On May 9, 2014, the Department of Veterans Affairs (“VA”) issued an Interim Final Rule defining which VA-guaranteed loans would be “qualified mortgages” or “QMs” for the purposes of the Truth in Lending Act’s (“TILA”) ability-to-repay requirements. With its recent release of Circular 26-13-3, the VA has now clarified the application of that rule through FAQs focusing largely on Interest Rate Reduction Refinance Loans (“IRRRLs”). These loans are VA streamlined refinances, which generally allow for reduced income verification for eligible veterans’ loans. IRRRLs represent a small sliver of mortgage lending in the United States, but their treatment under VA’s Interim Final Rule has presented significant problems for some lenders.
In general, TILA requires lenders to assess a borrower’s ability to repay prior to originating most closed-end, consumer-purpose residential mortgage loans. Under regulations promulgated by the Consumer Financial Protection Bureau (“CFPB”), certain loans are deemed to comply with the ability-to-repay requirements (“safe harbor QMs”), and other (generally higher-priced) loans are subject to a rebuttable presumption of compliance (“rebuttable presumption QMs”).
While the CFPB’s rule provided initial definitions of each type of QM, several federal agencies, including the Federal Housing Administration (“FHA”), VA, and Rural Housing Service (“RHS”) were authorized to issue their own rules governing the QM treatment of loans they make, insure, or guarantee. The FHA issued its FHA QM Rule, which became effective at the same time as the CFPB’s main QM Rule (i.e., for mortgage loan applications received on or after January 10, 2014). The VA then issued an Interim Final Rule several months later; it became effective on May 9, 2014. (The RHS has yet to issue a rule. Until RHS issues its rule, loans eligible for RHS insurance qualify for QM status so long as they do not include certain risky features, their terms do not exceed 30 years, and the total points and fees for any such loan do not exceed three percent of the total loan amount. The RHS has until January 10, 2021, to replace that default categorization with an agency-specific QM definition.)
VA’s Interim Final Rule provides that all VA-guaranteed loans are QMs. While that rule provides that most VA-guaranteed loans are safe harbor QMs, certain IRRRLs are entitled only to rebuttable presumption QM status. We previously summarized the Interim Final Rule in full, but for the purposes of this update, we note that an IRRRL is defined to have safe harbor QM status if the:
- loan being refinanced was originated at least six months before the IRRRL’s closing date, and the veteran had not been more than 30 days past due during the six months prior to the IRRRL’s closing;
- recoupment period for allowable fees and charges financed as part of the IRRRL or paid at closing does not exceed 36 months;
- IRRRL is either exempt from income verification requirements under VA regulations (38 C.F.R. § 36.4307) or it meets income verification requirements under VA’s underwriting standards (38 C.F.R. § 36.4340) and TILA (12 C.F.R. § 1026.43(c)). (The latter would effectively strip the IRRRL of some of its “streamlined” nature. This distinction was required, in part, by provisions of TILA, as amended by the Dodd-Frank Act, that permit federal agencies to exempt streamlined refinancings from general ability-to-repay standards only if certain conditions are met.); and
- IRRRL meets all other requirements for a VA guaranty.
All other VA-guaranteed IRRRLs would be rebuttable presumption QMs only. For example, a VA-guaranteed IRRRL that does not meet the six-month seasoning requirement would be a rebuttable presumption QM. The same would be true for a VA-guaranteed IRRRL for which allowable fees and charges financed as part of the IRRRL are recouped by the borrower over a term exceeding 36 months.
The FAQs VA issued last week provide clarification on several IRRRL-related issues.
First, it clarifies that the relevant dates for the six-month seasoning period in prong (i), above, are the dates on which the notes for the loan being refinanced and the new IRRRL were executed.
Second, for the purposes of the 36-month recoupment period referred to in prong (ii), above, the VA clarifies that prepaid expenses (such as real estate taxes and homeowners’ insurance) are not required to be included, and lender credits and/or premium pricing may also be excluded if they are incentives paid on behalf of the veteran (but not if they are the result of any sort of consideration paid by the veteran). This means that lender credits may be excluded from the recoupment period to the extent they offset fees allowed in 38 C.F.R. § 36.4313 (which sets out categories of fees expressly permitted for VA-guaranteed loans). This clarification provides additional flexibility to lenders in originating IRRRLs, though it also suggests that lender credits may need to be itemized (rather than provided as lump sums) in order to better support their exclusion from the 36-month recoupment requirement.
Third, the VA clarified that it continues to exempt IRRRLs from income verification requirements to the full extent permitted under TILA (as amended by the Dodd-Frank Act). The VA did not choose to exercise discretion by exempting a narrower range of IRRRLs than would otherwise be allowed. As a result, IRRRLs are exempt from income verification requirements as long as:
- the borrower is not 30 or more days past due on the loan being refinanced;
- the IRRRL does not increase the principal balance outstanding on the loan being refinanced (except in the case of certain energy efficient mortgages and to the extent of VA’s allowable fees and charges under 38 C.F.R. § 36.4313);
- total points and fees (as defined by TILA), other than bona fide third-party charges not retained by the mortgage originator, for the IRRRL do not exceed three percent of the total proposed principal amount;
- the interest rate for the IRRRL is lower than that of the loan being refinanced (except where a fixed-rate IRRRL replaces an adjustable-rate loan);
- the IRRRL is a fully amortizing loan;
- the IRRRL does not have a balloon payment feature; and
- both the IRRRL and the loan being refinanced satisfy all other VA requirements.
The FAQs also address other aspects of the VA’s QM rule not summarized here. They will self-rescind on January 1, 2017. While they are effective, the FAQs provide helpful guidance on certain aspects of IRRRL origination (as they relate to the VA QM Rule). Nevertheless, the intricacies of IRRRL treatment under the Interim Final Rule suggest the product may continue to be subject to ambiguities disproportionate to its limited role in the mortgage marketplace.