Although it has received far less attention than other titles of the Dodd-Frank Act (the "Act" or "Dodd-Frank"), such as those addressing derivatives, "too big to fail," risk retention and the Bureau of Consumer Financial Protection, Title XIV of the Act, which prescribes a host of new standards for residential mortgage loans, is among the most far-reaching of the legislation. Title XIV creates consumer protections significantly more stringent than those promulgated by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") which became effective in October 2009 relating to "higher-priced mortgage loans." The Act greatly increases originator's loan underwriting burdens and will create inevitable incentives for lenders to only offer prime quality "vanilla" loan products. Indeed, the Act will likely have the effect of reducing credit availability to the non-prime lending sector.
Most of the key provisions of Title XIV are not self-executing. In instances when federal regulators must promulgate implementing regulations, the regulations must become effective no later than 18 months after the transfer of certain functions to the new Bureau of Consumer Financial Protection (known as the "Designated Transfer Date").1
Please be advised that on August 18, 2010, the Federal Reserve Board issued a final rulemaking regarding, among other things, restrictions on loan originator compensation and on steering by loan originators. These rules are similar to, but not as broad as, certain provisions set forth in Dodd-Frank, and will become effective on April 1, 2011. The Federal Reserve Board acknowledges that implementation of the Dodd-Frank rules concerning loan origination compensation and steering by loan originators will be addressed in a future rulemaking with opportunity for public comment.
We summarize the salient provisions of the Act below.
I. Augmented Underwriting Requirements
A.Definition of Mortgage Originator
As a threshold matter, Section 1401 amends the federal Truth-in-Lending Act ("TILA") to define the term "mortgage originator" (a mortgage broker in this context) as:
Any person, who for direct or indirect compensation,
- takes a residential mortgage loan application;
- assists a consumer in obtaining or applying to obtain a residential mortgage loan; or
- offers or negotiates terms of a residential loan.
Notably, the Act excludes from the definition, among other things:
- persons who perform "purely administrative or clerical tasks;" or
- persons who only perform real estate brokerage activities provided that they are properly licensed;
- persons who make three or fewer purchase money loans in any 12 month period that are fully amortizing and where the borrower has a reasonable ability to repay the loan.
B.Standards for Mortgage Loan Origination
The centerpiece of Section XIV is an amendment to TILA that would mandate that consumers be offered loans that "reasonably reflect their ability to repay…and that are understandable and not unfair, deceptive or abusive." The amendment also requires originators to be appropriately licensed under applicable federal and state law, adhere to the requirements of the Secured and Fair Enforcement for Mortgage Licensing Act of 2008 ("SAFE Act") and include on all loan documents the originator's unique identifier as mandated by the SAFE Act.
C.Prohibition on Steering
Section 1403 of the Act prohibits mortgage lenders and brokers from giving or receiving compensation that varies based on the terms of the loan (other than the amount of the principal). This provisions essentially prohibits the payment of yield spread premiums for the referral of a loan to a lender at a higher than par interest rate.
The provision does not, however, prohibit payments to lenders that are ultimately passed on third parties for bona fide charges not retained by the lender, broker or any of their affiliates. Further, the provision does not impact compensation that secondary market purchasers pay for closed loans.
Section 1403 directs the newly created Bureau of Consumer Financial Protection (the "Bureau") to prescribe regulations to prohibit mortgage originators from steering any consumer to a residential mortgage loan that:
- the consumer lacks a reasonable ability to repay;
- has predatory characteristics or effects (such as equity stripping, excessive fees or abusive terms);
- is a non-qualified mortgage when the consumer was eligible for a qualified mortgage; and
- have abusive or unfair lending practices that promote disparities among consumers of equal credit worthiness but of different race, ethnicity, gender or assets.
Further, the Act prescribes that these regulations also prohibit mortgage originators from:
- mischaracterizing the credit history of a consumer or the residential mortgage loans available to a consumer;
- mischaracterizing or subordining the mischaracterization of the appraised value of the property securing the extension of credit; and
- discouraging a consumer from seeking a home mortgage loan secured by the consumer's principal dwelling from another originator if unable to suggest, offer or recommend to a consumer a loan that is not more expensive that a loan for which the consumer qualifies.
