Wednesday, January 29, 2014

QM Points and Fees: What to Do about Bona Fide Discount Points?

Lenders and clients of our firm continue to ask for clarifications regarding bona fide discount points in calculating QM points and fees.  Many articles have been written, many webinars have been had, and many clarifications have been given, yet folks are still not sure about what to do about bona fide discount points.  So, it is, I think, not redundant to go over the basics one more time.

Discount points are finance charges, and are therefore included in the QM points and fees.  However, the QM Rule dos allow the following exclusions:

  • up to two bona discount points paid by the consumer in connection with the loan if the loan's interest rate, without any discount, does not exceed the APOR by more than 1%;
  • Upon to one bona fide discount if the loan's interest, without any discount, does not exceed  the APOR by more than 2%.

The math above seems easy enough, but the real problem lies in the definition of "bona fide" in the QM Rule. According to Section 1026.32(b)(3)(i), bona fide discount point means:
an amount equal to 1 percent of the loan amount paid by the consumer that reduces the interest rate or time-price differential applicable to the transaction based on a calculation that is consistent with established industry practices for determining the amount of reduction in the interest rate or time-price differential appropriate for the amount of discount points paid by the consumer.  [emphasis added]
 In simpler terms, a discount is considered "bona fide" if the discount fee paid by the borrower corresponds to a reduction in interest rate, but the ratio (rate reduction vs. discount fee) must conform to "well established industry practices".

What is "well established industry practices"?  CFPB explains as follows:
To satisfy this standard, a creditor may show that the reduction is reasonably consistent with established industry norms and practices for secondary mortgage market transactions. For example, a creditor may rely on pricing in the to-be-announced (TBA) market for mortgage-backed securities (MBS) to establish that the interest rate reduction is consistent with the compensation that the creditor could reasonably expect to receive in the secondary market. The creditor may also establish that its interest rate reduction is consistent with established industry practices by showing that its calculation complies with requirements prescribed in Fannie Mae or Freddie Mac guidelines for interest rate reductions from bona fide discount points. For example, assume that the Fannie Mae Single-Family Selling Guide or the Freddie Mac Single Family Seller/Servicer Guide imposes a cap on points and fees but excludes from the cap discount points that result in a bona fide reduction in the interest rate. Assume the guidelines require that, for a discount point to be bona fide so that it would not count against the cap, a discount point must result in at least a 25 basis point reduction in the interest rate. Accordingly, if the creditor offers a 25 basis point interest rate reduction for a discount point and the requirements of § 1026.32(b)(1)(i)(E) or (F) are satisfied, the discount point is bona fide and is excluded from the calculation of points and fees. [Emphasis added]
CFPB's staff commentary specifically refers to FNMA's definition or method of determining whether discount points are bona fide.  However, FNMA has since removed its definition from its guidelines.

Without the benefit of the only readily available and familiar standard, the mortgage lending industry is in dire need of clarity.  Secondary market investors have varying ways of determining "bona fide"; however, I do see a common requirement for documentation showing the connection between points paid and a corresponding rate reduction, which documents may include, without limitation:

  • Rate sheet;
  • Screen print from LOS and/or Pricing Engine;
  • Rate lock agreement/confirmation with the borrower; and
  • Final HUD-1.  

 In order to successfully exclude certain number of discount points from QM points and fees, a lender will have to present sufficient documentation to establish that the discounts paid by the borrower were indeed bona fide.

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