan being subject to a prepayment penalty (prior law permitted certain prepayment penalties).  The combination of these changes and the changes to the definition of “prepayment penalty” will effectively prohibit the further origination of FHA loans commencing January 21, 2015, unless the requirement to pay interest after a prepayment is eliminated.

During the rulemaking process, the CFPB and HUD conferred regarding the prepayment penalty issue and negotiated an arrangement under which a requirement to pay interest after a prepayment of an FHA loan would once again be considered a prepayment penalty, but the change would not apply for FHA loans consummated before January 21, 2015 in order to provide HUD with the time to modify its rules.

On May 29, 2013, the CFPB adopted amendments to the final ability to repay rule.  The CFPB had proposed the amendments on the same day that it issued the ability to repay rule in January 2013. The amendments are effective on January 10, 2014, the same date that the ability to repay rule becomes effective. 

Among other changes, the amendments:

• Carve out from the inclusion of loan originator compensation in points and fees, the compensation paid by a mortgage broker to an employee loan originator and the compensation paid by a creditor to an employee loan originator.  Although the CFPB had proposed to tie the ability to exclude compensation paid by a creditor to an employee loan originator to the amount of origination fees imposed by the creditor, the CFPB decided to simply exclude the compensation from points and fees without conditions.  Compensation paid by a consumer or creditor to a mortgage broker will still be included in points and fees.

• Create a broader qualified mortgage for small creditors.  The small creditor qualified mortgage is not subject to the strict 43% debt-to-income limit that applies to the general qualified mortgage.  Also, the small creditor qualified mortgage is eligible for the safe harbor as long as the annual percentage rate does not exceed the applicable average prime offer rate by 3.5 or more percentage points for a first or subordinate lien loan.  In contrast, the general qualified mortgage is eligible for the safe harbor only if the annual percentage rate does not exceed the applicable average prime offer rate by 1.5 or more percentage points (3.5 percentage points for a subordinate lien loan).  To be a small creditor, a creditor must have assets less than $2.0 billion and make (together with its affiliates) 500 or fewer first lien loans per year that are subject to the rule.

• Create a transition period in which small creditors may make balloon qualified mortgages even if they do not satisfy the requirement that most of their transactions subject to the rule are made in rural or underserved areas.  The transition period will end January 10, 2016.  Balloon qualified mortgages also will be eligible for the safe harbor if the annual percentage rate does not exceed the applicable average prime offer rate by 3.5 or more percentage points for a first or subordinate lien loan.  During the transition period the CFPB intends to assess whether the definitions of “rural” and “underserved” should be modified, and to work with small creditors to transition to alternative products, such as adjustable rate loans.

• Exempt from the ability to repay rule are loans:

• Made by a housing finance agency, or by private creditors pursuant to a program administered by a housing finance agency.

• Made by certain community development creditors and certain non-profit creditors, subject to conditions.

• Made pursuant to certain homeownership stabilization and foreclosure prevention programs authorized by sections 101 and 109 of the Emergency Economic Stabilization Act of 2008 (12 USC 5211, 5219), such as a State Hardest Hit Fund program.

The CFPB decided not to adopt a proposed exemption for a refinance loan made pursuant to an eligible targeted refinancing program and that was eligible to be purchased for Fannie Mae or Freddie Mac while they remain in conservatorship.  The exemption would have covered HARP loans.

For more on the CFPB’s ability to repay rules, please see our prior blog posts, recent alert , and Mortgage Banking Update .

In keeping with its promise to provide further guidance to the industry on the recent mortgage loan rules, the CFPB recently issued proposed clarifications and changes to the ability to repay/qualified mortgage rule and the servicing rules. Comments on the proposal will be due 30 days after it is published in the Federal Register.

The CFPB notes that it received questions that it does not plan to address because it believes that the questions are already answered by the final rules. One example of such a question provided by the CFPB is whether residual income considerations have any effect on the status of a qualified mortgage that is not a higher-priced loan under the safe harbor. The CFPB advised that it believes the rule is already clear that residual income is relevant only to rebutting the presumption of compliance for qualified mortgages that are higher-priced loans, and has no effect on the safe harbor status of qualified mortgages that are not higher-priced loans. Despite the CFPB’s belief that the rule is clear in this area, the industry would prefer to see greater clarity in the rule on what may and may not be raised in court or other forums with regard to both the safe harbor and rebuttable presumption for qualified mortgages.

The proposal also includes clarifications and changes regarding the temporary qualified mortgage provisions for loans eligible for sale to Fannie Mae or Freddie Mac, including that a repurchase or indemnification demand, and even a resolution of a repurchase or indemnification demand, is not dispositive of qualified mortgage status. Whether the loan was eligible for sale to Fannie Mae or Freddie Mac would depend on the facts and circumstances.

The CFPB also proposes changes to the standards in Appendix Q, which provide guidance on the determination of a consumer’s debt and income for purposes of calculating whether the consumer satisfies the maximum 43% debt-to-income ratio applicable to the general qualified mortgage provisions. The proposed changes would address that Appendix Q is based on flexible underwriting standards that were not designed as a rigid debt-to-income rule, and simplify and clarify certain income determination obligations.

The CFPB also proposes to clarify that the mortgage servicing rules in Regulation X under the Real Estate Settlement Procedures Act do not create field preemption with regard to state servicing laws. Additionally, the CFPB clarifies the nature of the small servicer exemption and proposes technical revisions to the exemption. Please read more about the proposal in our e-alert.

