Why the CFPB’s Qualified Mortgage Rule Misses the Mark

This post grows out of two working papers (downloadable here and here) I’ve written with Joshua Mitts, a former student of mine who is now working at Sullivan & Cromwell.

Why the CFPB’s Qualified Mortgage Rule Misses the Mark
Ian Ayres & Joshua Mitts

Last Friday, the Consumer Financial Protection Bureau’s “qualified mortgage” rule went into effect.  This rule is designed to put an end to the risky lending practices that led to the financial crisis.  But a simpler rule could better assure borrowers’ ability to repay and simultaneously create greater repayment flexibility.

The purpose of the QM rule is to help assure that borrowers have sufficient monthly income to make their required mortgage payments, lessening the risk of large-scale defaults like those experienced after 2008. The rule creates a lender safe harbor for qualifying mortgages.  Lenders can still make non-qualifying loans, but must instead meet more onerous multi-factored underwriting standards. Qualifying loans reduce the risk that lenders will be held liable under Dodd-Frank for failing to make a “reasonable, good faith determination of a consumer’s ability to repay.” 

The CFPB has taken an important first step towards addressing this repayment inability risk by requiring as part of the QM rule that the maximum monthly payment (at any point during the course of repayment) be no more than 43 percent of the borrower’s monthly income (at the time of the initial loan).  But surprisingly, this debt-to-income (DTI) requirement need only be satisfied for the first five years of the loan.  There’s nothing stopping a lender from resetting the interest rate after five years, raising the borrower’s payments to an unsustainable level in light of his or her monthly income.

We think this is a gaping flaw in the QM rules.  The CFPB should mandate that the DTI ratio, calculated based on the maximum required monthly payment, be satisfied for the life of the loan, not merely the first five years.  There’s simply no reason to limit the ability to repay to such a short period.  Under the current QM rules, an interest rate reset five years from now could plunge millions of borrowers into payments they can’t afford.  This isn’t an abstract hypothetical.  Interest rate resets substantially exacerbated foreclosures during the housing crisis.

Insisting on a life-of-the-loan DTI rule could also simplify and soften the QM pre-requisites.  Presently, the QM rule would disqualify any loan that had repayment periods with interest-only or negative amortization.  These prerequisites should be eliminated.  We shouldn’t be concerned about temporary interest-only or negative amortization so long as the DTI requirement is satisfied for the life of the loan.  

To be sure, a fixed-rate mortgage with sufficiently low initial payments would automatically satisfy the life-of-loan DTI standard.  But traditional fixed-rate mortgages shouldn’t be the only kinds of loans to qualify as QMs.  Borrowers and lenders should be given the freedom to agree to any repayment stream that satisfies the life-of-loan DTI requirement.

There’s nothing wrong with giving homeowners the option to skip a payment every once in a while—say, at Christmastime, when the bills are piling up.  Indeed, mortgages that offer payment holidays once a year have been successfully used in New Zealand and other countries for several years.  Giving homeowners this flexibility might actually prevent unnecessary default and foreclosures by easing unexpected liquidity shortages.  “Payment holiday” terms may actually enhance borrowers’ ability to repay their mortgages.

Finally, the QM prerequisites should be better tailored to assure that the borrower’s expected income is sufficient to repay the loan.  Currently, there is nothing to stop lenders from making QM loans to elderly borrowers. But a 63-year-old is unlikely have a sufficient income 30 years later to repay the loan.  This doesn’t mean that elders shouldn’t be able to take out a mortgage to buy a home, but they shouldn’t be able to borrow on a QM basis.  Because QM loans are only appropriate when the borrower’s expected income will be sufficient to repay the loan, QMs should be limited to those loans that are to be repaid within 30 years or when the borrower reaches the age of 65, whichever comes first.  Elders can still choose to refinance their mortgages to cash out the accrued equity in their homes, but both lenders and borrowers should be clear when the repayment is not likely to come from the borrower’s future earnings. 

