Construction to Permanent Disclosures

Jonathan Foxx

Managing Director

Recently, we have seen an uptick in inquiries from some of our clients, colleagues, and requests from media, regarding disclosures for construction to permanent loans. In the inquiries, the specific facts dictated our responses. However, we can point out that Regulation Z permits a creditor to disclose the construction phase and permanent phase of a residential construction loan either as one transaction or as separate transactions. This aspect of the disclosure process seems to cause some confusion, so I would like to dispel with some of the more salient concerns expressed by lenders involved in originating these loan products.

What is the basic structure of construction to permanent mortgage loan transactions?

For the most part, they have two distinct phases that make them similar to two separate transactions. First, the construction period usually involves several disbursements of funds, at times and in amounts often unknown at the beginning of the period. The consumer generally pays only accrued interest until construction is completed. Second, unless the obligation is paid at the time the construction is completed, the loan converts to permanent financing in which the loan amount is amortized just as in a standard mortgage transaction.

So far, so good!

But on July 7, 2017, the CFPB amended Regulation Z to clarify that, for construction-permanent financing transactions, the creditor is required to disclose a Loan Estimate only for the transaction for which it received an application. So, for instance, if the creditor receives an application for construction financing only, the creditor is only required to provide a Loan Estimate for the construction transaction. If the creditor receives applications for separate construction and permanent financing transactions at the same time, then the creditor must provide the Loan Estimate disclosures as either a combined disclosure or separately for each phase of the transaction.

Therefore, the special disclosure rule permits the creditor to give either (A) one combined disclosure for both the construction financing and the permanent financing or (B) a separate set of disclosures for the two phases. The rule is applicable whether the consumer was initially obligated to accept construction only or for both construction and permanent financing. But, if the consumer is obligated on both phases and the creditor chooses to give two sets of disclosures, both sets must be given to the consumer initially, because both transactions would be consummated at that time.

Another issue that seems to perplex construction-permanent loan originators is the allocation of fees.

The following outline may help to clarify the fee allocation structure involved in this loan product. When using this special disclosure rule to disclose as multiple transactions, must allocate fees and charges between the construction and permanent phases of the transaction.

Here is a set of basic fee allocation structures:

• If a creditor discloses a construction-permanent loan as multiple transactions, the creditor must allocate to the construction transaction finance charges and points and fees that would not be imposed but for the construction financing. An example would be where a creditor must include inspection and handling fees for the staged disbursement of construction loan proceeds in the disclosures for the construction phase (viz., not in the disclosures for the permanent phase).
• If a creditor charges separate amounts for finance charges and points and fees for the construction phase and the permanent phase, the creditor must allocate the amounts to the phase for which they are charged.
• If a creditor charges an origination fee for construction financing only but charges a higher origination fee for construction-permanent financing, the creditor must allocate the difference between the two to the permanent phase.
• The creditor must allocate to the permanent financing all other finance charges and points and fees.
• The creditor may allocate in any manner it chooses any fees and charges not used to compute the finance charge or points and fees. Thus, a creditor may allocate in any manner it chooses a reasonable appraisal fee paid to an independent, third-party appraiser. 

There is also this important nuance: if the construction phase consists of a series of advances under an agreement to extend credit up to a certain amount, Regulation Z provides some disclosure flexibility. In this particular case, the creditor may disclose the construction phase as one or more than one transaction – so, it may disclose each advance as a separate transaction or all of the advances as one transaction – and also disclose the permanent financing as a separate transaction.

Preparing these disclosures is a complicated task, suitable only for compliance professionals. If you need assistance regarding construction to permanent finance transactions, with respect to reviewing your policies, procedures, disclosures, and loan flow process, please contact or email us. There is no initial consultation fee. We're glad to help!

The Lead Generation Company: Managing the Risks

Jonathan Foxx

President & Managing Director

Generating leads is an important way to reach consumers. It is also fraught with regulatory risk. A lead is consumer information that signals consumer interest or inquiry into products or services offered by a business, such as residential mortgage lenders and originators. There are several factors to be considered, not just licensing. I will list some rudimentary guidelines in this article, specifically with respect to contact with the consumer. Caution is urged to consult with a risk management professional to ensure compliance with federal and state guidelines required by a marketing campaign to generate leads. Although my focus is primarily on the online lead generation process, virtually all the guidelines provided herein may be extrapolated for use in offline lead generation campaigns.

