Revolving Door Regulators

Senator yesterday. Lobbyist today.

Representative yesterday. CEO today.

Cabinet level appointee yesterday. Bank Chairperson today.

Government Agency Director yesterday. Law firm senior partner today.

CFPB Regulator yesterday. Competitor today.

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IN THIS ARTICLE

The Inside-Outside Gambit

The Four Horsemen

A Business Model for Former Regulators

Partners in Business

Making a Market in Non-QM

Timeline

What did they know, and when did they know it?

Extinguishing the Fire

Library

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The Inside-Outside Gambit

There are many forms of corruption. Perhaps the most pernicious is where an elected or duly appointed representative of the citizenry leaves office to use the sloughed off position for financial gain in the private sector.

Let's set up a definition for such (mostly unregulated) behavior. I will give it a phrase: "inside-outside gambits."

What is an inside-outside gambit? It is the use of information obtained in the course of a former governmental position by an official for financial gain, directly or indirectly, soon or immediately after leaving government employment in that position. Such information includes contacts with decision-makers in the government; providing information about proprietary conversations leading up to the promulgating of laws, rules, and regulations; access to insiders and knowledge of their views; navigating the systemic and organizational structure; non-public facts regarding the governmental plans or condition that could provide a financial advantage. Note that I use the phrase "inside-outside," not "insider trading."

I am not talking about a situation where there is the illegal trading of a public company's stock or other securities (such as bonds or stock options) by individuals with access to non-public information about the subject company (such trading being illegal).

However, the effect of “inside-outside gambit” and “insider trading” is practically the same: these strategies lead to an unfair, usually economic, advantage.

A basic concept of law is that an injury must be sustained by a plaintiff. Broadly speaking, no injury, no case.

So who is harmed when an equity trader uses inside information for personal financial benefit? The public, of course. Certainly, that part of the public that invests in the stock market, relying on rules, regulations, and laws to be impartially applied, with equal access to all. And who is harmed when a former government official uses inside information for personal financial benefit almost immediately after being employed in the government position. Of course, the public. Certainly, that part of the public that relies on rules, regulations, and laws to be impartially applied, with equal access to all.

How about when regulators in the most powerful agency that regulates the origination of residential mortgage loans, the Consumer Financial Protection Bureau (CFPB), leave that agency and start a mortgage company soon after leaving the CFPB, to compete or partner with mortgage companies?

Loan Originator Compensation: New Rules

On January 24, 2013, as the last of the Final Rules of the Consumer Financial Protection Bureau (CFPB) rolled out, I offered an outline of all of them, entitled "CFPB's Gang of Seven (Final Rules)".*

I listed them in order of issuance, as follows:

1. Ability-to-Repay (ATR)
2. High-Cost Mortgage (HCM)
3. Escrow
4. Servicing
5. Appraisals for High-Risk Mortgages
6. Copies of Appraisals
7. Mortgage Loan Originator Compensation

Having come through the last two months responding to numerous questions about these Final Rules, I have been able to cobble together some of the most salient questions, regulatory features, and concerns that our clients have expressed about them. And when I have spoken to the media types, it seems that they also have a set of questions and interests that are not being fully addressed in the current dialogue. Of abiding interest is the change relating to loan originator compensation.

With that in mind, I want to provide a brief outline of some loan originator compensation issues, offering additional details garnered from two months in the trenches working through these regulatory issues on behalf of our clients. From time to time, I will have more to discuss about many regulatory changes anticipated in 2013 and 2014. I am going to conduct this review topic by topic, rather than just as specific regulations subject to a final rulemaking.

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IN THIS ARTICLE

Terms and Conditions
Retirement Plans
Factors and Proxies
Dual Compensation
Non-loan Originations Services
Points and Fees
Loan Originator Qualifications
Mandatory Arbitration Clause
Single Premium Insurance
Record Retention Requirements

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Terms and Conditions

By now, there is nary a residential mortgage lender or originator that does not know that, under Regulation Z, loan originator compensation is prohibited from being based upon the terms and conditions of a mortgage loan transaction.

