The federal Real Estate Settlement Procedures Act (“RESPA”) impacts the disclosures that consumers receive when closing a residential mortgage loan, as well as the economic relationships between entities engaged in any aspect of the residential mortgage loan business. Controversy over its interpretation by the Department of Housing and Urban Development (“HUD”) has led to unending attempts to improve and revise the law, fueled most recently by the collapse of the residential lending market. After more than six years, two proposed rules, one final rule that had to be withdrawn, seven roundtable discussions, countless meetings with interested parties, and more than 50,000 comments from members of the public (40,000 in 2002, and 12,000 more in 2008), HUD has finally succeeded in adopting a new RESPA reform rule (the “New Rule”).1 The changes that will impact the residential mortgage world are far reaching. Set forth below is a summary of the New Rule and some comments concerning whether or not it is likely to provide consumers with the intended benefits.
Summary of Changes
The New Rule, which was published Nov. 17, 2008, effects a number of significant changes to HUD’s Regulation X. Starting Jan. 1, 2010, it dramatically changes the form of Good Faith Estimate (“GFE”) that has been in use since 1992 and establishes consequences for inaccurate disclosures on that form, and it modifies the HUD-1 and HUD-1A Uniform Settlement Statement forms in several regards so that they better coincide with the new GFE. Effective Jan. 16, 2009, it clarifies that average cost pricing that satisfies certain conditions will not violate the Section 8 referral fee prohibition, and it creates a new “simplified” servicing disclosure statement to be provided at application. And beginning July 16, 2009 (unless withdrawn before then),2 it revises the definition of a prohibited “required use” in connection with a referral to an affiliated business arrangement. Details concerning these changes are discussed below.
The New Expanded GFE
Description. HUD has traded in its old, one-page model form GFE for a brand new three-page model (which is one page fewer than proposed). The first page is the most critical one. HUD envisions consumers using it to comparison shop for a mortgage loan. Previously, the GFE focused solely in settlement costs, not loan terms. Now, disclosed on this page are what HUD believes are the essential loan terms and attendant costs that a lender is obligated to offer to a loan applicant unless “changed circumstances” dictate otherwise. The new GFE must show the initial loan amount, term, initial interest rate, initial monthly payment amount, whether the interest rate can increase, and whether the loan allows for negative amortization or provides for a prepayment penalty or a balloon payment. These are all new disclosures for a GFE form, and some observers feel these items duplicate or conflict with the information on the Truth-in-Lending Act early-disclosure statement. The new GFE must also tell the consumer what the total origination charges and the charges for other settlement services are likely to be. Lenders and mortgage brokers (dubbed “Loan Originators” in the New Rule) may not force the customer to pay a fee to obtain the GFE, other than the cost of the credit report.
HUD expects consumers to take the first page of the new GFE to other Loan Originators to attempt to negotiate better deals. Under the New Rule, the consumer is given at least 10 days to shop, during which the “offer” encapsulated on the GFE must remain open and “fixed,” i.e., within prescribed tolerances, unless there are “changed circumstances.” If the consumer accepts the offer, the terms and costs are then fixed through the closing, again within the same prescribed tolerances and absent “changed circumstances.”
The second page of the new GFE gives a breakdown of the origination charges and the charges for the other settlement services. Rather than being itemized, as on the old GFE, these charges are grouped into categories, including “Our origination charge,” “Required services that we select,” “Title services and lender’s title insurance,” and “Required services that you can shop for.” The origination charge on the second page is adjusted to reflect any yield spread premium (“YSP”) that the lender will pay to a mortgage broker (if one is involved) or any discount points that the borrower may choose to pay to lower the interest rate. The theory of the “adjusted origination charge” may be difficult for a borrower to grasp.
The last page of the GFE gives general information to consumers as to how best to use the form. It also provides consumers with a “tradeoff table” on which the Loan Originator may set forth two loan options—one that describes a loan for which the consumer would pay a higher interest rate but less in settlement charges, and another that describes a loan for which the consumer would pay a lower interest rate but more in settlement charges. (The Loan Originator need not list any options, but for any option it chooses to list, it must be willing to provide the borrower with a GFE based on the same information it relied on to provide the current GFE.) Lastly, it provides a space where consumers may insert and compare relevant data concerning other loan offers that they receive.
GFE Timing. The New Rule says that a GFE must be provided within three business days following receipt of a consumer’s “application.” In this respect, the New Rule is the same as the old one. However, the New Rule redefines the term “application.” Under the New Rule, Loan Originators receive an “application” when potential borrowers submit financial information to them in anticipation of a credit decision, including, at minimum, their name, monthly income, social security number, property address, estimate of the value of the property, and the amount they wish to borrow, plus whatever other information the Loan Originator deems necessary. Loan Originators may require additional information as a condition of providing a GFE, but may not require borrowers to submit verifying information or documentation as part of an “application.”
