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APRIL 2014

Spring has sprung…. 

Ability-to-Repay (ATR) Standards 12 CFR 1026.43(c) (Reg Z)

¨     A creditor “shall not make” a loan that is a “covered transaction” unless it “makes a reasonable and good faith determination at or before consummation that the consumer will have a reasonable ability to repay the loan according to its terms.”  Basis for determination: In making the repayment ability determination, the creditor must generally consider the following 8 underwriting elements:

  • Current or reasonably expected income or assets
  • If income is relied upon, the consumer’s current employment status must be considered and income verified
  • The monthly payment on the new covered transaction
  • The consumer’s monthly payments on any simultaneous loan that the creditor has knowledge of
  • The consumer’s monthly payment for mortgage-related obligations (Insurance, taxes, etc.)
  • The consumer’s debt obligations, including alimony or child support
  • The consumer’s debt-to-income ratio and residual income
  • The consumer’s current credit history (credit score) 

¨     All information used for underwriting must generally be verified using third-party records (employer, consumer reporting agency, etc.) 

¨     A creditor may assume employment will continue if current employment is verified unless the verification indicates otherwise. Stability of income takes precedence over stability of employment, so job changes within the same line of work with advances in income or benefits may be favorably considered and continue for the next 3 years. 

¨     In one of the more significant changes, the CFPB eased the general requirement that a creditor determine that the consumer's income is "reasonably expected" to continue through at least the first three years of the loan. Under the amendments, the creditor must still determine whether the consumer's income level can be reasonably expected to continue, but the creditor may assume that salary or wage income can be reasonably expected to continue if it verifies current employment and income, and the verification does not indicate that employment has been or is set to be terminated. 

¨     The amendments also revise the standards for consideration of overtime, bonus, self-employment and social security income. A creditor will no longer be required to determine whether overtime or bonus income will continue, and may count such income provided it has not received documentation indicating that it will end. Overtime and bonus income can be used if it is documented that the consumer received it for the past two years and the documentation does not indicate it is likely to cease. 

¨     As originally issued, Appendix Q would have required social security income to be verified by either the Social Security Administration (SSA) or through Federal tax returns, the creditor to obtain a complete copy of the current awards letter, and the creditor to obtain proof of continuation of payments (for disability benefits, for example). Under the amendments, a creditor is only required to obtain a benefit verification letter from the SSA and may assume that social security benefits will continue and will not expire within 3 years unless the documentation indicates otherwise. 

¨     Information used for underwriting is required to be retained for 3 years but we recommend it remain in the file for 7 years after the loan is paid. 

Each institution should utilize some type of excel spread sheet to for this calculation. 

An exemption until 01/10/16 from the 43% standard is also provided to “small creditors” (assets less than $2.28  billion as of 12/31/13 and originated no more than 500 covered transactions) for loans retained in their own portfolio for at least 3 years.  

Although the “small creditor” exemption may apply to your financial institution, the federal 43% guideline promotes safe and sound banking practices and ensures borrowers have residual income. 

¨     For all covered transactions, and for any simultaneous loans, payment must generally be calculated using the following:

¨     The fully indexed rate or any introductory interest rate (whichever is greater)

¨     Monthly fully amortizing payments that are substantially equal

¨     Monthly debt-to-income ratio (DTI) analysis

¨     Irrelevant: payments are quarterly, semi-annual, annual, or none until maturity. 

Modification Agreements 

¨     Modification Agreements do not require any Real Estate Settlement Procedures Act (RESPA) or Truth-in-Lending Act (TILA) disclosures or Ability To Repay (ATR) calculations and are normally used to convert an Adjustable Rate Mortgage (ARM), Balloon, or other non-typical loan into a safer loan product, normally a Fixed Rate Mortgage. You are not permitted by the Modification Agreements (AM) to convert a Fixed Rate Mortgage Loan into an ARM and are not permitted to alter the note or advance funds.  This may be a tool to use for the balloon loans within the financial institution’s portfolio where the borrower may not meet ATR requirements and exceeds the federal guidelines of 43% Debt-To-Income ratio. 