The CFPB has provided new nomenclature for the terminology "transaction terms and conditions," without much changing the prohibition and certain exceptions to the standing rule. The new terminology is "term of a transaction," but now with the clarified meaning that term of a transaction means to include "any right or obligation of the parties to a credit transaction."

The usual cast of regulatory prohibitions continue in force. For instance, loan originator compensation is still prohibited from being based on such things as the interest rate of a loan, or upon the inclusion of additional fees or charges for products or services provided by other parties to the transaction.

And the usual cast of regulatory identifiers of a term of a transaction continue in force. Thus, fees or charges are a term of the transaction if they must be disclosed in the Good Faith Estimate (GFE) or HUD-1 or HUD-1A Settlement Statement (HUD-1). That obviously means to include loan originator or creditor fees or charges for the credit transaction or for a product or service provided by the loan originator or creditor that is related to the extension of credit; and it also means those fees or charges of other parties for any product or service required by the lender as a condition of the extension of credit. Keep in mind, however, that just because a fee or charge is stated on the HUD-1 does not in itself make the fee or charge a term of the transaction.

One rather controversial area involves the off-setting of compensation due to increased costs. The standing rule has provided that loan originator compensation is prohibited from being reduced in response to a change in the transaction terms. This has caused lenders all manner of frustration, not to mention loss of revenues and diminished profits. Yet, the new rule would allow compensation to be reduced in order to offset unexpected increases to estimated settlement costs, otherwise known as "unforeseen circumstances." What is a circumstance that is unforeseen? The imagination reels! But since the CFPB has offered no formal guidance to delineate very specifically what may or may not be an unexpected event, the lender must be extremely careful not to enter these dark waters too briskly.

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CFPB's Gang of Seven (Final Rules)

This has been a busy month for the Consumer Financial Protection Bureau (CFPB). Since the advent of the New Year, the CFPB has issued seven Final Rules that impact residential mortgage loan originations.

The finale was on Sunday, January 20, 2013, when the CFPB issued the seventh Final Rule, one day prior to the deadline set forth in the Dodd-Frank Act (Dodd-Frank), in § 1400(c), for automatic implementation of its Title XIV provisions.

By my count, these are the Final Rules, in order of their issuance:

1. Ability-to-Repay (ATR)
2. High-Cost Mortgage (HCM)
3. Escrow
4. Servicing
5. Appraisals for High-Risk Mortgages
6. Copies of Appraisals
7. Mortgage Loan Originator Compensation 

I recently discussed the Final Rule regarding the Ability-to-Repay. I will soon provide an outline of the CFPB's important Final Rule for Mortgage Loan Originator Compensation.

With regards to the latter, we will be updating the FAQs Outline - Loan Originator Compensation for the rule changes affecting loan origination compensation. For your consideration, I plan to provide soon a useful and practical understanding of the compensation revisions. In the near future, I will notify you of and provide access to the forthcoming article I am publishing on these regulatory guidelines.

In this article, I want to briefly outline this Gang of Seven (Final Rules). Please keep in mind that I am providing a broad sketch of the Final Rules. As is the case with many applications of legal and regulatory compliance, there are numerous statutory requirements and implementation guidelines that bring about consideration of some recourse to a competent risk management professional.

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IN THIS ARTICLE

Chart: Final Rules Compliance Dates
Gang Member # 1: Ability-to-Repay (ATR)
Gang Member # 2: High-Cost Mortgage (HCM)
Gang Member # 3: Escrow
Gang Member # 4: Servicing
Gang Member # 5: Appraisals for High-Risk Mortgages
Gang Member # 6: Copies of Appraisals
Gang Member # 7: Mortgage Loan Originator Compensation

Library

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Chart: Final Rules - Compliance Dates

Let's start first with a chart of the Final Rules and their respective compliance effective dates. I realize that there is considerable interest in the RESPA/TILA integration of mortgage disclosures; however, on November 16, 2012 the CFPB published a Final Rule exempting persons from complying with twelve specified Title XIV mortgage disclosure requirements. The RESPA/TILA disclosure integration is now scheduled for completion in September 2013. Without the aforementioned exemption, these twelve disclosure requirements would actually have taken effect on January 21, 2013.