My firm often is requested by clients to vet a lead generator, which I will call a Lead Generation Company. Careful risk management advice should be considered when developing and managing leads, whether obtained from an outsourced entity or a loan originator’s own website, in-house, or through online lead generation advertisements. Certainly, any loan originator that uses leads must have an internal compliance function that accounts for proper licensing of the Lead Generation Company (where required), monitoring of the data integrity derived therefrom, testing conformance with the originator’s policies, and training of staff in the appropriate use of lead generated, consumer data.

Banking departments these days are not just looking at licensing qua licensing. They are looking for loan originator compensation violations that are triggered by lead generation. For instance, they know that loans may have different cost structures depending on how the loans were initially received by the lender. A lead generated by the loan originator may be compensated differently than those generated by the creditor. As long as this doesn’t constitute a proxy for a loan term or condition, it is generally acceptable; that is, the loan officer may also be reimbursed for lead generation and other legitimate business costs, but the creditor must beware of how this may serve as a proxy for terms and conditions. It is up to the lender to make this determination (and properly document it).

Four Rules

In any lead generating marketing, the following four rules should be implemented:

1.     Complete, accessible, and straightforward disclosure of all parties’ intent regarding data collection and usage is essential;

2.     Data should not be brokered or sold without consent (or notice and choice) of all parties involved, including the consumer and the loan originator;

3.     Both the consumer, Lead Generation Company, and the loan originator should be made aware, through clear notices, of all parties involved in data collection and sharing; and,

4.     All parties should be educated and aware of current regulations regarding consumer protection and privacy.

These four rules become the bases of the policies, procedures, contractual arrangements, and protocols that ensure a viable marketing campaign that relies, in whole or in part, on lead generation.

Regulatory Focus

The regulators involved in enforcement of compliance with lead generation rules include, but are not limited to, state banking departments, state Attorneys General, the Federal Trade Commission (“FTC”),[i] and the Consumer Financial Protection Bureau (“Bureau”). We already know that the Bureau examines for whether the lead generator is a third-party provider and reviews the terms and appropriateness of the relationship. The Bureau reviews advertisements and advertising sources. It will review TV, radio, print media, Internet, scripts, recordings, and so forth. It will determine if there was proper consumer disclosure all along the way, from point of contact with the consumer to point of contact with the lender, including any intimation of fees and other terms and conditions. Plus, a review is conducted for online data security and sharing of consumer information.

Although the new loan originator qualification standards do not impose licensing requirements, every lender must ensure that each loan originator in its employ is licensed and registered in compliance with laws related to Secure and Fair Enforcement for Mortgage Licensing Act (SAFE), if applicable. Further, entities engaged in lead generation and marketing activities, as well as the companies that do business with such entities, need to pay particular attention to their activities to ensure that they do not inadvertently engage in loan originator activity. If they do, they’ll need to make sure that they meet the new loan originator qualification standards, including licensing requirements. Failure to meet these standards will give rise to severe civil liability that could impair the collectability of the loan.

The Bureau has stated that anytime a consumer gives out sensitive personal and financial information on the Internet there are risks involved to the consumer. In the context of Pay Day Loans, for instance, the Bureau has already warned consumers that if a consumer applies for a loan online, the consumer could be increasing risk significantly.

The Bureau has expressed concern that an online application or form that consumers fill out could be sold to a loan originator that offers to originate a loan on behalf of the consumer. Indeed, the Bureau also has indicated it has concerns that multiple lenders or other settlement service providers could pay for this information, thereby causing them to contact or email the consumer.

Consumer Advocacy

In a November 11, 2013 announcement to consumers, the Bureau stated, “Lead generators might not find you the lowest cost loans, and you should be cautious of sites that promise they will. Many consumers can also be confused about who actually made the loan, which makes getting help when you need it harder.”[ii] In addition, the Bureau has provided caution regarding key words, tags, and tactics.

