The CFPB’s New QM Rule Proposal Is a Long-Term Loser for Consumers

COMMENTARY Markets and Finance

The CFPB’s New QM Rule Proposal Is a Long-Term Loser for Consumers

Jul 17th, 2020 6 min read
COMMENTARY BY
Norbert J. Michel, Ph.D.

Director, Center for Data Analysis

Norbert Michel studies and writes about financial markets and monetary policy, including the reform of Fannie Mae and Freddie Mac.
The Dodd-Frank Act supposedly guarded against a repeat of the 2008 housing fiasco by creating two specially designated mortgages. BrianAJackson/Getty Images

Key Takeaways

The QM patch is the loophole in the 2013 qualified mortgage (QM) rule that gave special treatment to loans eligible for purchase by Fannie and Freddie.

The bureau is now mixing up the goal of ensuring fair and equitable access to credit with the goal of ensuring access to low-priced QM loans.

The real problem here is relying on a federal stamp of approval for mortgages in the first place.

My last column praised the Consumer Financial Protection Bureau for its pro-consumer reversal of the original small-dollar lending rule. This post will be more critical because it looks at the bureau’s latest proposal to deal with the infamous QM patch.

The QM patch, for those unfamiliar, is the loophole in the 2013 qualified mortgage (QM) rule that gave special treatment to loans eligible for purchase by Fannie and Freddie. The QM rule included a maximum total debt-to-income ratio (DTI) of 43 percent, an indication that high DTI loans were considered too risky for QM status. But the patch effectively exempted the bulk of the mortgage market from having to comply with the 43 percent DTI limit. 

Specifically, the patch allowed higher DTI loans to qualify for QM status as long as they met the Fannie Mae and Freddie Mac underwriting guidelines (provided the companies remained under government conservatorship which, of course, they still do). The patch is set to expire in 2021, and the good news is that the bureau still intends to let it expire.

The not-so-good news, though, is that the bureau seems ready to replace the patch with something much worse. To be fair, the proposed rule is not the final decision, and it does discuss several decent options. Nonetheless, the bureau is proposing to redefine the QM loan by replacing the DTI limit with a “price-based approach” that compares the interest rate on a loan to the average prime offer rate (APOR). (See page 5.) As long as the difference between a loan’s annual percentage rate and the APOR is less than two percentage points, the loan will qualify for QM status.

Lenders want to make QM loans, of course, because doing so provides them with legal protection against the charge that they improperly made a loan to someone that could not repay it.

The bureau believes that this APOR test “is a strong indicator of a consumer’s ability to repay and is a more holistic and flexible measure of a consumer’s ability to repay than DTI alone,” and the proposal presents some basic correlations for evidence that the rate spread (the difference between a loan’s annual percentage rate and the APOR) rises with the risk of a loan’s early delinquency.  

However, AEI scholars Ed Pinto and Tobias Peter and I have offered a more complete analysis, presented in this comment letter, which shows that an APOR test is not calibrated to default risk and that it would not provide as much friction against high-risk loans as did the patch itself. It’s little wonder that the special interest housing lobbyists have been pushing for an APOR rule for years

They want as expansive a definition as possible so that lenders will be able to write more loans with the QM safe harbor. The bureau is complying, and they are using the term “access to credit” as the fig leaf. 

According to the proposal, “The Bureau estimates that, after the Patch expires, many of these [approximately 957,000 mortgage] loans would either not be made or would be made but at a higher price.” There are several problems here.

First, if these loans would not qualify as a result of the DTI limit that the Bureau set in the first place, then there is good reason to doubt the bureau’s ability to set a meaningful risk limit for QM loans now. (And evidence does show that DTI is highly correlated with risk.)  

More broadly, the bureau is now mixing up the goal of ensuring fair and equitable access to credit with the goal of ensuring access to low-priced QM loans. Those are two very different goals, and ensuring access to the latter completely turns the so-called consumer protection goal of the Dodd-Frank Act on its head.

For those that have forgotten, the Dodd-Frank Act supposedly guarded against a repeat of the 2008 housing fiasco by creating two specially designated mortgages: The Qualified Residential Mortgage (QRM) and the Qualified Mortgage (QM). 

The QRM was envisioned as the gold standard mortgage, a high quality, low-risk mortgage stamp of approval. The QM, on the other hand, was supposed to function as a minimum quality mortgage, with the obvious implication that failure to meet the QM standard was a bad sign. Of course, Congress left it to the bureau to fill in much of the details. 

By the time the rules were written, there was essentially no difference between the QRM and the minimum standards of the QM, and most of the market was exempt from the strictest provisions of the general QM. (See Chapter 2.) 

Now, the bureau wants to ensure access to QM loans at low prices, something that would not have made any sense even if the rules had not lowered the standards to begin with. 

Aside from the doubtful proposition that this new approach will somehow prevent the buildup of financial risk in the mortgage market, it is difficult to see how it will not also lead to federal price controls: The new proposal would tie the sought-after QM status to the loan’s price. 

At best, the new policy will lead to even more uniform pricing that does not truly reflect risk. At worst, it will end up functioning as a de facto rate cap, because hardly any lender will want to charge more than the APOR limit.

The real problem here, of course, is relying on a federal stamp of approval for mortgages in the first place. That’s not something the bureau can actually fix, but it can avoid making the problem worse.

This piece originally appeared in Forbes https://www.forbes.com/sites/norbertmichel/2020/07/15/the-cfpbs-new-qm-rule-proposal-is-a-long-term-loser-for-consumers/#38cdd02b4f0e