Despite missing the President’s November 1 deadline for agencies to issue final regulations, and without regard to the pleas of 243 Members of Congress to coordinate with the Federal Reserve and forego finalizing its proposed rule, on November 17, 2008, the Department of Housing and Urban Development (“HUD”) published its final rule amending Regulation X, the implementing regulation to the Real Estate Settlement Procedures Act (“RESPA”). HUD’s stated reason for rushing the rule out before the end of the current Administration was that the regulation is needed to mitigate the current credit crisis. (Whether that explanation holds true, however, remains to be seen.)  

Major changes contained in the new RESPA rule include:  

  • Expanded Good Faith Estimate Disclosures. The amended Good Faith Estimate (“GFE”) must disclose key loan terms, provide a “tradeoff” table and provide a comparison shopping form for consumers.  
  • 10-Business Day “Guarantee.” Most terms disclosed on the GFE must remain available for 10 business days following receipt by the loan applicant.
  • Sets Fee Tolerances. Absent prescribed circumstances, the GFE is binding; and charging fees in excess of stated tolerances at closing constitutes a violation of RESPA.  
  • Revises HUD-1 Settlement Statement (“HUD-1”). The HUD-1 contains new disclosures to aid borrowers in comparing charges imposed at closing with those quoted in the GFE at application.
  • Permits “Average Charges.” Any settlement service vendor that can calculate an average charge for its services is permitted to use an average charge for that service.  
  • Redefines “Required Use.” “Required use” is redefined to include the concept of “disincentives.”  
  1. Good Faith Estimate  

A “good faith estimate,” as defined by Regulation X, is “an estimate, prepared in accordance with section 5 of RESPA of charges that a borrower is likely to incur in connection with a settlement.” 1 Arguably, HUD should completely revise that definition to more accurately describe the “good faith estimate” disclosure that lenders must prepare and provide to loan applicants as of January 2010. According to the final regulation, the good faith estimate is no longer merely an estimate of charges that borrowers are likely to incur. Rather, the disclosure is a binding detailed summary of the loan’s estimated closing costs, including key loan terms, important dates and definitive charges, as well as a tool for comparing loan terms offered by the lender providing the disclosure with loan terms that other lenders may offer. Lenders must use the form mandated by HUD without any changes (irrespective of whether the disclosure is relevant to that lender’s business practices).  

  1. Good Faith “Estimate” Is Binding

Before discussing the content of the GFE, a brief discussion of its binding nature is in order.  

Generally speaking, absent “changed circumstances,” lenders will be bound by the terms of the GFE as disclosed. Said differently, unless one of three specific exceptions applies, the lender is bound by the fees as disclosed on the GFE within the appropriate tolerance for that fee. This is a major operational change that will require advice planning in anticipation of the revised rule’s effective date for these GSE modifications, which is January 1, 2010.  

The first exception to this general rule is for “changed circumstances.” A “changed circumstance” is: (i) an Act of God, war, disaster, or other emergency; or (ii) information particular to the borrower or transaction that was relied on in providing the GFE and that changes or is found to be inaccurate after the GFE has been provided (this may include information about the credit quality of the borrower, the amount of the loan, the estimated value of the property, or any other information that was used in providing the GFE); (iii) new information particular to the borrower or transaction that was not relied on in providing the GFE; or (iv) other circumstances that are particular to the borrower or transaction, including boundary disputes, the need for flood insurance, or environmental problems. Changed circumstances do not include: (i) the borrower’s name, the borrower’s monthly income, the property address, an estimate of the value of the property, the mortgage loan amount sought, and any information contained in any credit report obtained by the loan originator prior to providing the GFE, unless the information changes or is found to be inaccurate after the GFE has been provided; or (ii) market price fluctuations by themselves. In the event of a “changed circumstance,” the lender must provide a new GFE within three business days and maintain evidence of the changed circumstance for three years.  

Second, if a borrower requests changes to the mortgage loan that change the settlement terms, a lender can provide a new GFE with three business days.  

Third, for new home purchases, a lender may provide a clear disclosure that it has up to 60 calendar days from the day of closing to issue a revised GFE.  

  1. Enhanced GFE Content
  1. Summary of Key Loan Terms – Page One  

Page one of the GFE provides an overview of the loan transaction in four key areas.  