Importantly, the Bureau’s view toward the Pay Day lead generator should be applied to residential mortgage lenders and originators that purchase leads from a Lead Generation company. Here’s the point: the Bureau has clearly issued an answer to the question, "What is the difference between an online payday lender and one with a storefront?" Its answer was that consumers need to make sure the online website is licensed to do business in the consumer's state and whether the lead generator follows the state's [payday] lending laws. Consider it a warning to all residential loan originators!

Therefore, when the Bureau starts looking at online lead generation involving residential mortgage loans, it is somewhat certain that it applies an even stricter standard to the Lead Generation Company that solicits mortgage information or a mortgage conversation from consumers and sells it or even passes it on to a loan originator. Questions that the Bureau would resolve, either by promulgating rules or through enforcement action, will likely be: (1) Is the Lead Generation Company violating the SAFE Act if it is not licensed in the state it is operating in?, and (2) If it is licensed under SAFE will it be violating the broadly defined Loan Officer Compensation Rule?

Lead Generation as Advertising

Depending on the advertising used to find a consumer for a loan originator, the Bureau may deem the communication to be an advertisement to generate a lead by using certain phrases, such as “Let us help you find a mortgage! Call us! Or Click Here for More Information!” If deemed an advertisement, the Bureau will move to the view that such advertising is a solicitation for a mortgage conversation from a consumer. The outcome of that position would likely lead to a violation of SAFE, because most states consider such a solicitation a violation of SAFE even if no payment is made by the lender or loan officer to the Lead Generation Company - because this type of solicitation would trigger a license requirement.

Even if the Lead Generation Company is properly licensed under a particular state's SAFE Act, if it sells that lead to an unlicensed loan originator in that state the Bureau could pursue an action against the Lead Generation Company because it assisted or facilitated a consumer’s information to be sold to an unlicensed entity, pursuant to various third party vendor management bulletins.

Some states already require a Lead Generation Company collecting consumer information to be licensed as "mortgage brokers" such as Arizona and Virginia. The licensing requirement varies from state to state. Referencing Pay Day lenders, most of the Pay Day lenders in Ohio, for example, have become Mortgage Brokers under the SAFE Act as it takes them out of the state usury statute for Pay Day lenders.

Three Concerns

What type of online Lead Generation Company could cause issues of concern?

(1) Unlicensed Lead Generation Company that tells consumers, for instance, whether they are "Qualified for a Loan or Not";

(2) Online Lead Generation Company that collects any sort of non-public personal information data (the definition of what is “NPI” may vary from state to state, but is also federally settled in Gramm-Leach-Bliley, et alia) and fails to inform and obtain the consumers consent that their information will be shared with a third party; and,

(3) Online Lead Generation Company where it has spoken directly with the consumer and then transfers the "Live Handoff" over to the loan originator (especially if the Lead Generation Company is not licensed, where required by state law). If the Lead Generation company acts as a special kind of mortgage broker then it may be best to stay away because this could violate the standards associated with the Loan Officer Qualifying Rule, mentioned above, which became effective on January 1, 2014.

Additionally, please note that the Bureau has broad authority to enforce Fair Lending Laws, the Telemarketing Sales Rule, Mortgage Lending and Regulations, Mortgage Acts and Practices Advertising Rule, and most certainly Unfair, Deceptive and Abusive Acts or Practices (UDAAP).[iii]

Steering Consumers to Expensive Mortgage Loans

The CFPB announced that it had filed a complaint yesterday in a federal district court against Utah-based Castle & Cooke Mortgage, LLC (“C & C”) and two of its officers for illegally giving bonuses to loan officers who steered consumers into mortgages with higher interest rates.

C & C is not some mom and pop mortgage company: in 2012 it originated in the range of $1.3 billion, and it does business in at least 22 states, and maintains approximately 45 branches across the country.

At the core of the complaint is the allegation that C & C violated the Loan Originator Compensation Rule (“LOC Rule”) which bans compensation based on loan terms, such as the interest rate of the loan. Specifically, the CFPB alleges that C & C violated the LOC Rule by establishing a quarterly bonus program, which paid certain C & C loan officers greater bonus compensation when they persuaded consumers to take on more expensive loans. The average quarterly bonus ranged from $6,100 to $8,700.