Fee and Rate Tolerances. To prevent “bait or switch” scenarios, HUD has made the GFE less of an “estimate” and more of a “promise.” As indicated above, the terms and costs disclosed on a GFE, once given, must remain open and “fixed” for at least 10 business days. If “accepted” by the borrower, those same terms and costs must remain in place until closing, absent “changed circumstances.” By “fixed,” HUD means within the applicable tolerances described below.
The first tolerance is zero percent. This tolerance applies to all lender and mortgage broker origination fees, all transfer fees, and, if the interest rate has been locked, any discount points or YSPs. This means that none of these items may exceed by any amount the number disclosed on the GFE. (The initial interest rate listed on the GFE is also subject to a zero percent tolerance, but only during whatever time period the Loan Originator indicates on the GFE that it will remain fixed—which can be less than 10 days—unless the consumer locks in that rate.)
The second tolerance is 10 percent. This tolerance applies to the total of (1) all lender-required settlement services paid to providers selected by the lender, (2) all lender-required settlement services paid to providers selected by the borrower from lender-provided lists, (3) premiums for optional owners’ title insurance selected by the borrower from lender-provided lists, and (4) government recording fees. This means that the sum of the actual charges for these items cannot exceed by more than 10 percent the sum of the charges disclosed on the GFE for these items.
Finally, any other charges disclosed on the GFE would be permitted to change at closing by any amount, so long as the estimate for the charge was offered in “good faith.”
Changed Circumstances. The New Rule defines “changed circumstances” that can obviate a tolerance as: (1) Acts of God, war, disaster, or other emergencies; (2) application information that the lender relied on in providing the GFE but which subsequently changes or is found to be inaccurate; (3) information on the borrower’s credit report obtained before providing the GFE that subsequently changes; (4) new information particular to the borrower or the transaction (excluding any of the items of financial information that at minimum are deemed to constitute an “application”) that was not relied on by the lender in providing the GFE; and (5) other circumstances particular to the borrower or the transaction, such as boundary disputes, the need for flood insurance, and environmental problems. Within three business days after learning that “changed circumstances” exist, the Loan Originator may deny the loan or issue a new GFE showing different terms and/or costs.
Post Settlement Cure. A lender may cure a tolerance violation within 30 calendar days after settlement by reimbursing to the borrower the excess amount. Currently, there is no private right of action for a GFE violation, but HUD plans to ask Congress to change that.
Comments. The big issue is whether the new GFE will help consumers shop for mortgage loans. Will they understand it? If they do understand it, will they actually use it? And will it be effective as a shopping tool? Doubts appear to exist in each of these regards.
With particular respect to whether the new GFE will be effective, there appear to be several concerns. First and foremost, the new GFE does not require the interest rate (or other terms that are dependent on the interest rate) to be fixed for at least 10 days. Loan Originators can agree to hold the interest rate shown on the GFE for as long (or as short) a period of time as they wish. For example, a Loan Originator can quote an interest rate at 5¼ percent that will be fixed for one hour. If the consumer uses the Loan Originator’s GFE to shop, and returns after one hour to accept its GFE “offer,” the Loan Originator may then change the interest rate. In addition, it appears that Loan Originators can accept financial information from a potential borrower that falls short of the information that is necessary to constitute an “application” as defined in the New Rule. In such a scenario, they would arguably not be required to provide a GFE unless and until the borrower submits the missing piece(s) of information. This could be well into the origination process, rather than at the beginning, as intended.
There is also the question of how the GFE “offer” will work when a mortgage broker is involved. The New Rule no longer requires the mortgage broker to give the GFE, and the lender to ascertain that it has been given. Rather, it says that, either the lender or the mortgage broker must give the GFE, and must do so within three business days after the mortgage broker receives the “application.” This presents problems for the lender, since the lender is the one who is going to be bound to make the loan described on the GFE. Lenders will likely not feel comfortable allowing their mortgage brokers to give the GFE. Lenders may also have trouble giving the GFE themselves within the three-day period, since there may be a delay between when the broker gets the application and when the lender receives it from the broker.
Finally, there is the likelihood that borrowers will receive multiple GFEs from a Loan Originator, thereby significantly lessening the effectiveness of the initial GFE as a shopping tool. Multiple GFEs appear probable because every loan application involves a multitude of factors, many of which are fluid. “Changed circumstances” therefore seem likely to occur. For example, the loan amount may change, the interest rate may be locked, the borrower’s credit score may increase or decrease, the appraisal may come in lower than estimated by the borrower, the borrower’s monthly income may prove to be different than reported by the borrower, etc. Under the New Rule, each time such a change occurs, the Loan Originator must give the consumer a new GFE. Moreover, by holding Loan Originators’ feet to the fire absent changed circumstances regarding the terms of their GFEs, the New Rule may have the unintended consequence of discouraging Loan Originators from impressing upon consumers the need to report this information at the time of initial application as accurately as possible.