  • Important Dates. Lenders must inform applicants regarding four key “dates”: (i) the date that the interest rate disclosed elsewhere on the disclosure is no longer available (i.e., the date by which an applicant must lock an interest rate); (ii) the date on which the terms disclosed on the GFE expire (this may be no less than 10 business days from the date the applicant receives the disclosure); (iii) the date by which the applicant must go to closing after locking an interest rate (the “rate lock period”); and (iv) the date by which a borrower must lock a rate prior to closing.  
  • Summary of Your Loan. Lenders must disclose the following key loan terms: (i) the initial loan amount; (ii) the loan term (in years); (iii) the initial interest rate; (iv) the initial monthly payment (principal + interest + mortgage insurance); (iv) for adjustable rate mortgage loans (“ARMs”), the fact that the interest rate can increase, the maximum amount of such increase and when the first rate change will occur; (v) assuming all payments are timely, whether the loan may negatively amortize and the maximum amount by which the loan balance can increase (i.e., 110%, 115%); (vi) assuming all payments are timely, whether the monthly payment (principal + interest + mortgage insurance) can increase and the maximum amount by which the payment can increase; (vii) any prepayment fees and the maximum penalty; and (viii) any balloon payment, its amount and when due.  
  • Escrow Account Information. Lenders that maintain escrow accounts (also called “impound accounts” in several jurisdictions such as California) for their borrowers are required to disclose the amount that they are holding for property taxes or other property-related charges. This amount is in addition to the monthly payment amount disclosed above in the “Summary of Your Loan” section of the GFE. Note that, according to amendments to Regulation Z, as of April 1, 2010, lenders are required to maintain escrow accounts for first lien loans that also are “higher priced mortgage loans” for the first year of the loan.2  
  • Summary of Your Settlement Charges. Lenders must disclose an aggregate total of “adjusted origination charges” + “charges for all other settlement services.” Each of these categories of fees is discussed in greater detail on page two of the GFE.  
  1. Adjusted Origination Pages + Charges for Other Settlement Services – Page Two

Page two of the GFE is divided into two parts. Part A is comprised of the calculation of the “adjusted origination charges” for the loan. Part B discloses the charges for all other settlement services.  

The “adjusted origination charge” arguably is the heart of the GFE disclosure because it conveys to the loan applicant the broker’s and lender’s respective charges for the loan. Yet it contains one of the mortgage industry’s most inexplicable disclosures. The adjusted origination charge is the sum of the origination charge3 plus or minus (as applicable) a “credit” or “charge” for adjusting the interest rate on the loan. “Yield spread premiums,” which, for the uninitiated, are payments made to the broker by the lender, must be disclosed as a “credit” on the GFE. Even those with industry experience find themselves at a loss for explaining HUD’s motivations for such a classification—given the simple fact that a borrower does not receive a credit for payment of a yield spread premium. As such, HUD’s decision to go forward with this disclosure scheme remains a mystery.  

The remaining settlement charges on the loan are divided into and disclosed as one of the following nine categories:  

  • Lender Selected Required Services. These charges are for services that the lender requires (i.e., appraisers) to complete the settlement and where the servicer is chosen by the lender.  
  • Title Services and Lenders Title Insurance. This charge includes the services of a title or settlement agent and title insurance to protect the lender, if applicable.
  • Owner’s Title Insurance. Borrowers may purchase owner’s title insurance to protect their interest in the property.  
  • Borrower Selected Required Services. These charges are for services that are required to complete the settlement but where the borrower can choose the servicer.  
  • Government Recording Charges. These charges are state and local fees to record the loan and title documents.  
  • Transfer Taxes. These charges are for state and local fees on mortgages and home sales.  
  • Initial Deposit for Escrow Account. This amount is held in escrow to pay future recurring charges on the property and include all property taxes, all insurance and other amounts as disclosed.  
  • Daily Interest “Per Diem” Charges. This charge is for daily interest on the loan from the date of settlement until the first day of the next month or the first day of the normal payment cycle. Note, however, that this computation is different from that permitted under Section 2948.5 of the California Civil Code, which generally permits charging interest commencing the day prior to loan closing.  
  • Homeowner’s Insurance. This charge is for the insurance that a borrower must purchase to protect the real property against fire or other loss.
  1. Instructions – Page Three

Tolerance Table  

The “instructions” page of the GFE essentially is a shopping guide for loan applicants and is divided into three sections. The first section informs the applicant about what fees can change at closing and by how much: (see table)

Essentially this table conveys three concepts: (i) lenders and brokers are prohibited from increasing their fees from the amounts disclosed on the GFE; (ii) third party fees and government recording charges can change individually in amounts greater or less than ten percent, provided the aggregate charges for all of those categories does not exceed ten percent of the amount disclosed on the GFE; and (iii) fees imposed by third parties that were chosen by the borrower without recommendation from the lender, escrow deposits, per diem interest and homeowner premiums can change at closing by any amount without violating RESPA. As discussed above, GFE disclosures are binding unless lenders are permitted to redisclose the GFE consistent with a prescribed exemption (i.e., borrower request, changed circumstances, delayed home purchase).