The CFPB further alleges, that, by contrast, those loan officers who did not charge consumers higher interest rates did not receive quarterly bonuses. (The CFPB also alleges that C & C did not record what portion of each loan officer’s quarterly bonus was attributable to a particular loan and did not reference its quarterly bonus program in each loan originator’s compensation agreement, in violation of federal consumer financial law.)

The idiomatic expression for this is called "selling up" or "upselling the consumer" or "up-charging the borrower." So, briefly put, the CFPB alleges that more than 1,100 illegal quarterly bonuses were paid - where the loan officers had been given the forgoing incentive - and that tens of thousands of customers may have been upsold by C & C since April 6, 2011, the compliance effective date of the LOC Rule.

The time frame is important. It is alleged that from July 8, 2011 through April 27, 2012 the company paid to its loan officers more than 500 quarterly bonuses, in amounts that varied based on loan terms or conditions, totaling more than $4 million. And is it further alleged that since May 2012, C & C had actually continued paying quarterly bonuses to loan officers in amounts that varied based on loan terms or conditions, and, thus by doing so from the compliance effective date, according to the CFPB, the company “recklessly or knowingly paid quarterly bonuses based on loan terms or conditions, in violation of the Compensation Rule.” The “recklessly and knowingly” allegation is made in order to set the bar for civil monetary penalties at the highest levels.

Bottom Line: The CFPB's position is that, by tying bonuses to the interest rate of the loans in this manner, C & C was in direct violation of the LOC Rule.

Another interesting facet of this complaint is that the case was referred to the CFPB by investigators with the Utah Department of Commerce, Division of Real Estate (jointly, “CFPB”). This should further reinforce the fact and make exceedingly clear that states and the CFPB are more and more working together seamlessly to enforce the applicable regulations. The complaint was filed in the United States District Court for the District of Utah, where the company is located and where the individual defendants reside.

Both the state regulator and the CFPB are claiming that C & C violated the LOC Rule by paying its loan officers quarterly bonuses in amounts based on terms or conditions of the loans they closed, thus "incentivizing loan officers to steer consumers into mortgages with less favorable terms," which, of course, is the very practice the LOC Rule seeks to prevent.

The remedies being sought would require C & C to desist from providing an incentive to loan officers to up-charge consumers by distributing quarterly bonuses based on the interest rates of loans sold. In addition to the restitution to consumers, the CFPB seeks civil monetary penalties, which is three tiered: up to $5,000 for any violation; up to $25,000 for reckless violations; and up to $1,000,000 for knowing violations.

I have read the full complaint. Permit me to outline the "before and after" process that the CFPB alleges C & C used, which forms the basis of the CFPB's complaint:

Before the LOC Rule compliance effective date, it is alleged:

1) Each branch of C & C employed loan officers who interacted directly with borrowers. C & C paid its loan officers to assist borrowers with obtaining credit to be secured by a dwelling.

2) A loan officer took an initial loan application, assessed the borrower’s creditworthiness, and determined the interest rates available to the borrower for a given loan product.

3) Borrowers did not directly compensate C & C's loan officers for the loan origination services they provided.

4) C & C paid its loan officers commissions based on the interest rates of the loans they offered to consumers, that is, the higher the interest rates, the higher the loan officers’ commissions.

CFPB’s Mortgage Rules for Readiness

The just released 2013 CFPB Dodd-Frank Mortgage Rules Readiness Guide (Guide) from the Consumer Financial Protection Bureau (CFPB) provides, finally, a set of criteria and preparation procedures for residential mortgage lenders and originators. It is Version 1.0 and, like previously issued guides and manuals, the CFPB will update the Guide periodically, using the results from its field examinations to further enhance the audit methodologies.

Note that it is called a “Readiness Guide.” Such documents are not meant to be, and are not, conclusive. Such guides are expected to be sign posts leading the way, a means by which a company may learn of the priorities and exigencies of a regulator’s oversight functions. In other words, as the Guide itself declaims: “The Guide summarizes the mortgage rules finalized by the CFPB in January 2013, but it is not a substitute for the rules.”

