Underwriting to Future Income Under the ATR/QM Rule
We're here today to share one of the most common questions that we get from underwriters regarding the ATR/QM rule: how/when to use future income to underwrite a mortgage loan.
Here's the situation: You have a borrower who expects an increase in pay with a new job that she'll be expecting to start in the future. Under the Ability-to-Repay/Qualified Mortgage Rule, can you use this future income to underwrite the loan?
Sure! Here's how ...
How exactly you use this is going to depend on several things: Whether this is a non-QM loan, or whether its one of several categories of QM, and the borrower's specific circumstances. An important thing to remember is the underlying ATR rule sets minimum requirements (mandatory) that apply to every loan ... while the QM categories place additional requirements (optional) that you have to meet if you want the protection of a QM (mistake means non-QM).
Let's go through the basics:
Ability-to-Repay
Under the underlying Ability-to-Repay rule (not getting to additional QM requirements yet), lenders are permitted to consider "reasonably anticipated future income" in underwriting the loan. There are two requirements that we must have to use this projected income:
#1-Reasonable and good-faith belief that the income will exist
First, we'll need to have a reasonable and good-faith belief that the income will actually exist, e.g., that the borrower will actually get the job, and it will pay what the borrower tells us. But what exactly will we consider "reasonable and good-faith?" This is the big unanswered question ... something that we'll struggle with over the next few years.
Example: Is it reasonable to assume that a borrower in her second year of medical school will have an increased income within the next couple of years? Can we use this as a compensating factor if her debt ratio is slightly over our standards? Probably not. First, you'll have a problem with the documentation requirement (see #2 below). More importantly, based on a conversation I had with a CFPB attorney on this issue, it appears too tenuous at this stage in her education. Maybe she doesn't graduate. Maybe she graduates but can't pass the boards. Maybe she passes but decides to forego a salary and do volunteer work in Ethiopia. It all comes down to what is "reasonable"--rules of thumb will likely develop as we see court cases and enforcement actions. Each situation will be different. But for reference, the CFPB has taken the position, informally, that in this scenario, the lender would need to have a written offer letter from a particular employer--and the borrower would at least need to be in her final year of medical school.
#2-Documentation from reasonably reliable 3rd party records
Of course, the ATR rule requires that anything we consider be supported through reasonably reliable 3rd party records. In this scenario, the most obvious appears to be a written offer letter from the employer that confirms the salary. Depending on whether you find that "reasonable," you may consider requiring additional proof that the borrower actually accepted the offer.
Note: If it doesn't meet these minimum requirements under the ATR Rule, it cannot be used to calculate DTI, nor can it be used as a compensating factor. Further- it would not be permitted for underwriting a Regular QM or GSE-Eligible QM--even if Appendix Q or Agency guidelines are otherwise unclear on the issue.
Regular QMs (and Appendix Q)
Here you're applying Appendix Q, and have to follow a strict rule for the use of future income from a new job. You cannot use this unless the borrower will start the job within 60 days of loan closing. You'll also have to document that the borrower has enough income or cash-on-hand to afford the payment until her new job starts.
GSE-Eligible QMs
When dealing with loans that are classified under the temporary exception for Agency-eligible product (whether it's Fannie or Freddie), you'll simply have to follow their guidelines for using income from a job the borrower hasn't started yet, which likely follows Appendix Q pretty closely.
Example: Husband and Wife apply for a loan. Considering only Husband's income, their DTI is 50%. But Wife is a teacher and plans to start work as a teacher in September. The loan is expected to close in June (more than 60 days before job starts). Wife has a written offer from the school that identifies her salary. What can you use this income for? You cannot calculate it towards the DTI on Regular QM loans or for GSE-eligible loans .... it fails the 60-day requirement. But can you use this for non-QM loans, something you're keeping in portfolio? Sure! You have documentation from a reasonably reliable 3rd party (the school district). And, at least to me, it seems "reasonably anticipated" that the school district will follow through on its offer--that it won't go out of business, or eliminate that particular position in such a short time. Also, it is easy to tell if the borrower has the appropriate degrees and accreditation. This looks like a great example of where you might want to make a portfolio loan that a less flexible lender would ignore.
Much of the ATR/QM Rule centers around what was "reasonably anticipated" by the lender. It will continue to be a challenge to determine exactly how we're supposed to comply with that requirement. But here's a start.
Other news/thoughts/trivia:
I doubt you normally enjoy reading through court opinions ... even when it involves the FDIC and a small cooperative bank. But pages 10-12 from the recent North Carolina opinion are worth it. In a nutshell, the court rejects the FDIC's argument that the board of directors should have predicted the financial crisis with some harsh (for a judge) language.
Anyone who will be in Newport on Thursday, let us know! John, Steve, Eileen Fuller, and myself will be there representing SCA.
Proud to be presenting on "Mortgage Lending in the Post- 2014 Regulatory Environment" this coming Friday in Portland, ME for the New England Financial Executives Council ... IF you're in the area ...
We're gathering information on the various options for outsourcing all or parts of your mortgage operation. If you are willing to share your ideas/experiences (anonymously, if you prefer), we will provide the results of our informal study in exchange. Just e-mail me at BenGiumarra@scapartnering.com.
Tough times at your shop? Layoffs? Turnover? Low volume? Fannie Mae was losing a million dollars a day in 1981. By 1989 it was earning a billion dollars a year. If you keep morale up and build momentum ... you should be able to get through anything.
"Whenever you see a successful business, someone once made a courageous decision"
- Peter F. Drucker
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