Ben Giumarra

When the CFPB’s Ability-to-Repay/Qualified Mortgage rule took effect in January 2014, many lenders shied away from doing anything other than fully protected “qualified mortgages.” The rule – which makes it illegal to provide a residential mortgage loan without a “good faith” determination that the borrower has a “reasonable” ability to repay the loan – encouraged these “QM-only” policies by presenting vague, and potentially serious, risks for non-compliance.

But though the rule hasn’t change in the four years since, it may be time to reconsider non-QM mortgages.

New Leadership at CFPB

Should the non-QM flood gates open with the exit of Richard Cordray? No. In fact, nothing the regulatory agencies do – aside from changing the actual rules – should have much, if any, impact on your decision to enter non-QM lending.

The real risks associated with non-QM lending have never been regulatory. Banking regulators are generally invested in the success of the regulated institutions that are knowledgeable in the subject matter and therefore relatively reasonable to work with. And their approach to this regulation, which places special demands on the expertise required of examiners, has been reasonable. If anything, more intensive regulatory examinations would serve only to help institutions by identifying issues that may ultimately become private matters.

The real risk with non-QM has always been the opportunity for private enforcement. The ability-to-repay argument can be raised in defense of a foreclosure for the life of the loan. Arguing around soft standards such as “good faith” and “reasonable” can quickly become costly in a courtroom.

Early on when your prudential regulator probably promised to go easy on you regarding ATR/QM compliance for a period, that reassurance was just cold comfort – the real risk of ATR/QM is not in regulatory penalties, but instead in the decreased liquidity and increased liability risks arising out of the consumer’s ability to challenge any ATR determination for the life of the loan. Maybe we trusted the regulators to cut us some slack, but we couldn’t rely on the same from the borrower’s attorney five years down the road in a foreclosure action.

ATR/QM in the Courts

Unfortunately (fortunately?), there have been no court battles surrounding the ATR/QM regulation that might shed light more specifically on how this will be interpreted. That being said, for those of us who studied the original rules closely, there were many more helpful details included than many people cared to discuss. That same information gives us a fairly clear roadmap towards safe non-QM lending … it’s just that there’s nothing at all new about that. I would have told you the same thing in 2013 before the rule even took effect.

Part of this is just because we haven’t seen too many loans originated post-2014 in foreclosure actions yet. It’s still relatively early on and the performance of these loans has been relatively strong. Perhaps that’s due to the economy alone, or perhaps the CFPB’s rules, along with an industry correction to the problems that caused the Great Recession, deserve some credit.

Also, remember that many “small creditors” – those that originate 2,000 or fewer mortgages per year for sale – have essentially been offering “non-QM” loans all along, subject to the requirement to hold them in portfolio for at least three years. It hasn’t happened yet, but one thing that would be very interesting would be to see some large transfers of these seasoned loans to the secondary market after the three-year waiting period has expired.

Four Years Later

My own stance hasn’t changed much since 2014. Non-QM does not mean sub-prime, and there are plenty of high-quality loans to be made in the non-QM space. Whether any particular lender should enter non-QM lending just depends on its own strategy and ability to limit the risks involved. Assume your bank wants to do 40-year mortgages (the 40-year term automatically making these non-QM). If there’s a demand for this product in your area, if you can charge enough to offset any additional risks, if you can point to historically strong performance with these loan types, and if you can button up your ability-repay-determination, there’s no reason not to offer it.

Some of the best ways to protect against non-QM risk include: prioritizing ATR/QM compliance in your quality assurance programs; having strong checklists to document the ATR determination; developing a clear regulation-specific procedure for this rule; supporting any non-QM products with research on the historical soundness of the applicable underwriting standards; and adding a residual income requirement (at least for loans you’re particularly worried about, such as for all non-QM or for all rebuttable presumption QM).

The ATR rule is a minimum baseline set by regulators and QM is merely a convenient benchmark for documenting compliance. I would argue that good financial institutions have the obligation to go beyond this, to decipher for itself what constitutes a “good” loan. Automatically refusing to originate loans outside of the QM benchmark is a disservice to those borrowers who have a reasonably ability to repay. In the same way, automatically approving loans that meet QM status is a disservice to borrowers who, for reasons more sophisticated than a regulation could state, don’t have a reasonable ability to repay.

Ben Giumarra is an attorney and director of quality assurance at Embrace Home Loans, where he supports direct mortgage lending activities along with Embrace’s partnerships with various financial institution. He may be reached at bgiumarra@embracehomeloans.com.