The New Qualified Mortgage Rules: What are they and what impact will they have? - Redwood Trust
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The New Qualified Mortgage Rules: What are they and what impact will they have? April 2021
THE NEW QUALIFIED MORTGAGE RULES
This brief paper is being issued by Redwood
The New Qualified Mortgage
Trust, a leader in expanding access to housing
Rules: What are they and what for homebuyers and renters, to share our
impact will they have? understanding of the state of play regarding the
rules defining Qualified Mortgages and the
During the final months of the Trump potential impact on the market.
Administration, the CFPB announced a series
We’re offering perspective now because many
of updates to rules1 affecting the non-Agency
participants in the mortgage market are still
mortgage finance market, including the GSE
trying to determine how the new Revised Final
Patch, the QM rules, and rules affecting
Rule might change the way mortgages are
seasoned QM loans. We refer in this paper to
underwritten and what opportunities and
these rules as the “Temporary GSE Patch Final
considerations it might create for investors.
Rule”, the “Revised Final Rule” and the
The output of these determinations will
“Seasoned QM Final Rule” respectively.
ultimately be felt by borrowers, both in the
In early March 2021, during the first weeks of steps required to procure a mortgage and, by
the Biden Administration, the Revised Final extension, borrowing costs. With the early
Rule and Seasoned QM Final Rule went into 2021 guidance from the CFPB that it may
effect. While the timing and full extent of the “revisit” the Revised Final Rule, industry
impact of these rules are not yet fully clear2, participants would greatly benefit from some
these developments were welcomed by many clarity since such rule is currently in effect.
participants in the mortgage finance industry,
because they suggest a more level playing field
Current Status
between the public and private mortgage
At the time of this writing, the market is at an
sectors may be on the horizon.
interesting juncture with regards to the QM
definition. As noted, the Revised Final Rule
1
In July 2019, the Consumer Financial Protection Bureau Final Rule”) and the other provides an alternative pathway to
(CFPB) issued an Advanced Notice of Proposed QM safe harbor status for certain seasoned mortgage loans
Rulemaking (ANPR) indicating it would let the so-called (the “Seasoned QM Final Rule”). The Revised Final Rule
Government-Sponsored Enterprise (GSE) Patch expire in was designed to replace the current requirement for general
January 2021, and sought information on possible QM loans that the consumer’s debt-to-income (DTI) ratio not
amendments to the Bureau’s Ability to Repay/Qualified exceed 43% with a limit based on the loan’s pricing. In
Mortgage (ATR/QM) rule that has been in effect since The adopting a price-based approach to replace the specific DTI
Dodd-Frank Wall Street Reform and Consumer Protection limit for General QM loans, the Bureau determined that a
Act amended the Truth in Lending Act (TILA) to establish loan’s price is “a strong indicator of a consumer’s ability to
ability-to-repay requirements for most residential mortgage repay and is a more holistic and flexible measure of a
loans. This was followed by the CFPB’s issuance of a consumer’s ability to repay than DTI alone.”
separate notice of proposed rulemaking (NPRM) in August
2020 to create a new category of seasoned qualified 2
The acting leadership of the CFPB announced it may
mortgages (Seasoned QMs). In October 2020, the CFPB reconsider the Revised Final Rule and, in any event, pushed
issued a final rule to extend the GSE Patch (the “Temporary back its mandatory compliance date. The CFPB also
GSE Patch Final Rule”). This was followed by the CFPB’s announced that it may also reconsider the Seasoned QM
issuance of two additional QM-related final rules in Final Rule.
December 2020. Of the two final rules from the Bureau, one
drastically simplifies the definition of a QM (the “Revised
REDWOOD TRUST, INC.
