The Consumer Financial Protection Bureau has released a new notice of proposed rulemaking that will create a seasoned qualified mortgage, a new category under the Dodd-Frank-created qualified mortgage (QM). The goal, it states, is to “encourage safe and responsible innovation in the mortgage origination market.”

That’s a laudable aim. And the Bureau deserves credit for trying to achieve it by acknowledging that a loan that seasons without delinquencies—the borrower makes regularly scheduled payments on time for many months—demonstrates that the lender did as good a job as possible when underwriting the loan.

In principle, it’s a great idea.

It stands to reason that, at some point during the term of a loan, any borrower default would be the result of an unforeseeable change in the borrower’s circumstances. When, for example, a borrower defaults five years after making consecutive payments as scheduled, it makes little sense to penalize the lender for a faulty initial assessment of the borrower’s ability to repay.

So the bureau deserves credit for trying to entrench this principle.

As always, though, the devil is in the details. And in context of the bureau’s new proposal to redefine the general QM, it’s doubtful that the new seasoned QM will result in very much innovation.

As described here, that proposal removes the 43 percent debt-to-income (DTI) limit for the general QM. It replaces the DTI limit (and the infamous QM patch) with a “price-based approach.” (See page 5.) Under the new approach, a loan qualifies for QM status provided that the difference between a loan’s annual percentage rate and the average prime offer rate (APOR) is less than two percentage points.

The problem is that the APOR test is not calibrated to default risk. And it won’t even provide as much friction against high-risk loans as did the QM patch itself. It’s telling that special interest housing lobbyists have been pushing for an APOR rule for years—their main concern is maximizing the number of loans in the system.

The supposed logic behind the QM, on the other hand, was that it would help guard against a repeat of the 2008 housing fiasco. To achieve this goal, the 2010 Dodd-Frank Act created two specially designated mortgages: The Qualified Residential Mortgage (QRM) and the Qualified Mortgage (QM).

The QRM was envisioned as the gold standard mortgage, a high-quality, low-risk mortgage stamp of approval. The QM, in contrast, was supposed to function as a minimum-quality mortgage, with the obvious implication that failure to meet the QM standard was a bad sign.

However, Congress left it up to the regulators to fill in the details, and the final rules ensured that there was essentially no difference between the QRM and the minimum standards of the QM. Worse, Congress provided exemptions for other government agencies (such as the FHA), and the bureau created the QM patch, ensuring that most of the mortgage market was exempt from the strictest provisions of the general QM. (See Chapter 2.)

Now, with the patch set to expire, the bureau is going to ensure that most of the market remains exempt from the strictest of standards by changing the definition of the general QM. As a result, many loans that would have not have been QMs will now qualify.

In this context, it is very difficult to see how the seasoned QM will help bring many solidly performing loans into the QM world.

The seasoned QM makes enormous sense in a mortgage market with stricter minimum standards precisely because it provides the opportunity to attain QM status after demonstrating the high quality of a loan rather than merely checking a few regulatory boxes. But that world will not exist with the new expansion of the general QM.

Furthermore, the seasoned QM proposal sets up so many regulatory boxes that there will be little difference between a loan originated as a QM and one that could later qualify for seasoned QM status.

To qualify for seasoned QM status, the loan has to have a fixed rate, with fully amortizing payments and no balloon payment, for a maximum term of 30 years. It also has to have total points and fees within specified limits, and the lender has to “consider the consumer’s DTI ratio or residual income and verify the consumer’s debt obligations and income.” Finally, to be eligible for seasoned QM status, the creditor has to hold the loan in its portfolio for the full seasoning period (3 years) rather than sell the loan immediately into the secondary market.

Then, the loan can obtain the seasoned QM designation provided that it does not have “two delinquencies of 30 or more days” as well as “no delinquencies of 60 or more days at the end of the seasoning period.”

Other than the performance criteria, essentially the only difference between these requirements and those of the general QM will be the portfolio requirement and (when the new proposal is final) the APOR test. In both cases, all the loans will have to check off pretty much the same set of regulatory boxes. The fact that creditors will be able to easily adjust the rates that they charge to qualify loans for the general QM means there will be very little incentive to use the seasoned QM. (Especially since the loan has to be held in portfolio, a problem for the non-bank sector that has been driving most of the innovation in the mortgage market.)

There’s simply not going to be much room for innovation here even without the overly strict criteria for the seasoned QM.

Incidentally, prohibiting adjustable-rate mortgages from seasoned QM eligibility makes little sense. History shows that fixed-rate mortgages can be just as problematic as those with adjustable rates, and lenders now have to qualify borrowers for adjustable rate mortgages after accounting for the highest possible reset rates.

Similarly, it makes little sense to prohibit interest-only loans from QM status. Many borrowers that can afford such loans prefer them due to the tax benefit, and the first few years of repayments on zero/low down-payment 30-year fixed-rate mortgages are almost all interest.

Still, the real problem is the ability to repay/QM concept itself, and that’s not something the CFPB can fix. Only Congress can fix it, and that’s not likely to happen anytime soon. Yet, as the bureau acknowledges in its latest QM proposal (on page 43):

Because the affordability of a given mortgage will vary from consumer to consumer based upon a range of factors, there is no single recognized metric, or set of metrics, that can directly measure whether the terms of mortgage loans are within consumers’ ability to repay.

Well said. Regardless, Congress mandated that lenders be held legally accountable for failing to accurately assess consumers’ ability to repay. It’s not much of a mystery why the non-QM market hasn’t blossomed, and if the bureau wants to increase innovation in the mortgage market, it needs to broaden the seasoned QM criteria.