Chart deals with only the Gang of Seven (Final Rules).

Appraisals and APR for Higher-Risk Mortgages

On August 15, 2012, six federal financial regulatory agencies issued a proposed rule to establish new appraisal requirements for "higher-risk mortgage loans." The proposed rule has been issued by the Board of Governors of the Federal Reserve System, the Consumer Financial Protection Bureau (Bureau), the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the National Credit Union Administration, and the Office of the Comptroller of the Currency.

The proposed rule would implement amendments to the Truth in Lending Act (TILA) enacted by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). Under the Dodd-Frank, mortgage loans are higher-risk if they are secured by a consumer's home and have interest rates above a certain threshold.

For higher-risk mortgage loans, the proposed rule would require creditors to use a licensed or certified appraiser who prepares a written report based on a physical inspection of the interior of the property. The proposed rule also would require creditors to disclose to applicants information about the purpose of the appraisal and provide consumers with a free copy of any appraisal report.

Creditors would have to obtain an additional appraisal at no cost to the consumer for a home-purchase higher-risk mortgage loan if the seller acquired the property for a lower price during the past six months. This requirement is meant to address fraudulent property flipping by seeking to ensure that the value of the property being used as collateral for the loan legitimately increased.

The aforementioned agencies are seeking comments from the public on all aspects of the proposal. The public will have 60 days, or until October 15, 2012, to review and comment on most of the proposal.

IN THIS ARTICLE

History

"Higher Risk" Mortgage Loans

Appraisal Requirements

Additional Written Appraisal

Calculating the Annual Percentage Rate

Replacing the Annual Percentage Rate

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History

On July 21, 2010, Dodd-Frank was signed into law. Section 1471 of Dodd-Frank establishes a new TILA section 129H, which sets forth appraisal requirements applicable to “higher-risk mortgages.”

Specifically, new TILA section 129H does not permit a creditor to extend credit in the form of a higher-risk mortgage loan to any consumer without first:

• Obtaining a written appraisal performed by a certified or licensed appraiser who conducts a physical property visit of the interior of the property.

• Obtaining an additional appraisal from a different certified or licensed appraiser if the purpose of the higher-risk mortgage loan is to finance the purchase or acquisition of a mortgaged property from a seller within 180 days of the purchase or acquisition of the

• Property by that seller at a price that was lower than the current sale price of the property. (The additional appraisal must include an analysis of the difference in sale prices, changes in market conditions, and any improvements made to the property between the date of the previous sale and the current sale.)

• Providing the applicant, at the time of the initial mortgage application, with a statement that any appraisal prepared for the mortgage is for the sole use of the creditor, and that the applicant may choose to have a separate appraisal conducted at the applicant’s expense.

• Providing the applicant with one copy of each appraisal conducted in accordance with TILA section 129H without charge, at least three (3) days prior to the transaction closing date.

"Higher Risk" Mortgage Loans

The new TILA section 129H(f) defines a “higher-risk mortgage” with reference to the annual percentage rate (APR) for the transaction. A higher-risk mortgage is a “residential mortgage loan” secured by a principal dwelling with an APR that exceeds the average prime offer rate (APOR) for a comparable transaction as of the date the interest rate is set, as follows:

• By 1.5 or more percentage points, for a first lien residential mortgage loan with an original principal obligation amount that does not exceed the amount for the maximum limitation on the original principal obligation of a mortgage in effect for a residence of the applicable size, as of the date of such interest rate set, pursuant to the sixth sentence of section 305(a)(2) of the Federal Home Loan Mortgage Corporation Act (12 U.S.C. 1454).
  

CFPB: Re-Opening "Ability-to-Repay"

On June 5, 2012, the Consumer Financial Protection Bureau (Bureau) announced that it is "reopening the comment period" for the proposed rule, issued on May 11, 2011 by the Federal Reserve Board (Board), addressing the new ability-to-repay requirements that generally will apply to consumer credit transactions secured by a dwelling and the definition of a "qualified mortgage."

