Here’s a scary thought: Consumer Financial Protection Bureau (CFPB) Director Richard Cordray—and whoever is writing his speeches—doesn’t understand the Qualified Mortgage rule or its implications for lenders. In a recent speech to the Credit Union National Association reported in the American Banker, Cordray urged credit unions to make loans outside the restrictions of the so-called Qualified Mortgage (QM) required by Dodd-Frank and finalized in a January rule by the Consumer Financial Protection Bureau.
Characterizing the QM restrictions as “a narrow category of very safe loans,” according to the American Banker, Cordray said, “[p]lenty of responsible lending remains available outside of the Qualified Mortgage space, and we encourage you to continue to offer mortgages to those borrowers you can evaluate as posing reasonable credit risk.”
The QM restrictions require lenders to make sure that the borrower can afford the loan at the time the loan is closed. No one really knows exactly what this means, and until actual cases are litigated no one will, but the penalties for failing to ascertain that the borrower can afford the loan are severe—possibly even including a borrower’s defense to foreclosure.
Nevertheless, Cordray seems unaware that none of the underwriting standards that are normally required to make sure a mortgage is of prime quality—including in particular a substantial down payment and a borrower’s credit score above 660 in the FICO system—are required under QM.
Accordingly, merely complying with QM requirements does not make a loan safe. For example, loans with 3% downpayments, 580 credit scores , and 50% debt-to-income ratios are routinely insured by FHA, but loans like this—which could pass the QM test if the borrower has a job and adequate income on the closing date—have a 10% default rate.
Thus, if they make such loans—and they will be under substantial pressure to do so by community activists, realtors, and homebuilders, to say nothing of the Justice Department’s disparate impact claims—lenders or servicers who try to foreclose on defaulted loans are going to find themselves defending claims that they failed to meet the requirements of the QM rule. This may require them to pay heavy financial penalties under QM and possibly give up the foreclosure effort.
The QM rule is a trap for the unwary, and Director Cordray may not know that he has set it.