The Act makes clear that Section 1403 shall not be construed as:
- permitting any yield spread premium or other similar compensation that would, for any mortgage loan, permit the total amount of direct and indirect compensation from all sources permitted to a mortgage originator to vary based on the terms of the loan (other than the amount of the principal);
- restricting a consumer's ability to finance, at the option of the consumer, including through principal or rate, any origination fees or costs permitted under this subsection , or the mortgage originator's right to receive such fees or costs so long as they do not vary based on the loan terms (other than the amount of the principal) or the consumer's decision about whether to finance such fees or costs; or
- prohibiting incentive payments to a mortgage originator based on the number of residential mortgage loans originated within a specific period of time.
D.Liability for Violations of Duty of Care and Steering Provisions
Mortgage originators who violate the duty of care and steering provisions are subject to liability under TILA in an amount up to the greater of actual damages or an amount equal to three times the total of direct and indirect compensation or gain earned by the mortgage originator in connection with the loan involved in the violation, plus the costs to the consumer of the action, including a reasonable attorney's fee.
Section 1405 authorizes the Bureau to promulgate regulations prohibiting acts or practices that the Board finds to be abusive, unfair, deceptive, predatory, necessary or proper to ensure that responsible, affordable mortgage credit remains available to consumers and to prevent circumvention or evasion of the new provisions.
F.Minimum Standards for Mortgages
Section 1411 directs the Bureau to issue regulations prohibiting creditors from making residential loans unless the creditor makes a reasonable and good faith determination based on verified information that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan, according to its terms, all applicable taxes and insurance (including mortgage guarantee insurance), and assessments.
Section 1411 mandates that if the creditor knows or has reason to know, that one or more residential mortgage loans secured by the same dwelling will be made to the same consumer, the creditor shall ensure that the consumer has a reasonable ability to repay the combined payments of all loans on the same dwelling.
H.Basis for Determination
In order to determine a consumer's ability to repay a residential mortgage loan under this subsection, the creditor must consider the consumer's credit history, current income, expected income the consumer is reasonably assured of receiving, current obligations, debt-to-income ratio or the residual income the consumer will have after paying non-mortgage debt and other mortgage-related obligations, employment status, and other financial resources other than the consumer's equity in the dwelling or real property that secures repayment of the loan.
The Act mandates that in determining repayment ability, the creditor must review W-2's, tax returns, payroll receipt, financial institutions records or other third party documents that provide reasonably reliable evidence of a consumer's income or assets. Loans guaranteed or insured by federal departments and agencies are eligible for streamlined refinancings if certain criteria are satisfied. In addition, the provisions do not apply to bridge loans with a term of 12 months or less or reverse mortgages.
J.Safe Harbor and Rebuttable Presumption
Creditors and their assignees are subject to a rebuttable presumption of compliance with the ability to repay provisions and a corresponding exemption from liability if the mortgage originated is a qualified mortgage. Section 1412 defines "Qualified Mortgage" as any residential mortgage loan with the following features:
- subject to limited exceptions, no negative amortization or balloon payments;
- income and financial resources were verified and documented;
- in the case of a fixed rate loan, the underwriting process is based on a payment schedule that fully amortizes the loan over the loan term, taking into account taxes and insurance;
- in the case of an adjustable rate loan, for which underwriting is based on the maximum rate permitted for the first 5 years, and a payment schedule that fully amortizes the loan over the loan term and takes into account all applicable taxes and insurance;
- complies with all Federal Reserve Board pronouncements relating to debt-to-income ratios;
- the total points and fees payable in connection with the loan do not exceed 3 percent of the total loan amount (see discussion below);
- subject to certain exceptions, the term of the loan may not exceed 30 years;
- unless exempt, reverse mortgages that satisfy the standards of a qualified mortgage.
K.Calculation of 3% Points and Fees
For purposes of computing the total points and fees under this section, the following of either fees, but not both, are excluded from the calculation:
- up to and including 2 bona fide discount points payable by the consumer in connection with the mortgage, but only if the interest rate from which the mortgage's interest rate will be discounted does not exceed by more than 1 percentage point the prime rate offer rate;2 or
- unless bona fide discount points have been excluded under (i) above, up to and including 1 bona fide discount point payable by the consumer in connection with the mortgage, but only if the interest rate from which the mortgage interest rate will be discounted does not exceed by more than 2 percentage points the average prime offer rate.