The ability-to-repay requirements were set forth in the May 11, 2011 proposal to amend Regulation Z (the implementing regulation of the Truth in Lending Act (TILA) to implement amendments to TILA made by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

Since then, pursuant to Dodd-Frank, the Board's rulemaking authority for TILA was transferred to the Bureau as of July 21, 2011. The original comment period to the proposed rule closed on July 22, 2011.

The Bureau is reopening the comment period until July 9, 2012 to seek comment specifically on certain new data and information submitted during or obtained after the close of the original comment period.

I have written extensively about the ability-to-repay. And I would urge you to read some of these articles to become familiar with these important requirements:*

Ability-to-Repay: Regulating or Underwriting? Part I
Ability-to-Repay: Regulating or Underwriting? Part II
Ability-to-Repay: The Basics and a Chart
Ability-to-Repay: The Chart
Ability-to-Repay: Additional Analysis
FRB: Proposes Rule - Ability-to-Repay

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IN THIS ARTICLE

History

New Data

Questions and Comments

Litigation and Liability

Foreclosure

Litigants and Complaints

Outcomes from Litigation

Factors or Costs

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History

Sections 1411, 1412, and 1414 of the Dodd-Frank created new TILA section 129C, which, among other things, established new ability-to-pay requirements. If a mortgage is a so-called "qualified mortgage," the compliance with the ability-to-repay rule would offer a presumption of compliance.

The word 'presumption' is a dispositive word in this proposal. Please keep the phrase "presumption of compliance" in mind as you read through this brief outline.

On May 11, 2011, the Board published for notice and comment a proposed ability-to-repay rule, amending Regulation Z to implement new TILA section 129C. The comment period for this initial proposal closed on July 22, 2011.

Then, on July 21, 2011 Dodd-Frank transferred the Board's rulemaking authority for TILA, among other consumer financial protection laws, to the Bureau. Accordingly, all comment letters on the proposed rule were also transferred to the Bureau. According to the Bureau, in response to the proposed rule approximately 1800 comment letters were received from numerous commenters, including members of Congress, lenders, consumer groups, trade associations, mortgage and real estate market participants, and individual consumers.

Even after the comment period closed, various interested parties, including industry and consumer group commenters, submitted to the Bureau oral and written ex parte presentations on the proposed rule.

Through various comment letters, ex parte communications, and the Bureau's own collection of data, the Bureau has received additional information and new data pertaining to the proposed rule.

The Bureau is now interested in providing opportunity for additional public comment on these materials. Thus, it is reopening the comment period until July 9, 2012, in order to request comments specifically on certain additional information or new data, but not other aspects of the proposed rule already submitted previously.

So, what are the new data?

New Data

The Bureau now seeks comment on mortgage loan data that the Bureau has received from the Federal Housing Finance Agency (FHFA). To date, the Bureau has received a sample drawn from the FHFA's Historical Loan Performance (HLP) data along with tabulations from the entire file.

The data include a one percent random sample of all mortgage loans in the HLP data from 1997 through 2011. Tabulations of the HLP data by the FHFA show the number of loans and performance of those loans by year and debt-to-income (DTI) range.

The HLP data consists of all mortgage loans purchased or guaranteed by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (jointly, the GSEs), but does not include loans backing private-label mortgage-backed securities (MBS) bought by the GSEs.

The data contains loan-level information on characteristics and performance of all single-family mortgages purchased or guaranteed by the GSEs. FHFA updates the HLP data quarterly with information from each GSE.

Among other elements, the data includes product type; payment-to-income and debt-to-income (PTI/DTI) ratios at origination; initial loan-to-value (LTV) ratios based on the purchase price or appraised property value and the first-lien balance; and credit scores.

The Bureau proposes to use these data to tabulate volumes and performance of loans with varying characteristics and to perform other statistical analyses that may assist the Bureau in defining loans with characteristics that make it appropriate to presume that the lender complied with the ability-to-pay requirements or assist the Bureau in assessing the benefits and costs to consumers, including access to credit, and covered persons of, as well as the market share covered by, alternative definitions of a "qualified mortgage."