To put a finer point on the use of the Guide, please always remember that only the rules and their official interpretations can provide complete and definitive information regarding their requirements.*

These rules can be found at http://www.consumerfinance.gov/regulatory-implementation/.

Each rule in the Guide also includes a hyperlink with additional information, which includes Small Entity Compliance Guides that may make the rule easier to digest. There are links to videos outlining the main elements of the rule. Furthermore, a convenient hyperlink compendium structure is embedded in the Guide, so that the rule headings are themselves hyperlinks directing the reader to the rule-specific CFPB website page.

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IN THIS ARTICLE

Sections of the Guide

Summary of the Rules

Questionnaire

Library

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SECTIONS OF THE GUIDE

The Guide consists of the following sections:

Part I: Summary of the Rules
Part II: Readiness Questionnaire
Part III: Frequently Asked Questions
Part IV: Tools

Part I (Summary of the Rules) contains an outline of the eight final rules issued in January 2013 concerning mortgage markets in the United States pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) Public Law 111-203, 124 Stat. 1376 (2010) (2013 Title XIV Final Rules).

The rules amend several existing regulations, including Regulation Z, X, and B. Throughout the year, CFPB expects to provide updates to the rules where necessary. Updates will be posted, along with summaries of the changes, on the regulatory implementation CFPB webpage.

The questionnaire in Part II (Readiness Questionnaire) is '”not intended” to encompass all details of a comprehensive compliance program. This should not be interpreted to mean that the questionnaire is a replacement for the examination procedures or regulations. It is intended to serve as a guide in preparing for implementation of the mortgage rules and in performing a self-assessment. Thus, the questionnaire should be used as a self-assessment in determining a company’s progress towards compliance with the new mortgage rules. The questionnaire contains twenty-nine self-assessment questions and numerous subsections. Do not confuse the questionnaire with a proxy examination tool: it will not be added to the Examination Manual. The CFPB views the questionnaire as a “voluntary guide” for preparation. I have no doubt that it will be used by management in their discussions with examiners. The extent of those discussions may be determined by the institution’s size, products offered, risk mitigation, risk profiles, and other factors, such as the overall strength of the compliance management system.

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."

Loan Originator Compensation–The Regulatory Examination

The easy part is over. Now the real fun begins.

Since April 6, 2011, the mortgage industry has been required to implement the new loan originator compensation rules (Rule). The Rule applies to closed-end transactions secured by a dwelling where the creditor receives a loan application on or after April 6, 2011.[1] The Rule placed restrictions on residential mortgage loan transactions in order to protect consumers against the unfairness, deception, and abuse that can arise with certain loan origination compensation practices, generally prohibits payments to loan originators based on loan terms and conditions, eliminates dual compensation to originators by consumers and any other person, and prohibits “steering” consumers to loans to receive greater compensation.

I have extensively explored the features of this Rule, unraveling its complexity in articles, newsletters, presentations, and panels.[2] Indeed, I have even published a compendium of analysis, called the FAQs Outline – Loan Originator Compensation, which, as of this writing, consists of over 400 FAQs and reaches to over 130 pages. [3] These are deep and narrow waters, and considerable caution is needed in order to navigate their many demanding twists and turns.

The development of these rules, from a regulatory perspective, stretches back to August 26, 2009, when the Federal Reserve Board (FRB) published a Proposed Rule in the Federal Register pertaining to closed-end credit; to July 21, 2010, when the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) [4] enacted Title XIV into law, which amended the Truth in Lending Act (TILA) to establish certain mortgage loan origination standards; then to August 16, 2010, when the FRB published its Final Rules amending Regulation Z (TILA’s implementing regulation); on through September 24, 2010, as the FRB issued final rulemaking and official staff commentary with respect to the loan originator compensation rules and anti-steering provisions (Rule); and finally coming to a virtual full stop on January 26, 2011, when the FRB issued its “Compliance Guide for Small Entities on Loan Originator Compensation and Steering.” [5] After that, the FRB offered some conference calls, a webinar – which cleared up some confusion, while causing still other confusion – and occasional updates of the oral, rather than the written, official variety. [6]

When April 6, 2011 arrived, the mortgage industry was still scrambling to understand the Rule, how to implement it across various origination channels, and, most importantly, how to integrate it into operational, logistical, and financial components. Vendors provided considerable updates and integration features. Nevertheless, for months afterward the Rule continued to perplex and frustrate, particularly with respect to properly implementing disclosures and compensation plans. It still causes considerable consternation.

