This educational report from “Finance Dodd Frank Ability to Repay” explains the regulatory landscape of consumer mortgages in the United States, focusing on the SAFE Act’s requirements for Mortgage Loan Originator (MLO) licensing and Dodd-Frank’s ability-to-repay (ATR) rules. It details the conditions for obtaining and maintaining an MLO license in California, including educational and examination requirements. The excerpt then differentiates between the general ATR rules and the four types of Qualified Mortgages (QMs), outlining the benefits and limitations of each. Finally, it explains the civil liability for violations of the ATR rules.

FAQ: Understanding Dodd-Frank and Consumer Mortgage Regulations

What are the key consumer protection laws impacting mortgages enacted in the 2000s?

Two major laws significantly impact consumer mortgages:

• The Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act) of 2008: This act established a nationwide licensing system for Mortgage Loan Originators (MLOs), creating uniform standards across states.
• The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: Dodd-Frank implemented stricter regulations for consumer mortgage lending, focusing on borrower protection and responsible lending practices.

What distinguishes a residential mortgage from a consumer mortgage?

While both involve financing for one-to-four unit residential properties for personal, household, or family use, there is a key distinction:

• Residential mortgages: These are specifically covered under the SAFE Act.
• Consumer mortgages: These encompass a broader scope, including both residential mortgages and seller-financed mortgages (carryback mortgages), and fall under Dodd-Frank regulations.

What is an MLO endorsement and who needs it?

In California, a DRE-licensed individual who arranges residential mortgages for a fee requires an MLO endorsement on their license.

• MLO endorsement: This signifies that the licensee has met the SAFE Act’s requirements, including education, examination, and background checks.
• Requirement: The endorsement is mandatory for brokers who arrange residential mortgages for a fee (mortgage brokers). Lenders providing loans from their funds without charging fees are generally exempt.

What are the primary obligations of lenders under Dodd-Frank’s Ability-to-Repay (ATR) rules?

Dodd-Frank’s ATR rules mandate lenders to thoroughly assess a borrower’s capacity to repay a mortgage before loan closing. This involves:

• Verification of income, assets, and debts: Lenders must review documents like W-2s, tax returns, bank statements, and credit reports to verify the borrower’s financial situation.
• Calculation of monthly payments and DTI: Lenders need to accurately calculate the borrower’s monthly mortgage payments, including principal, interest, taxes, and insurance, and assess their debt-to-income ratio (DTI).
• Consideration of employment status and credit history: Lenders must evaluate the stability of the borrower’s income and their creditworthiness based on their credit history.

What is a Qualified Mortgage (QM) and what are its advantages for lenders?

A QM is a mortgage that adheres to specific criteria defined by the Consumer Financial Protection Bureau (CFPB) under Dodd-Frank. The benefits for lenders offering QMs include:

• Safe harbor protection: Lenders are generally shielded from liability for claims of violating ATR rules.
• Eligibility for sale to GSEs: QMs can be sold to government-sponsored enterprises like Fannie Mae and Freddie Mac.
• Access to government guarantees: QMs can qualify for government insurance or guarantees from agencies like FHA, VA, USDA, or RHS.

What are the four types of QMs?

There are four categories of QMs catering to different lending scenarios:

• General QM: This type adheres to standard requirements for loan terms, fees, DTI, and verification procedures.
• Temporary QM: This category, applicable to loans before April 1, 2016, allows GSEs and government agencies flexibility in adapting to QM criteria.
• Small Lender QM: This type provides leniency for small lenders, allowing them to originate QMs with more flexible DTI requirements.
• Balloon-Payment QM: This QM, available only to small lenders, permits balloon payments but restricts the sale of the mortgage to other eligible small lenders.

Are prepayment penalties allowed on consumer mortgages?

Prepayment penalties, charges imposed for early loan payoff, are subject to restrictions:

• QM-only: Prepayment penalties are only permissible on Qualified Mortgages.
• Time and amount limits: The penalty can only be imposed during the first three years of the loan and is capped at specific percentages of the outstanding balance.
• Alternative option required: Lenders offering mortgages with prepayment penalties must also provide an option for a mortgage without this penalty.

What are the potential consequences for lenders who violate ATR rules?

Lenders who fail to comply with ATR regulations face serious consequences:

• Civil liability: Borrowers can sue lenders for violations, seeking damages for financial losses, reimbursement of fees, statutory penalties, and legal costs.
• Defense against foreclosure: Borrowers can use ATR violations as a defense in foreclosure proceedings, potentially limiting the lender’s recovery.
• Reputational damage: Violations can lead to negative publicity and harm the lender’s reputation.

Consumer Mortgage Re-regulation Study Guide

Short Answer Quiz

Instructions: Answer each question in 2-3 sentences.

1. What are the two major consumer protection laws passed in the 2000s, and what are their primary focuses?
2. Differentiate between a residential mortgage and a consumer mortgage.
3. Under what circumstances is a DRE licensee required to obtain an MLO endorsement?
4. Describe the steps a licensee must take to become MLO-endorsed.
5. What are the two ways a consumer mortgage can meet the requirements of the Reg Z ability-to-repay rules?
6. What are the advantages and disadvantages of originating a consumer mortgage under the general ability-to-repay rules?
7. List and briefly explain the eight items that must be assessed to determine a borrower’s ability to repay under the general ATR rules.
8. What are the benefits for a lender who originates a qualified mortgage (QM)?
9. Identify and briefly define the four types of qualified mortgages.
10. What are the limitations on prepayment penalties for consumer mortgages?

