Hello, and thank you for joining me. My name is Fernando Zoota and I am your host for the podcast and blog, Non-QM Insider, the show where we talk about regulations, guidelines and anything having to do with non-qualified mortgages. The topic of discussion is the Ability to Repay rule. Let’s first start by stating when I refer to the Ability to Repay rule, I’m referring to consumer purpose loans. In general (this isn’t 100%) and to keep it simple, a consumer purpose loan refers to a loan for an owner-occupied home. To understand Ability to Repay or ATR, as it’s known for short, we first must have a discuss about subprime. Sub-prime and Non-QM are related, but they’re not the same thing.
Let’s go back to around 1999, early 2000s and talk about Countrywide Mortgage. At the time they were the largest, or at least one of the largest, subprime lenders in the nation.
One of Countrywide Mortgage’s executives famously said, we will give a loan to anyone who can fog a mirror. In retrospect, that’s a crazy statement, but everyone went with it.
Basically, what they were saying is they would give anybody a loan because they weren’t really qualifying the borrower. Lenders were really lending on the equity or potential equity of the property. What they needed was a warm body to make the payments. The more payments made, the greater their equity position would be in the collateral (the home). One thing to know about non-prime loans is they’re typically adjustable-rate mortgages, ARMs. A borrower would be in an ARM for two, three- or five-year years. Back then, you needed somebody to make the payment for the duration of the ARM and then refinance or take the adjusted rate, whatever the case may be. All the while, you’re just gaining equity, gaining equity, gaining equity. That business model worked like a charm always up until it didn’t!
After the housing crisis was in full swing, I’m going to call that 2008. In 2009 the Board of Governors of the Federal Reserve System adopted a rule under the Truth in Lending Act called the Ability to Repay rule (ATR), and it was for higher-priced mortgages. ATR required lenders to make a good faith determination that the borrower can pay back the loan. No more stated income. If you say, I work for Walmart, I make $45,000 a year, here’s my pay stubs & W2s, a lender must verify the information as part of their good faith determination. What did lenders do? They verified employment and tax transcripts. They reviewed credit. They underwrote the person borrowing the money. They could no longer underwrite only the property, as in days past. Lender’s now had to underwriter the applicant to make sure (within reason) they had the ability to repay back the loan. This is a big difference from common practices back in the sub-prime era.
In 2010, Dodd-Frank, the Wall Street Reform Act, adopted the same ATR rule. What that meant, for practical purposes, all loans adopted the ATR rule. Moving forward, lenders had to underwrite the borrower. They determined their income, creditworthiness and their ability to pay back the loan. If they’re providing pay stubs they must be verified. If bank statements are used for income, lenders must verify the income within them. Whatever’s provided to underwrite the loan, must be verified. Yes, in years past, they did verify the borrower information, but to a lesser degree, now it is the law of the land. The final ruling of the ATR rule came out in 2013 and that’s when we see the first couple of lenders enter the market.
In 2014 & 2015, we would go out and meet with brokers, and they would say, “What is this stuff that you’re offering? This is subprime. This almost ruined the whole country! Get this out of my face.” Then we would have to respond, “No, this is different. This is Non-QM and we have different rules.” Now, the successful Account Executives were able to convince brokers that Non-QM was different– is different. The unsuccessful Account Executives could not or cannot explain to their customers that this was different. This was not subprime. This is Non-QM.