It seems simple enough on its face: when a lender makes a home loan, the lender must determine, document, and verify that the prospective borrower has the ability to repay their full loan. Over a decade after passage of the so-called “Ability-to-Repay” (ATR) rule – which required oversight of just this by the Consumer Financial Protection Bureau – many now see that effectively regulating how to determine, document, and verify a borrower’s ability to repay while also not restricting credit availability unnecessarily can sometimes be a tricky balancing act.
For the system to work, mortgage-backed security investors need an efficient and verifiable means to know that all loans in their securities comply with this law, and originators and issuers want certainty that they are not running afoul of the Bureau. The natural trajectory could be tightening of credit underwriting that disproportionally impacts some communities if uncertainty exists in the legal and regulatory requirements of the rule.
Fear of this outcome is why, for the better part of the past 12 years, ATR safe-harbor determinations were, in large part, simply punted to the black box underwriting systems of the government-sponsored enterprises Fannie Mae and Freddie Mac.
This “patch” construct was meant to be temporary, and, under the recently passed CFPB rules, is scheduled to soon be going away. Under revised CFPB rules, in place of the patch would be a price-based approach set as a spread over the Advanced Prime Offer Rate (APOR). The CFPB’s analysis being that this individual market signal better serves as the primary benchmark for the revised legal safe-harbor or rebuttable presumption to ATR compliance.
This approach has advantages: it’s simple, observable and verifiable. Even so, it is not the entire ATR rule requirement. The rule still calls for the lender to “document and verify” the borrower’s ability to repay with standards that need development. And there are risks that the rule may not keep up with changes in technological innovations and Americans’ quickly changing demographics. Additionally, the removal of the debt-to-income cap in the new rules may create need for greater clarity in methods used to consider the borrower’s repayment capacity.
The CFPB recognized this risk, and to mitigate it, the Bureau highlighted the crucial role of the whole mortgage market to work collectively to resolve the issues surrounding how lenders should “document, verify, and consider.” The final rule states the following:
“…the Bureau continues to encourage stakeholders, including groups of stakeholders, to develop verification standards. The Bureau is interested in reviewing any such standards that stakeholders develop for potential inclusion in the verification safe harbor.”
For this reason, it’s imperative that incorporating a mechanism for all market participants to discuss, analyze, and publish criteria that everyone – consumer advocacy groups, MBS issuers and investors – believe work. Without such a forum for analysis, we run the risk of oscillating between overly strict market practices that leave out many creditworthy borrowers, or a degradation of practices for safe harbor that undoes the justifiable intent of the original ATR rule.
This challenge becomes acute as markets need to innovate to allow borrowers outside of antiquated cookie-cutter credit profiles to have access to affordable and suitable homeownership financing options.
Prospective borrowers’ financial and employment circumstances vary widely today. “Gig economy” and other non-traditional borrowers, such as freelancers and independent contractors, make up a growing share of our population, and they do so with more flexible and periodic employment and varying month-to-month income. These borrowers need – and should have – both protections and access to mortgage credit.
Demographics are shifting, too. And with them, dynamics such as parents financing their children’s down payments are evaporating. All of this adds to the complexity of staying within the boundaries of the ability to repay rules while not wanting to unnecessarily leave communities – especially communities of color – out of the system.
An industry collaborative that involves all sides of a securitization transaction is a perfect forum for today’s market. As a supplement to proscriptive regulations that are often difficult to change, black box algorithms controlled by GSEs, and market spreads that are driven by many variables, a properly constituted industry standard setting organization could bring openness, discussion, and transparency to the process of striking the right balance between borrower protections and access to home loans in securitization transactions broadly, and ATR compliance specifically.
This organization should produce empirical data that the public could see to help create a productive dialogue around how to best protect borrowers, keep our system dynamic and provide market lenders and investors with increased regulatory certainty – thereby expanding financial inclusion to creditworthy borrowers in all communities and at a more efficient rate.
At the Structured Finance Association, we believe we have an opportunity to move the ball forward on this initiative. In 2021, we will work to build such an arrangement and we will begin by working to build data-driven industry consensus on these vexing questions facing the housing market today.