As we all know, generally there is no regulation issued – whether the statutes are at the federal or state level – that does not have a corresponding regulatory examination to assure enforcement. And so it goes: on October 6, 2011 - exactly six months to the day when the Rule became effective - the first examination guidelines for loan originator compensation were promulgated. [7]

In the "State Nondepository Examiner Guidelines for Regulation Z - Loan Originator Compensation Rule," hereinafter “Examiner Guidelines,” issued by the Multi-State Mortgage Committee (MMC), we now have a pretty good idea of the direction that federal and state regulators will be taking in their regulatory examinations for loan originator compensation. The Multi-State Mortgage Committee (MMC) is a ten-state representative body created by the Conference of State Bank Supervisors (CSBS) and the American Association of Residential Mortgage Regulators (AARMR). [8]

Are these examination guidelines perfectly worked through? Not really. Not yet. After some field testing, we should expect revisions. But as a first stab at a complex issue, they are helpful in giving a sense of the kind of information and documentation that examiners will be reviewing. These are revised procedures and they supersede the Regulation Z Interagency examination procedures. The Task Force on Consumer Compliance of the Federal Financial Institutions Examination Council (FFIEC) has approved interagency examination procedures for Regulation Z - Truth in Lending, including the Rule. The Examiner Guidelines supplement the Interagency procedures and are intended to assist state regulators of nondepository mortgage loan originators and creditors in standardized and uniform reviews of the Rule.

When the aforementioned Examiner Guidelines were issued, my firm re-set our audit and due diligence reviews for the Rule to accord with them, even in the midst of actual reviews of loan originator compensation compliance that we were then conducting for our clients.

Expect the Unexpected

As I have said many times, preparation is protection. Don’t wait for the regulator’s Document Request letter to implement any regulatory requirement. If you wait, by then it’s often too late. Remember, most examinations are look-backs, reaching to the previous examination, or a stated timeframe previous to the current examination. Most examiners have a “No Tolerance” view of firms that cannot provide supporting documents and information in a timely manner. The “record speaks for itself” is the inflexible standard! Our audit and due diligence reviews are the property of our client, and as fully confidential as if the client conducted its own review, with its internal resources – which, of course, is certainly a viable option. So, there really is no excuse for not being prepared for a regulatory examination for loan originator compensation or any other examination.

In my view, undertaking preparedness action for a loan originator compensation examination should consist of the following basics. [9] My remarks include some of my firm’s audit and due diligence practices as well as certain features of the recently issued Examiner Guidelines.

Preparation is Protection

REVIEW CONSTRUCT

• It is critical to set forth the bounds of the review. Indicate a research range that utilizes an audit sequence which, in part, incorporates federal Interagency procedures and guidelines implemented prior to the effective date of the Rule, as well as federal Interagency procedures and guidelines effective after the date of the Rule, as promulgated by the Multi-State Mortgage Committee (MMC) examiner guidelines, any federal agency, and, when issued, state government agencies.
• A significant portion of the review should be devoted to (1) completing the Institution Information Request and Institution Questionnaire provided in the Examiner Guidelines, (2) assembling items required in a Document Request, (3) providing information asked for in an Audit Checklist (whether specifically designed or Interagency), and (4) including independent review criteria through documentation review, on-site transaction testing (if required), off-site sampling of transaction documents, and interviews of institution staff or other parties.
  

Loan Originator Compensation: NEW Examiner Guidelines

On October 7, 2011, the Multi-State Mortgage Committee (MMC), a ten-state representative body created by the Conference of State Bank Supervisors (CSBS) and the American Association of Residential Mortgage Regulators (AARMR), issued examiner guidelines (dated 10/6/11) as a tool for consistent implementation of the Federal Reserve Board's final rules for closed-end credit under Regulation Z.