1THE NEW QUALIFIED MORTGAGE RULES
was slated to go into effect in early March 2021, new rule eases up on one strict formulation for
but almost immediately rumors began to swirl determining a mortgage loan’s eligibility to be
that the CFPB, under new leadership, intended deemed a Qualified Mortgage. It replaces a
to delay the original mandatory compliance borrower-specific DTI calculation with an
date of July 1, 2021. In late February those alternative (and simpler) market-based
rumors were confirmed, as the CFPB released approach for determining whether a loan can
a notice of proposed rulemaking (NPRM) to be considered a QM.
delay mandatory compliance with the Revised
The new rule also retains the two categories of
Final Rule to October 1, 2022. These dueling
QM: loans where the originator is presumed to
“mandatory compliance” dates have put
have met the ATR requirements of the QM rule
originators in the somewhat unique position of
and thereby receives a safe harbor in potential
having a choice (for an extended period of
litigation (“Safe Harbor QMs”), and loans where
time) of whether to apply the new or old
the borrower has the ability to rebut that
guidelines.
presumption in court (“Rebuttable Presumption
Without greater certainty surrounding the QMs”).
direction of the new rules, consumers may
This is where the market spread methodology
experience a further delay in the re-emergence
comes in: under the Revised Final Rule, a
of certain non-agency loan products. With that
loan’s spread to APOR is now the key
concern in mind, let’s understand this new rule
determinant of QM status. Loans with APRs
and its implications if it ultimately becomes the
less than 150bps above APOR and that meet
true law of the land for QM determination.
the originator’s underwriting guidelines for ATR
will qualify as Safe Harbor QMs. Loans with
What the New Revised Final Rule Says APRs between 150bps and 225 bps above
(and What It Doesn’t Say) APOR will qualify for Rebuttable Presumption
QMs. Lastly, loans with rates greater than
The Revised Final Rule retains the product 225bps above APOR do not qualify (non-QM).
limitations on QM (for instance, interest-only
and negative amortization loans still don’t
The Likely Impact of the New Revised
qualify as QM), as well as the cost thresholds
Final Rule
for determining if a loan is QM. However, as
noted above, the new rule removes the strict We believe the Revised Final Rule will
43% DTI ratio cutoff in favor of a market-based marginally level the playing field between the
spread at origination relative to the Average non-Agency and Agency markets by providing
Prime Offered Rate (APOR). APOR is a flexibility to non-Agency underwriters in
baseline market mortgage rate from which a determining a borrower’s ATR. This leeway has
loan’s credit risk can be imputed based upon previously only been enjoyed by the GSEs. If
the loan’s annual percentage rate (APR) this rule survives, it will likely lead to increased
relative to this benchmark. In other words, the credit availability, more loans classified as QM,
REDWOOD TRUST, INC.
2THE NEW QUALIFIED MORTGAGE RULES
and increased competition among lenders. For However…
these reasons, the rule change has been
The Revised Final Rule still requires that
widely lauded by mortgage originators.
originators make a reasonable, good-faith
However, some industry participants had
determination of a borrower’s ability to pay,
hoped to see a level playing field while
before or at the time a mortgage loan is
retaining the existing ATR criteria. In specific:
consummated, and that the consumer has the
require the GSEs to comply with the standards
wherewithal to perform under the terms of the
already in effect for the private sector.
loan. In other words, it still requires that lenders
have a methodology to support their
What About Appendix Q? determination of a borrower’s ATR. The
Revised Final Rule also requires that
In the original QM rule, the standards to
originators still “consider DTI” in their
determine and document the income used to
methodology.
calculate DTI were found in Appendix Q of 12
CFR Part 1026, also known as Regulation Z, What this means in practice is that with the
which implements the Truth in Lending Act. removal of Appendix Q, originators will have
Based on traditional Federal Housing flexibility around what they consider and how
Administration (FHA) lending guidelines, they verify/document a borrower’s ability to
Appendix Q was rather strict and doctrinaire, repay the loan. A methodology of some form,
but also vague in dealing with non-traditional however, needs to be in place.
sources of income (such as commission
income or restricted stock units). As a result,
Seasoned Loans
this portion of the rule came under increased
criticism from the mortgage industry, Under the Seasoned QM Final Rule, the
particularly as non-traditional sources of provision for seasoned non-QM loans is very
income became increasingly common during limiting. Loans that are priced between 150bps
the underwriting process. and 225bps above the APOR start out with
rebuttable presumption status, but over time
The Revised Final Rule removes Appendix Q,
can qualify for safe harbor status if they meet
so lenders will have more flexibility going
certain delinquency and performance
forward to establish their own methodologies
thresholds during the first 36 months post
for certain underwriting approaches, including
origination. The provision for seasoned non-
calculating and documenting income, and
QM loans favors whole loan trading versus
verifying employment and assets. The
securitization, as the rule does not allow non-
existence of Appendix Q made sense under the
QM loans in securitizations to benefit from
original QM rule, where a strict DTI threshold
seasoning.
required a common, formalized methodology
across originators, so that one borrower’s DTI
was comparable to another’s (at least for
purposes of determining QM status).
