Ability-to-Repay Rule

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1 This summary is provided by the Minnesota Credit Union Network for informational purposes only, and is intended to provide credit unions with the general regulatory requirements and effective dates for the new CFPB Mortgage Rules. It is not a substitute for a credit union s own review of the underlying regulation. This summary is distributed with the understanding that the Minnesota Credit Union Network is not engaged in rendering legal, accounting, investment or other professional advice, and this guide should not be relied upon or substituted for the same. Such advice should be sought from your attorney, certified public accountant or other appropriate professional. Further, this information has been provided in advance of the effective date of the rule below, and such rule is subject to change and amendment; please consult the CFPB and/or an attorney for any changes that may occur. Overview Ability-to-Repay Rule Many experts believe loose underwriting standards and a failure to take into consideration a borrower s ability to repay a mortgage contributed to the mortgage crisis of In response, the Federal Reserve Board in October of 2009 implemented an amendment to the Truth-in-Lending-Act (TILA) requiring lenders to take into consideration a borrower s ability-to-repay prior to making a higher-priced mortgage loan. 1 Under the Board s rule, a lender is presumed to have complied with the ability-to-repay requirement if the creditor followed certain underwriting procedures, including verifying the borrower s income, assets and current obligations. 2 In 2010, Congress passed the Dodd-Frank Act which adopted similar ability-to-repay requirements for nearly all closed-end residential mortgage loans. In addition, Congress created a presumption of compliance with the ability-to-repay requirements for certain mortgages called Qualified Mortgages. In January of 2013, the CFPB adopted a final rule implementing the Ability-to-Repay and Qualified Mortgage provisions of Dodd-Frank. Under the CFPB s Ability-to-Repay/Qualified Mortgage rule, mortgage lenders must make a good faith determination that the borrower has a reasonable ability to repay the loan by taking into consideration eight underwriting factors set forth by the CFPB. The Ability-to-Repay/Qualified Mortgage rule is scheduled to become effective on January 10, 2014, and applies to applications (generally for closed-end consumer credit transactions secured by a dwelling) received on or after that date. 3 Application of the Ability-to-Repay Rule Under the Ability-to-Repay rule (ATR rule), a credit union must make a reasonable and good faith determination at or before consummation of a mortgage that the borrower will have a reasonable ability to repay the loan according to its terms. 4 The ATR rule applies to all closed-end consumer credit transactions secured by a dwelling, which includes residential structures with one to four units, including condominiums and co-ops. 5 As the rule 1 A higher-priced mortgage loan is defined as a mortgage that is secured by a consumer s dwelling with an annual percentage rate (APR) that exceeds the average prime offer rate for a comparable transaction as of the date the interest rate is set by 1.5 or more percentage points for loans secured by a first lien on a dwelling, or 3.5 percentage points for loans secured by a subordinate lien on a dwelling. 12 C.F.R See also the summary section on Qualified Mortgages C.F.R (a)(4). 3 Protection Bureau, (October 17, 2013), p Comment 12 C.F.R (c)(1) 5 12 C.F.R (a).

2 applies to all closed-end transactions, the ATR rule also covers subordinate lien loans. 6 However, the ATR rule does not apply to: Open-end credit plans (ie, home equity lines of credit (HELOCs)); Time-share plans; Reverse mortgages; Temporary or bridge loans with terms of twelve (12) months or less (with possible renewal); Construction phase of twelve (12) months or less of a construction-to-permanent loan (with possible renewal); and Consumer credit transactions secured by vacant land. 7 Additionally, if a loan qualifies as a refinancing, as defined by the Truth-in-Lending-Act (12 C.F.R (a)), it will fall under the ATR rule. On the other hand, if the loan is a modification, and not subject to Truth-in-Lending, it is not subject to the ATR rule. 8 Underwriting Standards In order to comply with the ATR rule, a credit union s ATR evaluation must include eight (8) underwriting factors: Current or reasonably expected income or assets; Current employment status; Monthly mortgage payment on the covered transaction; Monthly payment on any simultaneous loan secured by the same property; Monthly payment for mortgage-related obligations, such as taxes, insurance, and homeowner s association fees; Current debt obligations, including alimony and child support; Monthly debt-to-income ratio or residual income; and Credit history. 9 The CFPB notes that these eight (8) factors are only the minimum factors a credit union must consider in order to comply with the ATR rule. Credit unions are not precluded from considering other factors in addition to the eight listed above. 10 Current or reasonably expected income or assets A credit union may consider any type of current or reasonably expected income, including salary, wages, self-employment income, dividends, rental income, military or reserve pay, bonus pay, interest payments, retirement benefits, and child support and/or alimony. 11 If a credit union relies on expected income in excess of the borrower s income, such as an annual bonus, the credit union must verify that expectation through third-party records that provide reasonably reliable evidence. 12 Seasonal or irregular 6 Protection Bureau, (October 17, 2013), pp at p C.F.R (c)(2)(i)-(viii). 10 Protection Bureau, (October 17, 2013), pp Comment 12 C.F.R (c)(2)(i). 12