The MMC guidelines (Examiner Guidelines), apply to residential mortgage loans, are intended to assist state regulators of non-depository mortgage loan originators and creditors in their review of licensee policies and practices for compliance with the Federal Reserve Board's final rule (Rule).

To date, the MMC State Nondepository Examiner Guidelines for Regulation Z - Loan Originator Compensation Rule constitutes the most explicit and comprehensive examination analysis of the Loan Compensation Rule, which placed restrictions to protect consumers against the unfairness, deception, and abuse that can arise with certain loan origination compensation practices, generally prohibits payments to loan originators based on loan terms and conditions, eliminates dual compensation to originators by consumers and any other person, and prohibits "steering" consumers to loans to receive greater compensation.

Please feel free to contact us at any time to discuss our loan originator compensation audit and examination reviews.

Preparation is Protection

FAQs Outline - Loan Originator Compensation
400 FAQs (128 Pages)

Independent Audit: MMC Examiner Guidelines

Task Force

The Task Force on Consumer Compliance of the Federal Financial Institutions Examination Council (FFIEC) has approved interagency examination procedures for Regulation Z - Truth in Lending, including the Rule.

These guidelines were developed by the MMC to provide examiners in the field with a standardized set of procedures for evaluating basic compliance with the rule. The Examiner Guidelines state that the guidelines themselves are not intended to be binding or restrictive on a state's autonomous determination and sovereign authority to take supervisory action.

These revised procedures supersede the Regulation Z interagency examination procedures. Although limited, for uniformity and consistency, the interagency procedures are included within the Examiner Guidelines.

These Examiner Guidelines supplement the interagency procedures and are intended to assist state regulators of nondepository  mortgage loan originators  and creditors in standardized and uniform reviews of the Rule.

Setting a Standard

These Examiner Guidelines clearly are intended to provide state examiners with a standard set of examination tools to determine institution compliance with certain "bright line" areas of the Rule.

The actual Rule is both complex and nuanced and the Examiner Guidelines state that the subject guidelines are not intended, nor able to provide instruction for every scenario that may arise.

The purpose of these guidelines is to provide the examiner with a standardized set of procedures for reviewing institutions for basic compliance with the Rule. The examiner should consider the facts of each unique situation and apply judgment appropriately.

Three Scopes and Three Modules

1. Full Scope: Pre-exam completion of Modules 2 and 3 followed by completion of Module 1 through documentation review, onsite transaction testing, and interviews of institution staff or other parties.

2. Limited Scope: Completion of Module 1, excluding transaction testing and interviews, based on the institution's responses to Modules 2 and 3.

3. Limited Scope with offsite testing: Combine the Limited Scope approach with an offsite sampling of transaction documents and/or telephone interviews of institution staff or other parties.

Module 1 consists of questions intended to guide the examiner for specific review.

Much of the checklist can be completed from a thorough, off-site review of the institution's responses to Modules 2 and 3.

Other sections require transaction-level review and interviews of institution staff and others.

Outline

I. INTRODUCTION
II. BACKGROUND
III. DEFINITIONS
IV. REVISED INTERAGENCY EXAMINATION PROCEDURES

V. MMC GUIDELINES FOR EXAMINATION OF THE REGULATION Z LOAN ORIGINATOR COMPENSATION RULE

APPLICATION AND COVERAGE

MODULE 1 - EXAMINER CHECKLIST

A. REVIEW OF POLICIES AND PROCEDURES

B. COMPENSATION

C. STEERING

D. OPERATIONAL MANAGEMENT

MODULE 2 - INSTITUTION INFORMATION REQUEST

MODULE 3 - INSTITUTION QUESTIONNAIRE

APPENDIX A to the STATE NONDEPOSITORY EXAMINER GUIDELINES FOR REGULATION Z - LOAN ORIGINATOR COMPENSATION RULE

APPENDIX B - BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM - Revised Interagency Examination Procedures for Regulation Z (3/18/11)

LIBRARY

Multistate Mortgage Committee (MMC) 
 
State Nondepository Examiner Guidelines for Regulation Z
Loan Originator Compensation Rule      
  
October 6, 2011

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