The New HUD-1/1A
Description. The New Rule revises the existing two-page HUD-1 by making certain changes to the second page and adding a third page. It similarly revises the existing one-page HUD-1A by making changes to the first page and adding a second page.
The changes consist primarily of the following: (1) Replacing the fee terminology that appears on the existing HUD-1/1A with the terminology that is used on the new GFE, specifically, “Our origination charge,” “Your credit or charge for the specific interest rate chosen,” “Your adjusted origination charge,” “Title services and lender’s title insurance,” and “Required services that you can shop for”; (2) including after each such fee the line number on the GFE at which the same charge appears; and (3) providing a breakdown of the portion of the total title insurance premium that goes to the title underwriter and the title agent.
The page that the New Rule adds to the HUD-1/1A replaces the “Closing Script” that HUD, in its March proposal, would have required the closing agent to read aloud to the borrower at closing. This page compares the loan terms and attendant costs disclosed on the GFE that the borrower received at time of application (or subsequently, where there were changed circumstances) with the terms and costs of the actual loan being closed, and specifically informs the borrower whether the 10 percent tolerance limit on the sum of all fees to which it applies has been exceeded. If the borrower has questions about the settlement fees or the loan terms, the form, at the bottom of this page, directs the borrower to “please contact your lender.”
Comments. Assuming consumers understand the disclosures on the new GFE, the final page of the new HUD-1/1A should help them understand whether or not the loan they are receiving is in fact the same loan that was disclosed to them initially on their GFE. If it is not the same, they will have the opportunity to discuss the changes with their lender. This should be a positive development for borrowers, although instances in which borrowers have closed loans despite voicing complaints that the loans they are getting are materially different than the loans they were promised appear to be fairly common. From the perspective of those in the mortgage loan origination business, these new requirements will pose significant operational and compliance issues. And those in the title insurance industry believe that it will not be helpful to disclose on the HUD-1/1A the breakdown of the title insurance premium.
“Affiliated business arrangements” (“AfBAs”) are exempt from scrutiny under RESPA § 8 and its criminal prohibition of referral fees. This exemption applies so long as three conditions are met: (1) The consumer is given an AfBA disclosure statement at the time of the referral, which informs the consumer about the nature of the relationship between the person who is making the referral, and the AfBA and the cost of the goods or services provided by the AfBA; (2) with certain exceptions, the consumer is not required to use the AfBA; and (3) the only thing of value that is received from the AfBA, other than payments that are otherwise permitted by RESPA, is a return on ownership interest.
With respect to the second of these three conditions, HUD has long taken the position that offering an incentive to a consumer to use an AfBA is not a “required use,” whereas imposing a penalty upon the consumer for refusing to use an AfBA is a required use. In addition, Regulation X has long stated that providing a package of settlement services to a consumer at a discount is not a “required use” so long as the package is optional to the consumer, and the discount “is a true discount below the prices that are generally available” and are not made up by higher costs elsewhere in the settlement process. 24 CFR §3500.2.
The New Rule changes the current definition of a “required use” in significant ways. First, it states that a “required use” now includes offering an economic incentive to use an AfBA, as well as imposing an economic disincentive not to use an AfBA. Second, it indicates that the offering by a “settlement services provider” of a discounted package of settlement services provided by one or more AfBAs is not a “required use” of those companies so long as (i) the discounted price is less than the sum of the market prices of the individual settlement services included in the package, (ii) use of the package is optional to the consumer, and (iii) the discount is not made up by higher costs elsewhere in the process.
One key effect of these changes is to prohibit homebuilders from offering buyers incentives (such as upgrades) or discounts for agreeing to use the homebuilders’ affiliated settlement service provider (such as mortgage lenders and title insurance companies). A builder is not a “settlement services provider.” This effect is most clearly spelled out in the Regulatory Impact Analysis attached to the New Rule (FR-5180-F-02) (the “Impact Analysis”):
Under the final rule, builders will not be allowed to offer positive economic incentives for the homebuyer to use an affiliated lender or settlement service provider. An incentive would have to be general, i.e., applicable to any lender or settlement service provider. It would be allowable for a builder to pay a portion of the buyer’s closing costs, but that offer could not depend on whether the buyer uses an affiliated lender or settlement service provider.
Impact Analysis at p. 3-89.