Ability-to-Repay: Regulating or Underwriting? Part II

Jonathan Foxx is the President and Managing Director of Lenders Compliance Group.

Click below to download my article:

ABILITY-TO-REPAY:

REGULATING OR UNDERWRITING?

Part II

It has been published in the National Mortgage Professional Magazine - July 2011.

I am providing this article to you as a courtesy, for your personal use. I hope you enjoy it.

Please feel free to contact me at any time.

EXCERPT # 1

It seems to me that the imposition of an ability-to-repay requirement as a regulatory mandate is an admission that market forces cannot discipline lenders or incentivize lenders to act in their own self-interest. 

This is an obvious shift in liabilities, because this mandate shifts the burden of compliance to the lenders in order to assure that their contractually bound borrowers can pay back their loans. Parties to any contract can become adversaries! 

In other words, the relationship between the creditor and the borrower is innately affected and extensively undermined by this Rule, inasmuch as it imposes a new kind of theory for a regulatory framework and, in my estimation, infantilizes lenders by making them comply with a regulator's ad hoc way of rationing the extension of credit.

ABILITY-TO-REPAY:

REGULATING OR UNDERWRITING?

Part II

EXCERPT # 2

If the rationing of credit is meted out through this regulatory construct, it can be legitimately asserted as well that lenders are not arms-length, contractual counterparties; that is, lenders now will have a duty to assess a prospective borrower's ability to repay, irrespective of collateral value and securitization.

This change in the dynamics between and the inherent, due diligence tension among the parties to a residential mortgage transaction raise serious issues about the systemic consequences soon to be engendered.

ABILITY-TO-REPAY:

REGULATING OR UNDERWRITING?

Part II

Ability-to-Repay: Regulating or Underwriting? (Magazine Article)

COMMENTARY: by JONATHAN FOXX

Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is President and Managing Director of Lenders Compliance Group, the nation’s first full-service, mortgage risk management firm in the country.

I think you may be interested in reading my article in the June 2011 edition of National Mortgage Professional Magazine, entitled:

Ability-to-Repay: Regulating or Underwriting?

The article is Part I of a two-part magazine series.

As you may know, on May 11, 2011, the Federal Reserve Board (FRB) issued a proposed rule (Rule) to implement ability-to-repay requirements for closed-end residential loans.

The Rule implements Section 1411, Section 1412, and part of Section 1414 of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010.  Comments on the Rule are to be received by no later than July 22, 2011. 

But, having published the proposed Rule, the FRB will soon retire from its involvement in this matter, because it will hand over its rulemaking authority in the subject statute to the Consumer Financial Protection Bureau (CFPB) on July 21, 2011.

Thus, the promulgation of the final Rule will be under the aegis of the CFPB.

In this article, I explore some of the salient features of this Rule, noting particularly that, as a revision to Regulation Z (the implementing regulation of the Truth in Lending Act), it requires creditors to determine a consumer's ability to repay a mortgage before making the loan and would also establish minimum mortgage underwriting standards.

The Rule applies to any consumer credit transaction secured by a dwelling, except an open-end credit plan,  timeshare plan, reverse mortgage, or temporary loan or ''bridge'' loan with a term of 12 months or less. It includes a closed-end home improvement loan on a vacation residence.

It appears that the Rule applies to purchase money and refinances, but not modifications of existing mortgages.

There is a prohibition on prepayment penalties unless the mortgage is a prime, fixed rate, qualified mortgage, and unless the amount of the prepayment penalty is limited.

As a courtesy, I am sharing this magazine article with you. I hope you enjoy reading it! 

Excerpt # 1

Complying with the requirements of the ability-to-repay Rule is essential, because borrowers in a foreclosure proceeding will likely claim that the creditor failed to comply with the Rule as a defense by way of recoupment or set off, without regard to the normal statute of limitations under the Truth-in-Lending Act (TILA). 

A violation of the Rule subjects the creditor to the TILA civil monetary penalties, plus the same enhanced civil remedies that apply to violations of TILA's high-cost loan rules, and TILA also would authorize state attorneys general to bring actions for violations of the Rule for a period of up to three years.