 “Tradeoff” and “Shopping” Table

To better facilitate a borrower’s understanding of the tradeoff between settlement charges and the interest rate, the GFE will now include a “tradeoff table.” The table demonstrates to the loan applicant the effect of paying discount points to lower the interest rate or accepting a higher interest rate in return for lower settlement charges. In a departure from the propose rule, however, lenders may leave the table blank, except for the first column, which discloses the terms of the loan for which the applicant applied. The “shopping chart” is simply a chart with blanks for the applicant to fill in with different loan terms cited by different lenders that the applicant contacts for price quotes.

  1. Settlement Statement  
  1. Enhanced Settlement Statement

Amendments to the HUD-1 and HUD-1A make it easier for borrowers to indentify discrepancies between the GFE and the applicable Settlement Statement. HUD accomplishes this by incorporating cross-references to the corresponding GFE information in the new HUD-1 and HUD-1A. Visually, at closing the borrower will be presented with the following data: (i) the charge he/she is paying for the service; (ii) the amount of such charge as disclosed on the GFE; and (iii) the dollar value or percentage difference between the two. This disclosure scheme takes the place of a hotly contested “closing script,” which was widely denounced as being in violation of state unauthorized practice of law statutes. Although settlement agents will still be responsible for providing this information to the borrower at closing, the lender must provide all necessary information and the borrower is instructed to contact the lender for any questions (which presumably includes any questions relating to fees being charged at closing that are in excess of applicable tolerances).

  1. Cure Provisions

If a lender closes a loan with a fee that is outside of a relevant tolerance, then the lender has violated section 5 of RESPA (and while Section 5 does not provide for a private right of action, it could serve as the basis for a state unfair and deceptive claim). Nevertheless, the final rule provides violators with 30 calendar days from the date of settlement to cure any violation of the permitted tolerances by refunding any amount paid by a borrower in excess of that allowed. More specifically, if a charge imposed at closing exceeds the amount quoted in the GFE by more than an applicable tolerance, the loan originator can deliver or mail reimbursement of the excess to the borrower. HUD explains that the “cure provision is important to allow originators to more effectively manage any uncertainty in costs associated with the required tolerances in the GFE.” HUD acknowledges that “some errors are inevitable when handling large numbers of complex transactions, and HUD does not intend for the tolerance requirements to create liability for inadvertent errors.”

  1.  “Average Charge” and “Required Use”  
  1.  “Average Charge”  

Generally speaking, according to the final rule, any settlement service provider that is able to calculate an average charge for a service is permitted to use an average charge for that service. This authority, however, does not exempt any average charge from compliance with an otherwise applicable threshold. While HUD does not mandate any particular calculation of the average charge, it does provide that the “total amounts received from borrowers for that service for a particular class of transactions . . . not exceed the total amounts paid to the providers of that service for that class of transactions.”4 For purposes of the above a “class of transactions” could be defined by geography or time or another metric created by the lender.  

Restrictions on the use of the average charge alternative disclosure exist for charges based on loan amounts or property values. This means that average charges cannot be used for title insurance or per diem interest. And, arguably, average charge pricing is appropriate for third party vendors, but not for internal charges.  

  1.  “Required Use”  

The final rule defines “required use” as, “a situation in which a person’s access to some distinct service, property, discount, rebate, or other economic incentive, or the person’s ability to avoid an economic disincentive or penalty, is contingent upon the person using or failing to use a referred provider of settlement services.” HUD believes that economic disincentives “are as problematic under RESPA as are incentives that are not true discounts.”  

The definition, however, carves out an exception for affiliate business relationships that provide bona fide combinations of services at a lower price than the market price of the services individually.  

  1. Conclusion

HUD has squeaked out a final RESPA rule as its political appointees pack up their desks in anticipation of their January 20 exit. Some amendments effectuated by this rulemaking, specifically, the use of average charges and the definition of “required use” will become law just prior to their exit – on January 16, 2009. The remaining changes discussed in this alert will become effective as of January 1, 2010, nearly one year after a new administration has begun work at HUD. Although creditors can begin using the new GFE and Settlement Statement disclosures prior to that effective date; they may want to make sure that this “under the wire and under fire” regulation does not undergo any more changes to more closely fit the view of the new Administration.