The legislation authorizes the Bureau to adjust the criteria that define a "Qualified Mortgage Loan" to protect further consumer's interests.
L.Defense to Foreclosure
Borrowers may assert a defense to foreclosure in either a judicial or non-judicial action – brought by the creditor or its assignees if the creditor violated the anti-steering and ability to repay provisions.
M.Additional Standards and Requirements
Residential mortgage loans that are not qualified mortgages may not contain prepayment penalties. For qualified mortgage loans, prepayment penalties must conform to the following limitations:
- during the first year of the loan, the penalty may not exceed 3% of the outstanding balance of the loan;
- during the second year of the loan, the prepayment penalty may not exceed 2% of the outstanding balance of the loan;
- during the third year of the loan, the prepayment penalty may not exceed 1% of the outstanding balance of the loan;
- after three years, no prepayment penalty may be charged.
For qualified mortgages, the creditor must not impose a prepayment penalty on a loan without offering the consumer the option of a loan without a prepayment penalty.
N.Single Premium Credit Prohibition
Like many state anti-predatory lending laws, the Act prohibits creditors from financing single premium credit insurance products except on a monthly basis. Credit unemployment insurance is not subject to this restriction as long as the premiums are reasonable, the creditor receives no direct or indirect compensation, and the premiums are paid pursuant to another insurance contract and are not paid to an affiliate of the creditor.
The Act prohibits all residential loans and home equity lines of credit secured by principal dwellings from requiring arbitration provisions.
Creditors may not make any residential loan secured by a dwelling other than a reverse mortgage with negative amortization unless certain requisite disclosures are given, and in the case of a first-time borrower of a non-qualified mortgage, rights to receive counseling from a HUD-certified counselor.
Q.Protection Against Loss of Anti-Deficiency Protection
The Act requires creditors making loans to borrowers in states that have enacted anti-deficiency laws to notify consumers prior to closing about the protection and apprise them of the significance of the loss of such protection.
R.Policy Regarding Partial Payments
In the case of any residential mortgage loan except timeshare plans, the creditor must disclose to the consumer before settlement its policies regarding the acceptance and application of partial payments.
S.Amendments to Civil Liability and Statutes of Limitation Provisions
Section 1416 increases the statutory civil liability for violations of TILA for open-end credit from its current $100 – $1,000 for individual actions to $200 – $2,000; and with respect to both open end and closed-end credit, it increases the possible statutory exposure to class action civil liability from the current $500,000 to $1,000,000.
Further, the statute of limitations for bringing civil claims under the new steering and ability to pay provisions has been expanded to three years, beyond the current 1 year statute.
T.Lender Rights in the Context of Borrower Deception
Section 1417 shields creditor and assignees from civil liability if the borrower has been convicted of obtaining the residential mortgage loan by actual fraud.
U.Six Month Notices Before Reset of Hybrid ARMs
Section 1418 requires that creditors provide borrowers with notices about key loan terms as well as alternative in connection with certain hybrid adjustable rate mortgages.
V.Consumer Disclosures and Monthly Statements
Section 1419 amends TILA to mandate the promulgation of new consumer disclosures for variable rate loans where an escrow will be established for the payment of all applicable taxes, insurance and assessments. Section 1420 amends TILA to require "the creditor, assignee or servicer" to furnish to the borrower a monthly statement setting forth, among other things, the principal balance, interest rate, the ARM reset date, a description of the prepayment penalties to be charged, if any, and the late fees and the servicer's contact information.
W.Enhanced State Attorney General Enforcement Authority
Section 1422 expands state attorney generals' enforcement authority to enforce particular provisions of TILA.
II. Expansion of High Cost Mortgage Definitions
Significantly, the Act substantially expands the scope of the Home Ownership and Equity Protection Act ("HOEPA"), the primary federal anti-predatory lending law. The amendments are especially noteworthy because few originators knowingly make loans subject to HOEPA, and consequently, under the expanded coverage, fewer non-prime loans will be made available to lesser served communities.
HOEPA currently applies only to refinances of loans with points and fees and/or interest rates in excess of certain thresholds. Section 1431 expands coverage of HOEPA to purchase money loans and home equity lines of credits, mimicking the broader coverage of many of the state anti-predatory lending laws.
