Using RS Edge to Quantify the Impact of The QM Patch Expiration

Using RS Edge Data to Quantify the Impact of the QM Patch Expiration

A 2014 Consumer Financial Protection Bureau (CFPB) rule established that mortgages purchased by the GSEs (Fannie Mae or Freddie Mac) can be considered “qualified” even if their debt-to-income ratio (DTI) exceeds 43 percent. This provision is known as the “qualified mortgage (QM) patch” or sometimes the “GSE patch.” It has become one of the most important holdouts of the Dodd-Frank Act and an important facilitator of U.S. lending activity under looser credit standards. The CFPB implemented the patch to encourage lenders to make loans that do not meet QM requirements, but are still “responsibly underwritten.” Because all GSE loans must pass the strict standards for conforming mortgages, they are presumed to be reasonably underwritten–notwithstanding sometimes having DTI ratios higher than 43 percent.

The QM patch is set to expire on January 10, 2021. This phaseout has spawned concern over the impact both on mortgage originators and potentially on borrowers when the patch is no longer available and GSEs are less apt to purchase loans with higher DTI ratios.[1]

We performed an analysis of GSE loan data housed in RiskSpan’s RS Edge platform to quantify this potential impact.

The Good News:

The slowdown in purchases of high-DTI loans is already occurring, which could partially mitigate the impact of the expiration of the patch.

We used RS Edge to analyze the percentage of QM loans to which the patch applies today. From 2016 through the beginning of 2019, Fannie and Freddie sharply increased their purchases of loans with DTI ratios greater than 43 percent, with these loans accounting for over 34 percent of Fannie’s purchases as recently as February 2019 and over 30 percent of Freddie’s purchases in November 2018 (see Figure 1).

Figure 1: % of GSE Acquisitions with DTI > 43 (2016 – 2019)


Our data shows, however, that Fannie and Freddie have already begun to wind down purchases of these loans. By the end of 2019, only about 23 percent of GSE loans purchased had DTI greater than 43 percent. This is illustrated more clearly in Figure 2, below.

Figure 2: % of GSE Acquisitions with DTI > 43 (2019 only)


As discussed in the December 2019 Wall Street Journal article “Fannie Mae and Freddie Mac Curb Some Loans as Regulator Reins in Risk,” the wind-down could be related to the GSE’s general efforts to hold stronger portfolios as they aim to climb out of conservatorship. However, our data suggests an equally plausible explanation for the slowdown Borrowers generally exhibit a greater willingness to stretch their incomes to buy a house than to refinance, so purchase loans are more likely than refinancings to feature higher DTI ratios. Figure 3 illustrates this phenomenon.

Figure 3: Most High-DTI Loans Back Home Purchases


The Bad News:

The bad news, of course, is that one-fifth of Freddie and Fannie loans purchased with DTI>43% is still significant. Over 900,000 mortgages purchased by the GSEs in 2019 were of the High-DTI variety, accounting for over $240 billion in UPB.

In theory, these 900,000 borrowers will no longer have a way of being slotted into QM loans after the patch expires next year. While this could be good news for the non-QM market, which would potentially be poised to capture this new business, it may not be the best news for these borrowers, who likely do not fancy paying the higher interest rates generally associated with non-QM lending.

Originators, not relishing the prospect of losing QM protection for these loans, have also expressed concern about the phaseout of the patch. A group of lenders that includes Wells Fargo and Quicken Loans has petitioned the CFPB to completely eliminate the DTI requirements under ability-to-pay rules.

Figure 4: % of DTI>43 Loans Sold to GSEs by Originator


We will be closely monitoring the situation and continuing to offer tools that will help to quantify the potential impact of the expiration.

[1] Consumer Financial Protection Bureau, July 25, 2019.