Qualified Mortgages or (“QM”) is a “covered transaction” that meets certain high quality standards. 

¨     Not all “covered transactions” therefore are QMs

¨     It is not illegal to make a covered transaction loan that is not a QM, but there are special privileges and protections afforded to QMs and many lenders may therefore no-longer wish to make covered transactions, which don’t meet QM standards

¨     If it is a Qualified Mortgage, it satisfies the ATR requirements and the following applies:

  • Provides a “safe harbor” legal protection if you are sued for not properly underwriting the loan
  • Favorable capital adequacy measurement
  • Exemption from Higher Priced Mortgage Appraisal Rules
  • Examiner presumption of a safer/sounder mortgage portfolio
  • Loans that can be sold to secondary market investors 

Qualified Mortgages should not:

¨     Have excess upfront points and fees

¨     Have “toxic” loan features associated with many of the loans that caused the mortgage crisis (negative amortization, interest only, or balloon features)

¨     Be written for unreasonably long terms (exceed 30 years)

¨     Have Debt-to-Income (DTI) ratios that exceed 43% unless exempted. 

Balloon Loans 

¨     Special rules for loans with balloon payment features when calculating ability-to-repay

  •  Very risky
  • Cannot qualify as Qualified Mortgage (QM) with certain exceptions. 

¨     For Balloon Loans:

  • ATR calculations must consider the maximum payment scheduled for the first five years after the date on which the first payment is due (including the full balloon payment) for a loan that is/is not a Higher Priced Mortgage Loan (HPML) covered transaction.
  • There is a provision in the Dodd-Frank Act that would treat certain balloon-payment loans as qualified mortgages if they are originated and held in portfolio by small creditors operating predominantly in rural or underserved areas. This provision is designed to assure credit availability in rural areas, where some creditors may only offer balloon-payment mortgages. Loans are only eligible if they have a term of at least five years, a fixed-interest rate, and meet certain basic underwriting standards; debt-to-income ratios must be considered but are not subject to the 43 percent general requirement. 

We feel that it is only a matter of time until the CFPB will force balloon loans out of the financial institution’s loan products. 


¨     Specific Points and Fees Standards

  • The significantly amended definitions of points and fees provided in Section 32 of Reg Z relating to “high-cost” mortgage loans, and the Complex “points and fees” rules, impact both what is and is not a “High-Cost Mortgage” and what loans meet QM standards 
  • “Points and Fees” include the following:

       All items included in the finance charge paid at or prior to closing except:

  • Interest or the time-time price differential, therefore no odd days interest
  • Any premium or other charges imposed in connection with any Federal or State Agency Program for any guaranty or insurance that protects against consumer default or other credit loss
  • Inspection fees for construction loans
  • Bona fide third party changes not retained by the financial institution or loan originator 


$100,000 or more                                           No more than 3% of the loan amount*

$60,000 or more but less than $100,000        No more than $3,000.00

$20,000 or more but less than $60,000          No more than 5% of the loan amount*

$12,500 or more but less than $20,000          No more than $1,000.00

Less than $12,500                                           No more than 8% of the loan amount*

*Loan Amount is the amount borrowed less the prepaid finance charge 

Higher Priced Mortgage Loans (HPML) 

¨     Closed end, secured by a borrower’s principal dwelling

¨     Loans whose Annual Percentage Rate (APR) exceeds the Average Prime Offer Rate (APOR):

  • First lien – 1.5%
  • Second lien – 3.5%
  • Jumbo liens – 2.5% 

¨     Exceptions from HPMLs

  • Loans to finance initial construction of dwelling
  • Loans with a term of 12 months or less (Bridge Loan)
  • Reverse mortgage
  • Home equity lines of credit (HELOC)
  • Loans not covered by Regulation Z (Business Purpose) 

¨     You cannot structure a loan as open end to avoid requirements