REDWOOD TRUST, INC.
3THE NEW QUALIFIED MORTGAGE RULES
Market Impact
There’s a reason why no consensus has yet underlying value of the securitization for at
emerged on the market impact, as the Revised least several years, and therefore have
Final Rule is long, complicated and has some important ramifications on loan pricing. For a
potentially offsetting elements. What we do non-agency mortgage securitization to be
know is that more flexibility in underwriting exempt from risk retention requirements, every
generally leads to a loosening of credit loan in the underlying pool must be QRM (the
standards, and thereby tends to lead to more inclusion of a single loan that is not QRM
volume - potentially the highest order impact of triggers a full risk retention obligation on the
the new rule. part of the sponsor).
This increased flexibility will likely result in Mercifully, regulators set these definitions as
loans that would previously be deemed non- the same, meaning a QM is a QRM for
QM qualifying as QM going forward. A purposes of risk retention requirements. The
corresponding reduction in non-QM lending will market often uses these terms
follow, making growth difficult for monoline interchangeably, although they technically
origination platforms previously focused largely aren’t. If these definitions diverge in the future
on non-QM lending, as compared to full- (and, say, the QRM definition becomes tighter),
service originators offering a broader suite of this will impact the non-agency securitization
loan products. Lower volume may also market and therefore how certain cohorts of
constrain the availability of dedicated loans are originated and priced. This includes
warehouse facilities for non-QM loans and loans made on non-owner occupied properties,
could extend aggregation periods for dedicated more of which may find their way into the non-
non-QM securitizations. agency market based on a recently-announced
cap on purchases of these loans (plus loans
made on second homes) by the GSEs.
Impact on Risk Retention in Non-
Agency Mortgage Securitizations
What About the GSEs?
Just to add one more layer of complication, we
should remind readers that the original idea of The combination of the Temporary GSE Patch
a QM was created to help define a borrower’s Final Rule and the Revised Final Rule ends the
ability to repay a loan. Since regulators have a “QM patch”, which provided the GSEs with an
dual mandate of protecting borrowers and exemption from complying with the 43% DTI
investors, the category of a Qualified cap and Appendix Q underwriting standards.
Residential Mortgage (QRM) was also created The QM patch basically said that if a loan is
to determine which loans are subject to risk underwritten to GSE guidelines, the loan by
retention by the sponsor of a securitization. definition is a QM. This was one of many
Risk retention requirements compel a sponsor factors making GSE loans easier and cheaper
to retain (in specified forms) 5% of the to underwrite relative to non-Agency.
REDWOOD TRUST, INC.
4THE NEW QUALIFIED MORTGAGE RULES
Without this exemption, originators selling to repay the loan, an absolute standard that lends
GSEs will now have to underwrite to QM itself to quantitative measures such as DTI.
guidelines that they develop and can defend, The Revised Final Rule, however, is focused
although the Revised Final Rule makes it on the interest rate of the loan relative to a
easier for originators to do this in one important market benchmark. Mortgage rates are
way: by adopting GSE or FHA guidelines. This determined by supply and demand, and
may have an important impact on the speed competitive capital markets forces. Therefore,
with which the non-agency market adopts a loan’s spread to a benchmark - determined
certain elements of automated underwriting as it is by these market dynamics – is a relative
present in GSE processes. measure, not an absolute measure. DTI is an
absolute measure of a borrower’s debt burden
relative to the income they earn. If the objective
Does Everyone Now Get to Use GSE
of the ATR requirements is to measure a
Guides?
specific borrower’s absolute ability to pay - not
That’s one way to look at it, but let’s be more relative to someone else’s - then it seems as if
specific: The Revised Final Rule allows an a DTI measure (in some form) would be a more
originator to use GSE or FHA standards to appropriate assessment tool given that it is not
underwrite a loan and satisfy ATR influenced by unrelated market forces.