The QM rule is an important first step towards discouraging the type of improvident lending that sparked the financial crisis.  But as currently constituted it is unnecessarily complicated and poorly tailored toward assuring that borrowers have sufficient earnings to make their payments.

Voice of Reason

How did this solve anything? The main problem was the adjustable rate mortgages where people were suckered into affordable payments, but then had the rug pulled out from under them. The only law that you need is all interest rates must be flat from year 1-30 at the signing of the loan, with the rate changing only when both parties have signatures on an additional refinancing agreement, where that rate becomes the new one.

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I had a 5-year ARM for about eight years a while back. The interest rate adjusted down at the five-year mark. That's not unusual. There was both a floor and a ceiling on how low and high the adjustment could be, and a limit on how quickly it could adjust. This, too, is not unusual.

I knew what I was signing. I knew that I had the ability to deal with the highest possible payment under this mortgage. I knew, too, that I'd be overpaying a bit each month, which meant that the "highest possible payment" in the mortgage paperwork would not be possible after the five-year fixed period expired even if interest rates had skyrocketed. It worked really well for me, and it turned out to be cheaper than the traditional 30-year fixed would have been during those same years.

Why should *I* be prohibited from getting that product? Your method of protecting "suckers" would have cost me several thousand dollars.



Mortgages that adjust to maximal interest after 5 years can be useful products. In this case, underwriting must evaluate the borrower's likely ability to refinance (the typical use of the product). Need safeguards to make sure naive borrowers don't think it's a conventional 30 year. If a prospectus for a derivative security assumed that anyone would actually be paying the maximal interest, that should lead to a fraud case.


It is an interesting proposal. I need to read the WP's. I'm curious what adjustment rule would work to permit ARM's Particularly in the admittedly unlikely case of high interest rates. If they had risen significantly, it is likely due to high inflation and without adjustment the lender is now being repaid at a real rate below what they anticipated. Keying the new rates to original income would probably not make sense. In all likelihood given the high inflation, the borrowers wage is now much higher in nominal amounts so may be a reasonable reference. However reference relative to it would penalize who worked hard to get a higher salary, while penalizing lenders to those who may not have worked as hard thus had relatively small salary gains. A possible resolution would be to use use inflation, in the rule.


This is a surprisingly poorly thought out article. Not allowing a QM to a 63 year old? The author apparently hasn't heard about Fair Lending and Equal Credit Opportunity Act Laws. The difficulty with underwriting us that the decision to approve/deny is based on a single point in time. The reason five years makes sense is that most peoples financial situations change entirely every five years. People get promotion, have children, retire, etc. predicting someone loss term financial future by its nature would lead to unfair banking practices based on what would be well-intentioned but likely flawed assumptions. In fact, the average 30-year fixed rate loan only lasts about 7 years because people sell their house or refinance.

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Then maybe seven years would make more sense. Or maybe it should be not when the median mortgage is changed, because that would still leave 50% of mortgages affected, but for however long two-thirds or three-quarters of them last.

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I don't like the idea of using age 65 as the benchmark, especially since the full Social Security retirement age right now is 66 (anyone who qualified for retirement at age 65 is already older than that). Age 67 or 70 would make more sense.


Why the assumption that someone taking out a 30-year mortgage at 63 would not have sufficient income 30 years later? It should, after all, be quite simple to compute anyone's expected minimum income at that age: add up expected Social Security paymentts plus RMDs on 401k & IRAs.

Enter your name...

Well, for starters, most of us are dead when we're 93.


And how is this a problem, exactly? (For the lender, of course - if the borrower has problems, they're out of our reach.) The property & mortgage are part of the estate, and either pass to the heirs, or the property is sold to settle the estate. Same as if I borrow at 30, and die at 35.


I'm confused or this is poorly worded or both.

"requiring as part of the QM rule that the maximum monthly payment (at any point during the course of repayment) be no more than 43 percent of the borrower’s monthly income (at the time of the initial loan)."

How is "at any point during the course of repayment" consistent with "this debt-to-income (DTI) requirement need only be satisfied for the first five years of the loan?"


How would you even propose to calculate what someones income is over a 30 year span?!

