The Government Sponsored Enterprises (GSE) patch is likely to expire in January 2021. This change poses concerns to many individuals, as it would make access to mortgages more challenging for less qualified, but still worthy candidates. For background, the GSE patch overrides the 2013 Consumer Financial Protection Bureau (CFPB) rules intended to reduce the risk of defaults by clarifying the factors lenders must employ when assessing a borrower for a qualified mortgage (QM) for Fannie Mae and Freddie Mac, allowing some less qualified borrowers to get mortgages.

To lessen the impact, the CFPB has proposed a “price-based” approach and an extension to the GSE patch that they hope will continue to protect consumers, while also allowing private mortgage companies to compete more effectively. Although this change presents some advantages for the market, many experts worry this will create a housing bubble, or worse yet violate fair lending laws.

In this article, I’ll dive into the proposed changes to the GSE patch and CFPH rules and outline how these updates could impact individuals looking to enter the real estate market and those already holding investments.  

The GSE patch is a temporary adjustment to the Ability to Repay/Qualified Mortgage (ATR/QM) requirements for Freddie Mac and Fannie Mae mortgages. It amends the QM rule’s requirements for making a reasonable, good faith decision that a borrower has the ability to repay a loan. This amendment makes it easier for more individuals to obtain a mortgage and invest in real estate. 

The patch eliminates the QM rule that states that a borrower’s debt to income ratio (DIT) must be less than 43 percent for Fannie Mae and Freddie Mac loans. For example, if debts are $1,000 a month (mortgage, car loan, credit card, etc.) and your income is $3,000, your DTI would be 33 percent. If your debts are $1,500 and your income is $3,000, your DTI would be 50 percent and you would not qualify for a Freddie Mac or Fannie Mae loan without the patch. If the patch expires, it is estimated that close to a million loans would not be made at all or that they would have to be made at a higher price. This nuance drastically impacts widespread access to fair loans and the ability to make mortgage payments. 

The real estate and construction industries are concerned that these changes will result in fewer sales and projects under construction. The parties are lobbying to renew the patch, along with some groups that represent minorities, as underrepresented groups could be disproportionately impacted by the change. Alternatively, private mortgage lenders are in favor of the patch’s expiration because they believe it will help them compete more effectively with GSE loans.

The CFPB does not support extending the patch or changing the law to reflect it. The Bureau believes that the expiration of the patch presents an opportunity to “level the playing field for consumers” by promoting more vigorous competition among mortgage providers. While the patch has helped more borrowers qualify for loans, it has also increased the risk of defaulting on these transactions. Another problem with the patch is that it makes it more difficult for private mortgage lenders to compete, as the patch currently enables close to a third of all GSE loans, a hefty share of the market.

The CFPB is committed to letting the patch expire while providing a way to make the transition as smooth and orderly as possible. This includes proposing to extend the patch until there is enough time to put alternatives into a place that will ease the transition.

The bureau is planning to replace the General QM definition in Regulation Z, changing the DTI limit to a price-based approach. The bureau believes that a loan’s price (when comparing it to the prime rate) is a better indicator of a consumer’s ability to repay the loan. Price thresholds will vary but will have higher price thresholds for smaller loans, something that is important for protecting access to mortgages for low-income minorities. The CFPB is also proposing to extend the GSE patch until the amendment to Regulation Z can take effect.

Proponents of privatization applaud the expiration of the GSE patch as part of their goal of decreasing GSE market penetration. They consider it an important step towards the housing reform goals of the current administration, which include broader deregulation and less focus on fairness for low income and minority consumers. 

The House Policy Council (HPC) applauds the change that they believe will result in clearer standards and QM’s that are more in line with a consumer’s ability to pay because loans will only be going to creditworthy borrowers. HPC Vice President Meg Burns said she was “thrilled.” Advocates for minorities are concerned that the patch will make it even more difficult for some groups, especially African Americans, to become homeowners. Statistics show that African Americans are 29 percent more likely to have a DTI of over 43 than all other borrowers. In addition, more than half of white households have a credit score of “good” (above 700), while only 21 percent of minority households have this rating. The expiration of the patch combined with already existing lower credit ratings, and unofficial “redlining,” are likely to reduce the ability of many people of color to buy their first homes.

In an effort to encourage innovation, and to provide affordable mortgages to more consumers, the CFPB is proposing to create a new category of Seasoned QM’s. In order to be considered a Seasoned QM under the proposal, the following requirements would need to be met:

• Loans must be first-lien.
• Loans must be fixed-rate.
• Loans must meet certain performance requirements over a 36-month period.
• Covered transactions must be held in the creditor’s portfolio during the seasoning period and
• Creditors must at least consider DTI or residual income.

Additionally, Seasoned QM’s would only apply for transactions with two delinquencies or less and no sixty-day delinquencies. The CRPB proposes that a national emergency, such as a pandemic, would excuse a consumer from disqualification if they obtain an accommodation. CFPB Director Kathleen Kraninger says this proposal’s goal is to use a “very deliberative rulemaking process to protect, promote and preserve the financial well-being of American consumers, while at the same time offering access to responsible, affordable mortgage credit.”

Higher loan prices will, inevitably, lead to higher delinquencies. The current low-interest rates have led to a refinancing boom, and with the workforce shifting remote with no return to previous levels of in-office routines, many homebuyers are looking outside of crowded cities and towns at places previously too far from metro areas for employment. The caution here is not to see a repeat of the 2008 housing crisis, where we went on a roller-coaster cycle of recovery, and low-income minorities were left disproportionately impacted.  

Sascha Mehlhase is Vice-President of Product and Innovation at ABC Legal Services. Sascha oversees ABC Legal’s growing product, marketing, and customer experience teams in transforming ABC Legal into the best-in-class technology and service industry leader, while simultaneously finding new avenues to scale. With nearly 20 years of product and marketing experience in software and technology, Sascha has advanced product strategies and led global teams in a variety of industries. Most recently, as senior director of product management at Intrado, Sascha oversaw its cloud-based telecom and communications platform as a service business and drove the company’s international product expansion into more than 170 countries. Sascha earned an MBA from Loyola University, Chicago, and a B.A. in Social Economics from Hamburg University, Germany.

Suggested Citation: Sascha Mehlhase, The Consumer Financial Protection Bureau: Seasoned Qualified Mortgage Proposal and GSE Patch, JURIST – Professional Commentary, October 22, 2020, https://www.jurist.org/commentary/2020/10/sascha-mehlhase-abc-cfbp/.

This article was prepared for publication by Vishwajeet Deshmukh, a JURIST staff editor. Please direct any questions or comments to him at commentary@jurist.org.