HUD’s stated rationale for taking this action is its belief that “the average consumer will gain by formally separating the home purchase and loan decisions.” Impact Analysis, at p. 3-90. In this regard, HUD assumes that the average consumer is unable to accurately value builder incentives and that most builders will “offset the cost of the incentive by charging a higher interest rate, home price or closing costs” (despite the fact that the current rule prohibits them from doing so). Id. HUD thus seems to be saying that, because it is unable to take effective enforcement action against those builders who offer incentives but who raise prices elsewhere in the process to make up for the incentive, it will simply prohibit all builders from offering incentives.
Litigation challenging HUD’s new definition of “required use” has already commenced.3 Additionally, HUD has now delayed the effective date of this new definition until July 16, 2009 and has solicited public comment as to whether to withdraw it.
Average Cost Pricing
The price that a settlement service provides another settlement service provider for a particular settlement service, such as for a credit report, often varies from one loan to another. While many providers would have liked to charge all of their customers an average price for such a service, they were discouraged from doing so by fears that such a practice would be construed as a violation of RESPA § 8; i.e., that borrowers could assert an illegal overcharge or unearned fee if the average price exceeded the actual cost of their particular service. In the New Rule, HUD made it clear that average cost pricing does not violate Section 8 so long as the provider charges the same average price for every transaction within the class of transactions defined by the provider (based on the period of time, type of loan and geographic area), and recalculates the average price at least every six months. (HUD had proposed a more rigid formula, but backed off in the face of critical comments.) Average cost pricing, however, may not be used for settlement services, the price of which is based on the loan amount or the value of the property.
Simplified Servicing Disclosure Statement
Since 1990, Regulation X has required lenders to provide borrowers, within three business days after receipt of their loan application, with a servicing disclosure statement that generally discloses whether the lender expects to service the loan. A suggested format for such statement was provided in Appendix MS-1. In 1996, Congress simplified this requirement. The New Rule finally implements this 1996 simplification by creating a new model servicing disclosure statement. This change is effective now.
Volume Discounts. In its proposal, HUD had sought to clarify that volume discounts do not violate RESPA § 8 so long as the full amount of those discounts are passed through to borrowers. However, various settlement service providers objected to this aspect of the proposal on the grounds essentially that it was too restrictive, while consumer groups also objected that it was anti-competitive and would harm small businesses. In the end, HUD declined to adopt the language in the proposal, promising instead to continue to study the issue and perhaps, at some later time, pursue further rulemaking or issue a statement of policy.
Enforcement. RESPA currently does not give consumers a private right of action for disclosure violations connected with the GFE and the HUD-1/1A. In the preamble to the New Rule, HUD indicates its intention to seek legislation to change this. In the meantime, regulators can still take action against their regulated institutions if those institutions do not comply with the disclosure requirements in the New Rule. In addition, plaintiffs’ attorneys may try to convince courts that the GFE constitutes a contract between the consumer and the Loan Originator, such that any material discrepancy between the GFE and the HUD-1 constitutes an actionable breach of the terms of such contract.
Lack of Coordination With FRB. Industry members and others pleaded with HUD not to adopt the New Rule and, instead, to work with the Federal Reserve Board to produce a combined early disclosure to replace the now separate RESPA GFE and the early Truth-in-Lending disclosure. HUD ignored these pleas, with a possible consequence being more, rather than less, consumer confusion.
Inconsistent State Laws. Likely many state law provisions designed to protect consumers are inconsistent with the New Rule. In New Jersey, for example, lenders are required to itemize charges that the New Rule requires be grouped together, such as application fees, commitment fees, lock-in fees and origination fees/discount points, and to provide written lock-in agreements whenever they agree to lock in a customer’s interest rate for a stated period of time, even though that period of time might be only for the duration of the period specified on the new GFE.
RESPA currently authorizes HUD to preempt state laws only if they are inconsistent with RESPA and are not more protective of consumers.4 Therefore, unless HUD’s authority to preempt state laws is expanded, or unless states are willing to revise their laws to make them consistent with the New Rule, compliance by Loan Originators may prove problematic.
Effective Date. The changes effected by the New Rule with respect to the GFE and the HUD-1 are scheduled to become effective Jan. 1, 2010. All of the other changes, except for the definitional change as to what constitutes a “required use,” became effective Jan. 16, 2009. The required-use change was originally scheduled to become effective Jan. 16, 2009 as well, but has been delayed by HUD until July 16, 2009.
What’s Next/What Should You Be Doing? Two lawsuits have already been filed seeking to overturn parts of the New Rule.5 Whether they will be successful remains to be seen. In addition, the new administration and/or the new HUD Secretary may decide, at the urging of various industry segments, to take a fresh look at the New Rule (and seemingly already have, with respect to the “required use” definition). Regardless, mortgage lenders, mortgage brokers and other settlement service providers should begin the process of implementing the required changes now, because complying with the New Rule will undoubtedly present significant challenges.