"Borrowers and lenders should be given the freedom to agree to any repayment stream..."

They currently do that right now. No one has ever had a gun pointed to thier head and forced into an adjustable rate mortgage. All you're proposing is an additional incalculatable factor.


As great as some points of this article may sound on paper, the reality of the truth is some of the points violate Fair Equal Opportunity Act Laws that have been in effect for decades. I love ideas but we need valid points that have some working scientific notation.


I work at a credit union in the commercial lending area. While not readily involved or up-to-date on consumer regs such as the "ability to repay" requirement that recently went into effect, I became involved as one of my members (CU speak for clients) applied to refi his home with us and the mortgage department contacted me in understanding his personal income sources. Suffice, he is a high net worth individual with non-traditional sources of income having much flow through trusts and LLCs in protecting assets and deferring taxes. As the income does not in any way show on his personal accounts, they could not qualify him for the refi by regulation.

Now, the National Credit Union Association is filing for a change to the regs in not having this requirement impact CUs as no CU in the country was involved in the activities that lead to the recession. It will take some time to find out whether this will result, but nonetheless we are unable to process his request at this time.

It is a sorry state when a small community financial institution that is prudent with its lending practices cannot make a loan to a well-known member who we can confirm has the resources to repay, but not in a manner required by bureaucracy. Thankfully, the member is understanding and will not be meaningfully harmed by this. I know the tenor of the article published is targeted at the widespread practices that set-off the recession, but I think it time that laws also recognize community-based financial institutions still exist and continue to operate in the best interest of all stakeholders. I would think your recommendations need also express this sentiment and include provisions for a "Small is Beautiful" world.

Jere in Portland, ME



Well, I'm also in consumer banking and that's probably the right call.

A trust is a distinct legal individual, the same as a person. The customer does NOT have assets. He has access to assets.

The lending, in that case, should be in the trust's name or the LLC. The individual is not a qualified borrower.

You don't get it both ways. Either you claim and pay your taxes, then you can borrow money, or you don't.


These rules are too complicated and are full of loopholes ripe for fraud.

Why not just get the government out of the lending business? Here in the Silicon Valley cheap loans just mean the price of houses goes higher. That just means transferring extra money to old people (when they sell their price-inflated houses), to the bankers (higher origination charges), and to the real-estate interests (higher commissions).

Move back to the sound money authorized by The Constitution and let private banks lend out whatever money they have to whoever they want. If the bank makes bad loans then the bank owners and bank investors take a loss. The role of government is to jail bankers who make loans with IOUs instead of money they actually have (i.e.: fractional reserve lending instead of straight money lending). In this way the citizens who don't which to participate in banking business aren't forced to bail out the fraud.


Chad Hardgrave

The problem with your life of loan position is that all variable rate mortgage products would fail because you have to assume the worst possible scenario when underwriting the loan--consequently, you would have to max out the possible increase for every future change date which would quickly blow the life of loan requirements. Further, variable rate mortgages actually tend to even out historically and often perform better than their fixed rate counterparts, so the life of loan requirements would destroy an excellent mortgage option. Additionally, Americans tend to refinance or move within 5 years, so the five year test serves its purpose for a majority of mortgage loans.

Honestly, the Dodd Frank rules were unnecessary, the market corrected itself before any of these laws even went into effect. But I'm certain it made for wonderful campaign back patting.


Assuming that the income of a 63-year-old or older would most likely be less than someone younger is ludicrous. In today's society, no job is secure from one day to the next at any age. People are working longer and many of those in their 60s have funds stored away. As for myself, I am looking into refinancing at age 64. I have funds stored and I am able to afford and will continue to afford the mortgage that I have now. However, I would like to lower the interest rate in turn lowering my monthly payment. This would allow me to pay the mortgage and afford to periodically double the monthly payment to lower the principal. People at any age can do this, not just those under 60. The determining factor should be not only income to debt ratio, but what assets an individual pulls from to maintain mortgage payments. Many people don't live on SS or a pension alone. Age is irrelevant!