On January 10, 2013, the CFPB issued the long-awaited ability to repay/qualified mortgage rule and, while the devil will be in the details, it appears that cautious optimism for the mortgage industry is warranted. The industry fought hard for the creation of a safe harbor for qualified mortgages and the rule includes a safe harbor for lower-priced qualified mortgages. The final rule is effective January 10, 2014. The CFPB also issued concurrent proposals to address particular concerns under the final rule. Comments on the proposals are due February 25, 2013. Please see our alert regarding the final rule.

We note, the CFPB held a public hearing to address the final rule at Westminster Hall in Baltimore, MD, which is the site of Edgar Allen Poe’s burial place. According to unconfirmed reports, during the portion of the hearing when the CFPB was explaining how the rule would prevent mortgage loans being made without regard to repayment ability, a raven was heard to say “never more”.

U.S. Representatives Capito (R, WV) and Sherman (D, CA) are circulating a draft of a letter on the Hill which urges the CFPB to “craft a safe harbor [in the Ability to Repay/QM rule] that strikes the right balance between protecting consumers from poorly underwritten mortgages while ensuring they have access to safe and affordable mortgage products.” The letter expresses the concern that, without the safe harbor and the legal certainty that the safe harbor arguably would provide, there is little incentive for lenders to make “qualified mortgages” which may restrict the availability of credit for some borrowers. Under Dodd-Frank Section 1412, a loan that meets the definition of a “qualified mortgage” (QM) is presumed to meet the ability to repay requirements of the rule. In May, 2011, the Fed proposed two possible standards for a QM. The critical difference between the two standards is that, under one alternative, the origination of a QM would create a safe harbor that the lender has complied with the ability to repay requirements and, under the other alternative, it would create a rebuttable presumption of compliance. (See our earlier post on the alternatives and our post on industry support for the safe harbor alternative.) The Ability to Repay/QM regulation is among the most anxiously awaited final rules to be issued by the CFPB and is expected to be issued this summer. Read the congressional draft letter.

As my fellow blogger, Chris Willis, indicated in his prior post, Raj Date, the current acting director of the Consumer Financial Protection Bureau, has been actively previewing the CFPB’s forthcoming rule-making priorities. Indeed, in another speech at the American Banker’s Regulatory Symposium last week, Mr. Date elaborated on the CFPB’s goals with regard to regulating mortgage lending, announcing that the CFPB will soon complete a new rule requiring lenders to gauge whether homeowners are capable of repaying their mortgages. Dubbed the “ability-to-repay” rule, Date stated that the rule, which is required by Dodd-Frank, will be unveiled “early next year in order to provide clarity to the market as quickly as we can, without sacrificing the quality of our analysis.” The CFPB took over responsibility for finalizing this rule from the Federal Reserve in July.

Date stated that the forthcoming ability-to-repay rule will establish various underwriting standards aimed at preventing the types of lending practices that lawmakers and regulators assert led to record foreclosures in the wake of the 2008 credit crisis. The law also will establish minimum underwriting standards for most mortgages. A key issue is what types of legal protections lenders will receive if they offer a qualified mortgage, as the term ultimately is defined in the final rule. Banks and other lending institutions are pushing for full legal protection for making qualified mortgages, essentially establishing a “safe harbor” from any subsequent liability. In contrast, consumer advocates want borrowers to have some type of legal recourse if they believe a lender did not meet the standards laid out in the rule, even with regard to qualified mortgage loans.

Date indicated that the CFPB is still in the process of considering the comments it has received on the ability-to-repay rule. Nevertheless, in light of Date’s comments last week, we are likely nearing the point of “speak now or forever hold your peace” with regard to this issue. How the CFPB handles the final implementation of the ability-to-pay rule will be an early test of its responsiveness to the concerns of the banking industry and its capacity to balance the needs of that industry with consumer protection concerns. The ability-to-pay provisions of Dodd-Frank are yet another example of the philosophy that substantive regulation of loan terms is necessary to protect consumers. A qualified mortgage standard that restricts the loan terms a lender can offer while leaving a lender who meets that standard exposed to liability ignores the reality that a sustainable system of regulation must require responsible decision-making by both parties – lenders and borrowers.

Banks that offer mortgage products are being buried in new regulations that are straining their compliance capabilities, increasing their costs and, for community banks, threatening the viability of their entire business model. That’s the message the American Bankers Association tried to send in its recent letter to Raj Date, President Obama’s replacement for Elizabeth Warren as Special Advisor to the Treasury Secretary on the CFPB.

The letter makes three recommendations for improving the situation.

First, the ABA would like the CFPB to coordinate its activities with what other agencies are doing in the mortgage arena and issue a projected timetable for proposing, finalizing and implementing all of the mortgage-related rulemaking mandated by Dodd-Frank. Second, because the ABA thinks whatever qualified mortgage (QM) standard the CFPB adopts will set the scope of most future mortgage lending, it wants the CFPB to get moving on reviewing comments on the Fed’s ability-to-repay QM safe harbor proposal. (Comments were due by July 22.) Third, the ABA wants the CFPB to issue guidance to resolve the wide-spread confusion over what kinds of compensation arrangements are prohibited by the new limits on mortgage originator compensation because they are considered to be a “proxy” for a loan term or condition.

We think the ABA’s recommendations are well-founded and hope the CFPB is paying attention.