3 income is acceptable, provided the credit union reasonably determines that the borrower s annual income divided equally across 12 months is sufficient to make the monthly loan payments. 13 A credit union may consider any of the borrower s assets, including savings and checking accounts, amounts vested in a retirement account, stocks, bonds, and certificates of deposit. 14 However, the credit union cannot consider the dwelling that secures the covered transaction to be an asset of the borrower. 15 For two or more applicants, a credit union only needs to consider income and/or assets sufficient to support the credit union s repayment ability determination. If the income and/or assets of one applicant are sufficient, the credit union does not need to consider the income and/or assets of the other applicant(s). 16 Current employment status In considering a borrower s employment status, the employment does not need to be full-time, and employment does not need to occur at regular intervals. 17 If a credit union relies upon the borrower s employment as part of its determination, the employment may be full-time, part-time, seasonal, irregular, military, or self-employment. 18 Further, a credit union only has to verify a borrower s employment if the credit union is relying upon that employment income in determining the borrower s repayment ability. 19 In verifying a borrower s employment, a credit union may call the employer and obtain oral verification. However, a credit union must make a written record of the verification and the information received. 20 Also, while you do not have to retain paper copies of documents relied upon, you must be able to reproduce the documentation itself. For example, if the credit union received a w-2 electronically from the member the credit union should retain or otherwise be able to reproduce the record during the three year required retention period. Monthly payment on the covered transaction In order to properly make its repayment ability determination, a credit union must calculate the borrower s monthly payment as set forth in 12 C.F.R (c)(5). The calculation must be based on substantially equal monthly payments that would fully amortize the loan. See the CFPB s Ability-to-Repay and Qualified Mortgage Rule - Small Entity Compliance Guide, p. 21 for guidance. A link to the Guide is at the end of this summary. Monthly payment on any simultaneous loan In determining a borrower s ability to repay, credit unions must take into consideration any simultaneous loan that the credit union knows or has reason to know will be made, such as home equity lines of credit (HELOC), in addition to the mortgage. 21 Knows or has reason to know is included in the rule to require lenders to take into consideration any piggyback second-lien loan that the lender knows or has reason to know will be used to finance part of the borrower s down payment. 13 Comment 12 C.F.R (c)(2)(i) Comment 12 C.F.R (c)(2)(ii) Protection Bureau, (October 17, 2013), p C.F.R. 1026(c)(2)(iv).

4 In order to comply with this requirement, credit unions must follow policies and procedures that are designed to determine whether the borrower has applied for another credit transaction that is secured by the same dwelling. 22 The CFPB cites as an example instances in which the borrower seeks to borrow less than the full amount of the purchase price. In this instance, credit unions must require the borrower to identify the source of the down payment and provide verification. 23 If the source of the down payment, in full or in part, comes from another loan, the credit union must take into consideration that loan s periodic payment. 24 On the other hand, credit unions do not have to take into consideration credit transactions that occur after consummation of the loan. 25 Monthly payment for mortgage-related obligations Credit unions must take into consideration the borrower s monthly payments for mortgage-related obligations, such as: property taxes; insurance premiums required by lenders; fees or special assessments required by a cooperative, condominium, or homeowners association; ground rent; and leasehold payments. 26 However, credit unions only have to take into consideration payments that occur on a regular basis. Payments that are satisfied at the loan s consummation (or closing), or are one-time charges, are excluded from this calculation. 27 Current debt obligations, alimony, and child support Credit unions must consider the borrower s current debt obligations and any alimony or child support the borrower is required to pay. 28 These debts include: student loans; car loans; revolving debt; and existing mortgages. 29 The rule does grant credit unions some latitude when taking into consideration a borrower s debt obligations, particularly if the debt will be paid off soon. 30 On the other hand, credit unions should take into consideration debts that are in forbearance or deferred if they are likely to affect the borrower s ability to repay. 31 Monthly debt-to-income ratio or residual income Credit unions must take into consideration the borrower s debt-to-income (DTI) ratio or residual income. 32 In order to calculate a borrower s DTI ratio, a credit union must consider the ratio of the borrower s monthly debt obligations to the borrower s total monthly income. 33 Credit unions may include all of the borrower s earned income, unearned income, and other regular payments (such as alimony, child support, or government benefits) when determining the borrower s income. 34 When determining the borrower s debt obligations, a credit union should take into consideration the loan being applied for, any simultaneous loans secured by the same property, mortgage-related obligations, and current debt 22 Comment 12 C.F.R (c)(2)(iv) Comment 12 C.F.R (c)(2)(v); see also 12 C.F.R (b)(8) and 12 C.F.R (b)(5), (7), (8), or (10). 27 Comment 12 C.F.R (c)(2)(v) C.F.R (c)(2)(vi). 29 Comment 12 C.F.R (c)(2)(vi) C.F.R (c)(2)(vii) C.F.R (c)(7)(ii). 34 Protection Bureau, (October 17, 2013), p. 19.