Short Answer Quiz: Answer Key

1. The Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act) of 2008 created a national licensing system for mortgage loan originators (MLOs). The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 established minimum standards and oversight for consumer mortgage origination.
2. A residential mortgage is secured by a one-to-four unit residential property and primarily used for personal, household, or family purposes. A consumer mortgage shares the same definition but explicitly includes seller carryback mortgages.
3. A DRE licensee needs an MLO endorsement when they arrange residential mortgage loans for a fee. This applies to individuals who take applications for or negotiate these loans and receive compensation for doing so.
4. To obtain an MLO endorsement, a licensee must:

• Complete 20 hours of pre-license education.
• Pass both the national and California state MLO exams.
• Submit an application through the NMLS, including personal, employment, and financial history, fingerprints, authorization for a criminal background check, and a credit report.

1. A consumer mortgage can comply with Reg Z ability-to-repay rules by either:

• Conforming to the general ATR rules, which offer flexibility but no liability protection.
• Meeting the criteria of one of the four qualified mortgage (QM) definitions, which offer more stringent guidelines but provide liability protection and other benefits.

1. Advantages of general ATR rules: Lenders have flexibility in setting their risk tolerance and can use a wider range of mortgage features and terms. Disadvantages of general ATR rules: No safe harbor protection from liability, ineligibility for sale to GSEs, and no government guarantees.
2. The eight items assessed for borrower repayment ability:
3. Current and expected income/assets.
4. Employment status (if using employment income).
5. Monthly payment on the target mortgage.
6. Monthly payment on other mortgages secured by the property.
7. Monthly payment for mortgage-related obligations (taxes, insurance, HOA fees).
8. Current debt obligations (including alimony and child support).
9. Monthly debt-to-income ratio (DTI) or residual income.
10. Credit history.
11. Benefits of originating a QM:

• Ability to sell the mortgage to GSEs.
• Access to government insurance or guarantees.
• Safe harbor protection from liability for failing to comply with ATR rules.

1. Four types of QMs:

• General QM: Follows strict criteria regarding loan features, DTI, and verification requirements.
• Temporary QM: Similar to general QM but temporarily defers to GSE and government agency underwriting standards until they develop their own QM definitions.
• Small lender QM: Provides flexibility for small lenders in terms of DTI and loan features, but requires portfolio retention for at least three years.
• Balloon-payment QM: Allows balloon payments under specific conditions and is only available to small lenders meeting specific criteria.

1. Prepayment penalties are ONLY allowed on QMs. Restrictions include:

• A maximum penalty period of three years after origination.
• Limits on the penalty amount (2% of outstanding balance in year 2, 1% in year 3).
• Lenders must offer a non-penalty mortgage option alongside any penalty option.

Essay Questions

1. Discuss the role of the California Department of Real Estate (DRE) and the Nationwide Mortgage Licensing System and Registry (NMLS) in implementing the SAFE Act in California. Explain the significance of the MLO endorsement for DRE licensees.
2. Analyze the various components of the Dodd-Frank Act and their impact on the mortgage industry. Discuss how these regulations aim to protect consumers from predatory lending practices.
3. Compare and contrast the general ability-to-repay rules with the qualified mortgage rules. Discuss the implications of choosing one method over the other from the perspective of both the lender and the borrower.
4. Explain the concept of a “substantially equal monthly payment schedule” in the context of the ability-to-repay rules. Provide examples of how this calculation is applied to both fixed-rate and adjustable-rate mortgages.
5. Critically evaluate the different types of qualified mortgages, highlighting their specific features, eligibility requirements, and advantages and disadvantages. Consider their impact on the availability of mortgage products for various borrower profiles.

Glossary of Key Terms

• Balloon payment: A final payment on a loan that is significantly larger than the regular periodic payments.
• Balloon-payment qualified mortgage: A type of qualified mortgage available only to small lenders that allows for a balloon payment under specific conditions.
• Business mortgage: A mortgage loan used for purposes other than personal, household, or family use, or one secured by real estate other than a one-to-four-unit residential property.
• Consumer mortgage: A mortgage loan secured by a one-to-four-unit residential property and used primarily for personal, household, or family purposes, including seller carryback mortgages.
• Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank): A federal law passed in 2010 to reform the financial industry and protect consumers from abusive financial practices, including predatory lending.
• General ability-to-repay (ATR) rules: A set of rules outlined in Regulation Z that require lenders to assess a borrower’s ability to repay a loan before extending credit.
• General qualified mortgage: A type of qualified mortgage that meets specific criteria regarding loan features, debt-to-income ratio, and verification requirements.
• Mortgage loan originator (MLO): An individual who is licensed and qualified to take mortgage loan applications, negotiate loan terms, and arrange for mortgage financing.
• Prepayment penalty: A fee charged by a lender when a borrower pays off a loan before its maturity date.
• Qualified mortgage (QM): A mortgage loan that meets specific criteria set by the Consumer Financial Protection Bureau, providing lenders with safe harbor protection from liability and other benefits.
• Residential mortgage: A mortgage loan secured by a one-to-four unit residential property and used primarily for personal, household, or family purposes.
• Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act): A federal law passed in 2008 to establish a nationwide licensing system for mortgage loan originators.
• Small lender: A lender with assets below a certain threshold who originates a limited number of mortgages annually.
• Small lender qualified mortgage: A type of qualified mortgage with more flexible criteria, available only to small lenders.
• Temporary qualified mortgage: A type of qualified mortgage that temporarily defers to GSE and government agency underwriting standards until they develop their own QM definitions.