On November 17, 2008, the Department of Housing and Urban Development (“HUD”) published its long-awaited rule amending Regulation X. Regulation X is the rule that implements the Real Estate Settlement Procedures Act (“RESPA”). The new rule makes sweeping revisions to the Good Faith Estimate (“GFE”) and corresponding modifications to the Uniform Settlement Statements (the “HUD-1” and the “HUD1-a”). It also contains a new definition of “application” that may change the point at which many GFEs will be provided. Even more significantly, the rule will require that the GFE be “binding” for at least 10 business days, and it will limit the amount by which many of the estimated fees may increase before closing.

The new rule will permit lenders to engage in the practice commonly referred to as “average cost pricing,” provided that certain requirements are met. Average cost pricing is when a lender charges third party fees to all customers based on an average amount versus the exact fee that the third party actually imposes on each loan. However, HUD has reserved authorization of volume discounts. It also changed the definition of “required use” for purposes of affiliated business arrangements. Effective April 16, 2009, a settlement servicer provider will be deemed to have required the use of an affiliated provider if the first provider has provided a financial incentive to the customer to use the affiliate’s services. For example, the new definition will prohibit builders from providing closing cost assistance on the condition that the buyer obtains financing through an affiliated mortgage lender or broker. Finally, the rule makes some technical amendments, including implementing the 1996 statutory changes to the servicing disclosure statement.

On December 19, 2008, the National Association of Mortgage Brokers filed suit to enjoin implementation of the rule. Assuming that they don’t prevail, lenders will have until January 1, 2010, to start complying with most of the new rule. However, the guidelines for average cost pricing and the technical amendments were effective January 16, 2009. The new definition of required use was also to take effect on January 16, but HUD recently agreed to extend the effective date to April 16, 2009.

The New Definition of “Application”

Under the new rule, lenders and brokers will be required to issue GFEs within three business days after receiving an application. The final rule defines “application” as:

“… the submission of a borrower’s financial information in anticipation of a credit decision relating to a federally related mortgage loan, which shall include the borrower’s name, the borrower’s monthly income, the borrower’s social security number (to obtain a credit report), the property address, an estimate of the value of the property, the mortgage loan amount sought, and any other information deemed necessary by the loan originator.”

The phrase “and any other information deemed necessary by the loan originator” may be deceiving. Although the rule is unclear, it appears that HUD expects loan originators to issue GFEs once they have received the six enumerated data points. The final rule says that lenders and brokers may request more information (such as a full application form), but it doesn’t seem to anticipate that they would wait until they receive more information before issuing the GFE. (Nor would such an interpretation make sense.) The rule expressly precludes lenders and brokers from requiring documentation verifying the information before providing GFEs.

New Good Faith Estimate

The new GFE form is three pages long and will be divided into several sections. As a general rule, the disclosed terms must be valid for at least 10 business days. In addition, lenders and brokers may not charge any fee (other than a credit report fee) until the applicant expresses an interest in proceeding with the loan.

The estimated settlement charges must now be lumped into two different groups and must be itemized, sub-totaled in the applicable section and then totaled together. Allocating fees to the right group is critical, as this assignment will partially dictate how much those fees may increase after the lender or broker issues the GFE. The new GFE will also include some key loan terms that are not required to be disclosed on the current GFE. These include the interest rate, whether the interest rate and payment may increase and when, whether negative amortization may occur, whether the loan has a prepayment penalty or fee and how much it could be, whether the loan calls for a balloon payment, and whether the loan carries an escrow account for taxes and insurance.

The new sections of fees are “Adjusted Origination Charges” and “Charges for All Other Settlement Services.” The Adjusted Origination Charges include all origination fees imposed by the lender and broker. They include a typical origination fee, discount points, yield spread premium (“YSP”), and other loan processing and closing charges imposed by the lender and broker. (No longer will YSPs be disclosed as fees paid outside of closing.) In the case of the YSP, the GFE must disclose whether the YSP is being credited to other fees.

The “Charges for All Other Settlement Services” are broken into nine subsets: 1) required services for which the lender or broker select the provider; 2) Title services and lender’s title insurance; 3) Owner’s title insurance; 4) Required services for which the borrower may shop; 5) Government recording charges; 6) Transfer taxes; 7) Initial escrow deposits; 8) Daily interest charges; and 9) Homeowners Insurance.

Tolerances; May the Estimated Fees Increase?