Excerpt # 2

A loan that is a covered transaction must qualify, among other things, as a "qualified mortgage" (QM) if the creditor wishes to include a prepayment penalty in the loan.

The Rule provides a presumption of compliance with the ability-to-repay requirements if the mortgage loan is a ''qualified mortgage,'' which does not contain certain risky features and limits points and fees on the loan.

Furthermore, one feature of a higher-risk mortgage loan (i.e., subject to enhanced appraisal requirements under Dodd-Frank § 1471) is the loan may not be a QM.  (Under Dodd-Frank § 941, a "qualified residential mortgage" may not be broader in scope than a QM as defined in the Rule.) 

Ability-to-Repay: Review and Discussion

COMMENTARY: by JONATHAN FOXX

Jonathan Foxx, former Chief Compliance Officer of two publicly traded financial institutions, is President and Managing Director of Lenders Compliance Group, the nation’s first full-service, mortgage risk management firm in the country.

On Thursday of this week (6/23/11), I will be speaking at the Empire State Mortgage Bankers Association.

Topic

Ability-to-Repay: 

Regulating or Underwriting?

Time and Venue

This speaking engagement will coincide with the publication of my forthcoming article on this subject in the National Mortgage Professional Magazine.

On May 11, 2011, the FRB issued a proposed rule (Rule) intended to implement ability-to-repay requirements for closed-end residential loans.

The Rule implements Section 1411, Section 1412, and part of Section 1414 of the Dodd-Frank Wall Street Reform and Consumer Financial Protection Act of 2010. Comments on the Rule are to be received by no later than July 22, 2011.

We notified you recently about this proposed Rule here, here, and here.

In my remarks, I will explore some of the salient features of the Rule, noting particularly that, as a revision to Regulation Z, it requires creditors to determine a consumer's ability to repay a mortgage before making the loan and would also establish certain minimum mortgage underwriting standards.

We will review how violations of the Rule would be incurred, the exposure to regulatory risk, and the ways by which a loan originator may be deemed or presumed to be in compliance with the Rule. I will also discuss how Qualified Mortgages (QMs) offer a safe harbor.

Attendants will receive:

• Ability-to-Repay Chart
• Magazine Article
• Complete June Edition 

I look forward to seeing you soon!

Ability to Repay - Additional Analysis

In our Tuesday (4/19/11) newsletter and also in our post we notified you of the FRB's proposed amendments to Regulation Z that would set out how residential mortgage lenders would be required to determine a consumer's ability to repay a mortgage (Proposal). 

The Proposal would define what are termed "qualified mortgages" and also set minimum underwriting standards for many mortgages.

The proposed amendments, which are required by the Dodd-Frank Act (DFA), also would implement limits on prepayment penalties and attempt to prevent lenders from evading the rules.

In today's review, we will provide further analysis of the Proposal.

Comment Period: Until July 22, 2011.

Because the Consumer Financial Protection Bureau (CFPB) will take over Regulation Z rulemaking authority on July 21, 2011, the FRB has said that it will not be taking final action on the proposal and that the comments it receives will be transferred to the CFPB.

Loan Products

The Proposal would apply the ability-to-repay requirement to nearly any consumer credit plan secured by a dwelling, but it would exclude open-end credit plans, reverse mortgages, construction or other temporary loans with terms of 12 months or less, and timeshare plans. 

The FRB claims that the proposed requirements are similar to those it adopted for higher-priced mortgages in July 2008 under the Home Ownership and Equity Protection Act (HOEPA), but they would apply to mortgages that are not higher-priced and those that are not secured by the consumer's principal dwelling.

Ability to Repay

The DFA prohibits a lender from making a mortgage loan unless it has made "a reasonable and good faith determination, based on verified and documented information, that the consumer will have a reasonable ability to repay the loan, including any mortgage-related obligations." Examples of "mortgage-related obligations" are property taxes and homeowners' association assessments.