requirements. Effectively this means that GSE
That said, the Revised Final Rule, if it remains
standards are QM under both the old and new
the policy of the CFPB, we believe will
QM rules. Now, however, the private sector can
generally make credit more available to the
adopt those standards and satisfy QM as well -
marketplace and will increase the availability of
the more level playing field we referenced credit as a whole.
earlier. The ability for the private sector to adopt
or even modify GSE standards will allow for
Practical Implications of the Policy
flexibility and creativity among originators in
Uncertainty
creating new standards, some of which might
even be adopted by the GSEs. As it stands now, originators can adopt the new
policy or stick with the old one until the CFPB
Housing Policy Impact completes its latest rulemaking initiative. In our
view, the prospect of this type of “stub period”
There are inherent conflicts and tradeoffs for will create challenges for market participants,
policymakers focused on expanding credit namely the liquidity and salability of loans
availability while also protecting consumers measured against what may be a short-term
and investors from undue risk. That’s not an standard. As a result, many market participants
easy balance to strike. may choose not to change their underwriting
guidelines and infrastructure until a final
As we have discussed, the idea of a qualified
determination is made by the CFPB.
mortgage is based upon a borrower’s ability to
REDWOOD TRUST, INC.
5THE NEW QUALIFIED MORTGAGE RULES
Authors including, among other things, those described in
Dashiell I. Robinson, President the Company’s Annual Report on Form 10-K for
Fred J. Matera, MD-Head of Residential the year ended December 31, 2020 and any
James D. Ferrol, Senior Vice President subsequent Quarterly Reports on Form 10-Q and
Cara L. Newman, Senior Vice President Annual Reports on Form 10-K under the caption
“Risk Factors.” Many of these risks and
uncertainties are, and will be, exacerbated by the
Disclaimer COVID-19 pandemic and any worsening of the
This presentation and the information, analytic global business and economic environment as a
tools, and/or models referenced herein are result. Other risks, uncertainties, and factors that
intended for informational purposes only. could cause actual results to differ materially from
Redwood Trust, Inc. (“Redwood”) has no those projected may be described from time to
obligation to update this information and may time in reports the Company files with the
cease provision of this information at any time Securities and Exchange Commission, including
and without notice. All opinions and estimates are reports on Form 8-K.
given as of the date hereof and are subject to
change. Redwood is not obliged to inform the
recipients of this communication of any change to About Redwood
such opinions or estimates. Trust: Redwood Trust, Inc. (NYSE: RWT) is a
specialty finance company focused on several
All information is provided “as is” without warranty distinct areas of housing credit. Our operating
of any kind. Redwood is not responsible for any platforms occupy a unique position in the housing
errors or omissions in the information contained finance value chain, providing liquidity to growing
herein. Redwood makes no representation and segments of the U.S. housing market not served
disclaims all express, implied, and statutory by government programs. We deliver customized
warranties including warranties of accuracy, housing credit investments to a diverse mix of
completeness, reliability, fitness for a particular investors, through our best-in-class securitization
purpose or merchantability of the information platforms; whole-loan distribution activities; and
contained herein. our publicly-traded shares. Our consolidated
investment portfolio has evolved to incorporate a
This presentation contains forward-looking diverse mix of residential, business purpose and
statements, including statements regarding the multifamily investments. Our goal is to provide
impact and practical implications of the new attractive returns to shareholders through a
qualified mortgage rules. Forward-looking stable and growing stream of earnings and
statements involve numerous risks and dividends, capital appreciation, and a
uncertainties. Our actual results may differ from commitment to technological innovation that
our beliefs, expectations, estimates, and facilitates risk-minded scale. Since going public in
projections and, consequently, you should not 1994, we have managed our business through
rely on these forward-looking statements as several cycles, built a track record of innovation,
predictions of future events. Forward-looking and a best-in-class reputation for service and a
statements are not historical in nature and can be common-sense approach to credit investing.
identified by words such as “anticipate,” Redwood Trust is internally managed, and
“estimate,” “will,” “should,” “expect,” “believe,” structured as a real estate investment trust
“intend,” “seek,” “plan” and similar expressions or ("REIT") for tax purposes. For more information
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