5 obligations, alimony, or child support. 35 The credit union does not have to consider any debts that have been previously paid off, or will be paid off at consummation of the loan. 36 Residual income, on the other hand, is calculated by taking the borrower s monthly income after subtracting the borrower s total monthly debt obligations from total income. 37 NOTE while the Qualified Mortgage standard has a specific DTI threshold of 43 percent (discussed below), credit unions are only required to consider the borrower s DTI under the ATR rule. The borrower s DTI does not have to meet a specific threshold under the ATR rule. 38 Credit history While credit unions are required to take into consideration a borrower s credit history, they are not required to obtain or consider a consolidated credit score. 39 Credit history is defined to include factors such as the number and age of credit lines, payment history, and any judgments, collections, or bankruptcies. 40 When two or more borrowers apply for a loan as joint obligors, credit unions must take into consideration the credit history of all applicants. 41 On the other hand, when an applicant is merely a surety or guarantor, a credit union does not have to consider that applicant s credit history. 42 If a credit union obtains a credit report and knows, or has reason to know, information on the credit report is inaccurate, the credit union may ignore the information. 43 Verifying a Borrower s Credit Information For the information obtained and relied upon in making its ATR determination, the credit union must verify that information using reasonably reliable third-party records. 44 Credit unions may rely upon records such as: Records from government organizations such as a tax authority or local government; Federal, state, or local government agency letters detailing the consumer s income, benefits, or entitlements; Statements provided by a cooperative, condominium, or homeowners association; A ground rent or lease agreement; Credit reports; Statements for student loans, auto loans, credit cards, or existing mortgages; Court orders for alimony or child support; Copies of the consumer s federal or state tax returns; W-2 forms or other IRS forms for reporting wages or tax withholding; Payroll statements; 35 Protection Bureau, (October 17, 2013), p C.F.R (c)(7)(ii)(B). 38 Protection Bureau, (October 17, 2013), p Comment 12 C.F.R (c)(2)(viii) Protection Bureau, (October 17, 2013), p C.F.R (c)(3)

6 Military leave and earnings statements; Financial institution records, such as bank account statements or investment account statements reflecting the value of particular assets; Records from the consumer s employer or a third party that obtained consumer-specific income information from the employer; Check-cashing receipts; and Remittance-transfer receipts. 45 Again, credit unions are only required to verify the information used in making its ATR determination, and are not required to verify superfluous information provided by the borrower. Credit unions should review its processes, underwriting guidelines, software, contracts, and/or other aspects of its mortgage lending operation to ensure compliance with the ATR rule. While many credit unions are already using the eight ATR factors discussed above in the underwriting process, credit unions should review its policies and procedures to ensure that they state the eight factors are being considered during the underwriting process, and also describe the process by which they are considered. 46 Liability under the ATR Rule If a borrower has difficulty repaying a loan originated by a credit union based upon the credit union s failure to comply with the ATR rule the borrower could bring a lawsuit under the ATR rule against the credit union. 47 Borrowers will have to prove the credit union failed to make a reasonable, good-faith determination of their ATR prior to the loan s consummation. 48 If the borrower prevails, a credit union may be liable for, among other things, up to three years of finance charges and fees the borrower paid, as well as the borrower s legal fees. 49 Borrowers will have three years to bring an ATR claim against a credit union. Upon expiration of the claims period, the borrower may only bring an ATR claim as setoff/recoupment claims in a defense to foreclosure. 50 However, a credit union should not be held in violation of ATR requirements if consumers cannot repay their mortgage loans solely because they experienced an unexpected job loss after origination. 51 Record Retention Credit unions must retain records showing compliance with the ATR/QM rule, including the prepayment penalty limitations, for at least three years from the loan s consummation. 52 The CFPB suggests credit unions may want to retain records for longer than three years for business purposes. In addition, while credit unions are not required to keep the actual documentation used during the underwriting process, it must be able to reproduce the records. 53 For example, if a credit union uses a W-2 to verify income, it must be able to produce an electronic copy of the form itself. Being able to produce the information only that was listed on the W-2 would be insufficient Protection Bureau, (October 17, 2013), p , p , p C.F.R (c)(3). 53 Protection Bureau, (October 17, 2013), p

7 Additional Educational Resources The following are helpful resources available that may assist you in compliance with the new Mortgage Rules. The CFPB s Ability-to-Repay and Qualified Mortgage Rule - Small Entity Compliance Guide The CFPB s YouTube video The CFPB s Comparison Chart which compares the Ability-to-Repay requirements with the requirements for originating Qualified Mortgage loans This information has been prepared only for the benefit of our members, and may not be provided to third parties without the express permission of the Minnesota Credit Union Network Minnesota Credit Union Network