Does QM require a crystal ball?
Today we'd like to discuss how far the ATR/QM (and appendix Q) regulations require us to go in predicting future changes in a borrower's income or obligations.
The ATR rules require a good-faith determination that the borrower has the reasonable ability to repay the loan. To meet this flexible standard (and to make sure you're within the QM back-end ratio threshold), you'll need to be using accurate information--accurately calculating income, debts, etc.
How important is it to use the correct amount of income, debts, etc.? You can't satisfy the ATR standard if, for example, you're mistakenly basing your decision off of a $100k annual salary when the borrower is only making $50k. And you might exceed the 43% DTI if you forget to include a second lien or homeowner's association fee in the monthly housing expenses.
But what happens when a borrower's repayment ability is going to change in the future? Do we have to "consider" that for ATR purposes, or include that towards QM's DTI requirement? Lenders are normally not required to consider changes in circumstances after consummation (not expected to have a crystal ball). But there is an exception where a lender has "reason to know." Lenders must consider future changes in circumstances where it has reason to know, i.e., reason to predict the future change affecting the borrower's repayment ability.
Two obvious examples:
Consumer writes on application about plan to retire soon after closing and devote himself to his personal vegetable garden
Consumer tells LO that she plans to transition to part-time employment this coming year
In these cases, you have "reason to know" of future changes in circumstances that you must account for in determining ability-to- repay and calculating DTI for QM purposes.
But what if--
This is a construction-to-perm. loan where you know the property taxes will increase after the house is built
The home has been rezoned into a flood zone and, unless Congress acts quickly, the Flood insurance is going to increase exponentially within a few months after closing
What makes this tough--and why everyone is so upset with ATR/QM--is that the answer (at least for now) is simply whether it is reasonable.
Based on what we've seen, our best guesses are that (1) you must estimate the increased property taxes, but (2) you can use the current Flood payment. Be on the lookout for specific guidance on issues like this. But until then, here is how how we would analyze such questions:
#1) Start with the general rule that we're determining ability-to-repay at consummation.
Lenders are generally not responsible for future changes such as "a significant reduction in income due to a job loss or a significant obligation arising from a major medical expense." Official Comment to 1026.43(c)(1)-2. The rule specifically says that lenders "need not project potential changes, such as by estimating possible increases in taxes and insurance." Official Comment 1026.43(c)(2)(v)-5.
#2) Watch for future changes that can be "reasonably anticipated"
This includes conversations with the LO. When these lawsuits / challenges start coming, we all know what many borrowers are going to say, "well, I told the loan officer that I was planning to retire / undergo surgery / pay off my son's student debt. Make sure your LOs pass along any information that might be relevant.
#3) Don't be "unreasonable" in how far you go in predicting the future
You are safe if no future change can be reasonably anticipated based on information in the "consumer's application or the records used to determine repayment ability." The fact that your wife is a doctor with the opinion that your borrower looks unhealthy does not mean you need to attempt to predict future health problems that may affect his repayment ability - that is not information contained from the application or that you would use to underwrite the loan. Also, "Information is [considered] known if it is reasonably available to the creditor at the time of underwriting the loan." - Official Comment 1026.43(c)(2)(v)-5
#4) If you have reason to know, understand how to make estimates of future income/obligations
As explained in Official Comment 1026.17(c)(2)(i)-1:
Basis for estimates. Disclosures may be estimated when the exact information is unknown at the time disclosures are made. Information is unknown if it is not reasonably available to the creditor at the time the disclosures are made. The "reasonably available" standard requires that the creditor, acting in good faith, exercise due diligence in obtaining information. For example, the creditor must, at a minimum, utilize generally accepted calculation tools, but need not invest in the most sophisticated computer program to make a particular type of calculation. The creditor normally may rely on the representations of other parties in obtaining information. For example, the creditor might look to the consumer for the time of consummation, to insurance companies for the cost of insurance, or to realtors for taxes and escrow fees. The creditor may utilize estimates in making disclosures even though the creditor knows that more precise information will be available by the point of consummation.
This Comment also gives us two examples:
Assume that the property is subject to . . . a homeowners association. The creditor complies . . . by relying on an estimate of mortgage-related obligations prepared by the homeowners association. [T]he creditor need only exercise due diligence in determining mortgage-related obligations, and complies . . . by relying on the representations of other reliable parties in preparing estimates.
Assume that the homeowners association has imposed a special assessment on the seller, but (a) the seller does not inform the creditor of the special assessment, (b) the homeowners association does not include the special assessment in the estimate of expenses prepared for the creditor, and (c) the creditor is unaware of the special assessment. The creditor complies . . . if it does not include the special assessment in the determination of mortgage-related obligations.
In other news:
The CFPB reform bill has passed the House - of course it will fail in the Senate (and even if passed would be vetoed by the President). This is good news for "King Richard" but probably not for this Cordray critic. The bill would split the Director's authority among a panel of appointees and bring the CFPB's budget back within Congress' control.
Boston Business Journal posted a list of interesting events for March
Here's a WSJ letter from the National Association of Realtors' President on how middle-class Americans are hurt by flood insurance
No comment on the Affordable Care Act - maybe it's great, maybe it's not, but I hope we can agree this is a stretch - I'm quitting my job. Thanks, Obamacare!
Adaptation is important (see "Who Moved My Cheese"), but don't forget what got you here in the first place. Richard Chapman (famous business professor) said,
"Keep growing your core business; beware the unfamiliar."
Thanks so much for reading our weekly newsletters. We're not always going to be perfect, but because we always do our best and try not to overpromise, we hope that we're always going to be trustworthy. Your calls and e-mails are very helpful - please keep contributing.
**These are our opinions. We're not authorized, or willing, to express those of others.**