8 Criteria

A consumer's individual ability to repay uses 8 criteria:

1. the income or assets the lender is relying on in making its decision;
2. the consumer's current employment status;
3. the mortgage's monthly payment;
4. the monthly payment on any other mortgages on the property, such as home equity lines of credit;
5. the monthly payment for all mortgage-related obligations;
6. the consumer's other current debt obligations;
7. the consumer's monthly debt-to-income ratio or residual income; and
8. the consumer's credit history.

Special Features

If the mortgage includes an adjustable interest rate, it must be underwritten based on the fully indexed interest rate, or based on the introductory rate if that is higher than the fully indexed rate.

Features such as balloon payments, interest-only payments and negative amortization would not be prohibited. However, there would be strict underwriting standards.

Refinancing: "Nonstandard" into a "Standard" Mortgage

The lender is required to consider and verify the consumer's income and assets, if the lender is refinancing a mortgage loan and also adding certain features to the loan, such as a balloon payment, negative amortization, or interest-only payments. Notwithstanding this requirement, all the other aforementioned criteria must be considered.

The consumer must qualify for the loan based on the highest interest rate that could be imposed in the first five years after consummation, rather than over the life of the loan. There would be a requirement to satisfy limits on points and fees and the loan must materially reduce the consumer's monthly payments. Importantly, the refinancing option would be available only if the consumer is not delinquent under the existing mortgage.

Qualified Balloon Loan - Rural or Underserved Area

Some balloon loans would be considered to be qualified mortgages in rural and underserved areas. These loans would not only comply with all of the other criteria for a qualified mortgage but also would need to be underwritten based on scheduled payments other than the balloon.

Prepayment Penalties

The DFA provides limits on prepayment penalties. A prepayment penalty would be permitted only in the case of a prime, fixed-rate mortgage that meets the criteria for being a qualified mortgage.

The amount of the permitted penalty would decrease with the passage of time; for instance, a 3% penalty would be permitted in the first year of the loan, a 2% penalty in the second year, and a 1% penalty in the third year.

No penalty would be permitted more than three years after the loan was consummated. A lender that offers a consumer a loan with a prepayment penalty would also be required to offer a loan without that feature.

Safe Harbor or Rebuttable Presumption

Meeting the requirements of the "qualified mortgage" would provide the lender with some protection from liability. However, the DFA is actually not clear as to whether the consequent protection was intended to be a safe harbor from liability or only a means to provide a rebuttable presumption that the lender had complied with the ability to repay mandates.

Thus, the Proposal offers these two "alternatives" toward resolving the uncertainty vis-a-vis a "qualified mortgage:"

1. Safe Harbor Alternative: The loan would not permit negative amortization, interest-only payments, or balloon payments; the loan term would not exceed 30 years; the points and fees would not exceed 3 percent of the total loan amount; the consumer's income and assets would be documented and verified; and, the loan would be underwritten based on the maximum interest rate in the first five years, using a fully-amortizing payment schedule and considering any mortgage-related obligations.

2. Rebuttable Presumption Alternative: Includes the Safe Harbor Alternative and adds a requirement for the lender to consider and verify the monthly payment of any simultaneous mortgage and the consumer's employment, other current debt obligations, debt-to-income ratio or residual income, and credit history.

Lender Liability

The DFA provides that violations of the ability to repay requirements face tripartite penalties: (1) damages consisting of the sum of all finance charges and fees paid by the consumer, (2) the consumer's actual damages, and (3) described statutory damages.

A consumer could file a claim at any time within three years of the violation, although the consumer could assert the violation as a set-off or recoupment in a foreclosure suit at any time.

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FRB: Ability-to-Repay, Proposed Rule - Notice
April 18, 2011

FRB: Proposes Rule - Ability to Repay

Today, the Federal Reserve Board (FRB) requested public comment on a proposed rule under Regulation Z that would require creditors to determine a consumer's ability to repay a mortgage before making the loan and would establish minimum mortgage underwriting standards.

The FRB notice was issued on April 18, 2011.

The revisions to the regulation, which implements the Truth in Lending Act (TILA), are being made pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA).

The proposal would apply to all consumer mortgages (except home equity lines of credit, timeshare plans, reverse mortgages, or temporary loans).