Further Section 1431 creates a new APR test for HOEPA loans that is based on an undefined "average prime offer rate" instead of the currently used yield on a Treasury Security of comparable maturity to the loan term.3
Under this new test, first lien loans either not secured by personal property or in amounts of $50,000 or greater will be subject to HOEPA if the APR at consummation exceeds the average prime offer rate by 6.5 percentage points.4
For subordinate lien loans, HOEPA is triggered if the APR at consummation exceeds the average prime offer rate by 8.5 percentage points.
Section 1431 also creates a new HOEPA points and fees threshold. Under the current law, HOEPA is triggered if the total points and fees payable by the consumer at or before loan closing exceed the greatest of 8% of the "total loan amount" or $592.
By contrast, under the new test, HOEPA is triggered if the total points and fees payable in connection with the transaction, other than bona fide third party charges not retained by the mortgage originator, creditor or an affiliate of the creditor or broker exceed:
- in the case of a transaction of $20,000 or more, 5 percent of the "total transaction amount" (a term the Act does not define); or
- in the case of a transaction of less than $20,000, the lesser of 8% of the "total transaction amount" or $1,000; or
- the credit transaction documents permit the creditor to charge prepayment penalties more than 36 months after the transaction closing or such penalties exceed in the aggregate, more than 2 percent of the amount prepaid.
Notably, Section 1432 and 1433 impose new restrictions on already heavily regulated HOEPA loans. The Act prohibits prepayment penalties and balloon payments (except when the payment schedule is adjusted to the seasonal or irregular income of the consumer.) The Act also amends Section 129 of TILA to augment prohibitions applicable to HOEPA loans in the following ways:
- creditors are prohibited from encouraging default on an existing loan;
- generally limit late fees to four percent of the amount of the payment past due;
- creditors may not accelerate the loan except for payment defaults or material breaches of loan covenants;
- creditors may not finance any prepayment penalties or points and fees in connection with HOEPA loans;
- creditors may not structure the loan as an open-end loan or divide the loan into separate parts with the intent to evade the average of HOEPA;
- the Act prohibits modification and extension fees;
- while borrowers may receive four free payoff statements each year, creditors may charge a "reasonable" fax or courier fee if the payoff statement is free;
- a creditor may not make a HOEPA loan without, first requiring certification from a HUD-certified counselor that the borrower has received counseling on the advisability of the mortgage.
A.Corrections and Unintentional Violations
Under current law, there is no statutory "cure" for HOEPA violations. The Act, however, provides the following limited cure options, which are akin to provisions in certain state anti-predatory lending laws.
A creditor or assignee, when acting in good faith, may correct a violation of HOEPA if:
- within 30 days of the loan closing and prior to the institution of any action by the consumer, it notifies the consumer, makes "restitution" and adjustments to either render the loan compliant with HOEPA or no longer subject to the statute; or
- within 60 days of the creditor's discovery or receipt of notification of an unintentional violation or bona fide error, it notifies the consumer and makes "restitution" and adjustments either to render the loan compliant with HOEPA or no longer subject to the statute. The Act does not elaborate on what constitutes "restitution."
Please call Stephen Ornstein at (202) 408-9122, Matthew Yoon at (212) 768-5337 or John Holahan at (202) 408-9118 with any questions.
- The Designated Transfer Date shall not be earlier than 180 days nor later than 12 months after the enactment of the Act (July 21, 2010), except if Congress grants an extension. In no event, however, may the Designated Transfer Date be later than 18 months after enactment.
- The term "average prime offer rate" means the average prime offer rate for a comparable transaction as of the date on which the interest rate for the transaction is set as published by the Federal Reserve Board.
- Under existing law, a loan is subject to HOEPA if the APR at consummation will exceed by more than 8 percentage points for first lien loans or by more than 10 percentage points for subordinate lien loans, the yield on Treasury securities having comparable periods of maturity to the loan maturity as of the fifteenth day of the month immediately preceding the month in which the application for the extension of credit is received by the creditor.
- For first mortgage loans of less than $50,000 secured by personal property, such as mobile homes, the APR at consummation exceeds the average prime offer rate by 8.5 percentage points.