If the interest rate is not locked at the time the GFE is issued (or, if it was locked before the GFE was issued, the lock has expired), then the interest rate and the charges based on the rate (e.g., per diem interest) may change. Otherwise, the Adjusted Origination Charges and the transfer taxes may not increase unless there has actually been a “change in circumstances.” (See below.) In other words, HUD is assigning a zero tolerance to these estimates.

In the case of: 1) lender required settlement services where the lender or broker select the provider; or 2) lender required services, title services and lender title insurance and owner’s title insurance when the borrower uses a provider identified by the lender or broker, the fees may not increase by more than 10 percent. There is no limit by which all other disclosed charges may increase (unless, of course, the GFE is so erroneous as to fail to qualify as a good faith estimate at all).

HUD will be issuing additional guidance on what constitutes “changed circumstances.” When the circumstances change, the lender or broker must provide a new GFE within three business days after the change. The applicable tolerances then apply to the newly disclosed terms.

Changes to the HUD-1s

The new HUD-1s will contain revisions corresponding to the changes to the GFE. These will include grouping the settlement fees into the same categories. The settlement agents will also be required to identify how the fees have changed. In other words, the HUD-1s will highlight any increases that exceed the permitted tolerances. The HUD- 1s will also include the same additional loan terms (interest rate, whether the interest rate and payment can increase, etc.) that must be included on the new GFE.

Average Cost Pricing, Volume Discounts and Required Use

The new rule provides some guidance on average cost pricing. Again, average cost pricing is when a lender charges third party fees to all customers based on an average amount versus the exact fee that the third party actually imposes on each loan. Average cost pricing will be permissible if: 1) it is no more than the average amount paid for the service on a particular class of transactions; and 2) the total of the average amounts paid by borrowers and sellers for the service does not exceed the actual costs paid to the service providers. Lenders and brokers will have some flexibility in establishing the “class of transactions.” However, the transactions must have occurred during a period of at least 30 days and no more than six months prior to the current loan, must have occurred in a designated geographic area and may be transactions of a specified loan type. Let’s say that a lender wants to determine the average cost charge for settlement fees on fixed rate loans in Washington. It could do so by averaging the actual settlement fees on all fixed rate loans secured by Washington properties that closed in the period between 30 days and six months prior to the loan date. Please note, however, that average cost pricing will not be allowed for any fees that may vary by loan amount or property value. Also, to take advantage of the rule, lenders must regularly recalculate the average cost.

Contrary to the hopes of the industry, the final rule does not permit volume discounts. Rather, HUD has reserved the issue for further consideration. HUD is also modifying the definition of “required use” for purposes of the limitations on affiliated business arrangements. Generally, RESPA prohibits settlement service providers from requiring the use of affiliated service providers. In the final rule, “required use” includes requiring the use of an affiliate in order to receive some “distinct … discount, rebate or other economic incentive.” The final rule will still permit discounts resulting from combined or packaged services as long as use of the packaged services is optional and the discounts don’t result in higher costs elsewhere in the transaction.

So Where Do We Go From Here?

As is the case with many major regulatory revisions, the new rule raises almost as many questions as it answers. Just a few of the issues we will be assisting clients with over the next several months are:

  • Once the new rule is effective, may lenders and brokers still offer prequalifications and preapprovals without triggering the new definition of “application”?
  • May a lender reject a broker submitted application because it doesn’t contain all six elements of an “application” without triggering adverse action requirements under Regulation B?
  • Can the GFE provide a date by which the loan must go to settlement in order for the disclosures to remain valid?
  • In a brokered transaction, can a lender issue its own GFE and avoid being bound by the broker’s GFE? If not, what processes must a lender implement to ensure the accuracy of the broker’s disclosures? If the lender can issue its own GFE and does so, does that release the broker from its GFE?
  • If the loan originator provides some bona fide settlement services, are those fees still separately itemized or will they have to be lumped with the origination charge?
  • How are broker required services to be treated under the new rule?
  • Do the new requirements for average cost pricing mean lenders can no longer reduce or waive those fees from time to time?
  • We will also need guidance from the Federal Reserve Board on if and how some of the new RESPA disclosure requirements will impact the required Truth-in-Lending disclosures (this includes treatment of fees as finance charges under Regulation Z).
  • How, if at all, do the new disclosure requirements conflict with state laws and, in the case of conflicts, what are the state regulated brokers and lenders to do?