The proposal would also implement the Dodd-Frank Act's limits on prepayment penalties.

Comment Period: Until July 22, 2011.

Because the general rulemaking authority for TILA is scheduled to transfer to the Consumer Financial Protection Bureau on July 21, 2011. 

Accordingly, this rulemaking will not be finalized by the FRB.

Four Compliance Options

Consistent with the DFA, the proposal would provide four options for complying with the ability-to-repay requirement.

General Ability-to-Repay Standard - Option # 1

First, a creditor can meet the general ability-to-repay standard by considering and verifying specified underwriting factors, such as the consumer's income or assets.

Considering and verifying the following eight underwriting factors:

• Income or assets relied upon in making the ability-to-repay determination

• Current employment status

• The monthly payment on the mortgage

• The monthly payment on any simultaneous mortgage

• The monthly payment for mortgage-related obligations

• Current debt obligations

• The monthly debt-to-income ratio, or residual income

• Credit history

Additionally, the underwriting of the payment for an adjustable-rate mortgage would be based on the fully indexed rate.

Qualified Mortgage - Option # 2

Second, a creditor can make a "qualified mortgage," which provides the creditor with special protection from liability provided the loan does not have certain features, such as negative amortization; the fees are within specified limits; and the creditor underwrites the mortgage payment using the maximum interest rate in the first five years. 

The FRB seeks comments on two alternative approaches for defining a "qualified mortgage."

Two alternative definitions of a "qualified mortgage."

Alternative 1

Alternative 1 would operate as a legal safe harbor and define a "qualified mortgage" as a mortgage for which:

• The loan does not contain negative amortization, interest-only payments, or a balloon payment, or a loan term exceeding 30 years;

• The total points and fees do not exceed 3 percent of the total loan amount;

• The income or assets relied upon in making the ability-to-repay determination are considered and verified; and

• The underwriting of the mortgage (1) is based on the maximum interest rate that may apply in the first five years, (2) uses a payment scheduled that fully amortizes the loan over the loan term, and (3) takes into account any mortgage-related obligations.

Alternative 2

Alternative 2 would provide a rebuttable presumption of compliance and would define a "qualified mortgage" as including the criteria listed under Alternative 1 as well as additional underwriting requirements from the general ability-to-repay standard.

The creditor would also have to consider and verify:

• The consumer's employment status,

• The monthly payment for any simultaneous mortgage,

• The consumer's current debt obligations,

• The monthly debt-to-income ratio or residual income, and
• The consumer's credit history.

Balloon-Payment Qualified Mortgage - Option # 3

Third, a creditor operating predominantly in rural or underserved areas can make a balloon-payment qualified mortgage. This option is meant to preserve access to credit for consumers located in rural or underserved areas where banks originate balloon loans to hedge against interest rate risk for loans held in portfolio.

Under this option, a creditor can make a balloon-payment qualified mortgage with a loan term of five years or more by:

• Complying with the requirements for a qualified mortgage; and
• Underwriting the mortgage based on the scheduled payment, except for the balloon payment.

Refinancing of a Non-Standard Mortgage - Option # 4

Fourth, a creditor can refinance a "non-standard mortgage" with risky features into a more stable "standard mortgage" with a lower monthly payment. This option is meant to preserve access to streamlined refinancings.

Under this option, a creditor complies by:

• Refinancing the consumer into a "standard mortgage" that has limits on loan fees and that does not contain certain features such as negative amortization, interest-only payments, or a balloon payment;

• Considering and verifying the underwriting factors listed in the general ability-to-repay standard, except the requirement to consider and verify the consumer's income or assets; and
• Underwriting the "standard mortgage" based on the maximum interest rate that can apply in the first five years.

Other Rule Proposals

• Implement the Dodd-Frank Act's limits on prepayment penalties

• Lengthen the time creditors must retain records that evidence compliance with the ability-to-repay and prepayment penalty provisions
• Prohibit evasion of the rule by structuring a closed-end extension of credit as an open-end plan

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FRB: Ability-to-Repay, Proposed Rule - Notice
April 18, 2011