We have entered a new era of predatory lending regulation and compliance for lenders. Since the beginning of 2009, lawmakers have proposed and passed several regulations that attempt to prevent the rash of risky, and in some cases, predatory, loans that have rocked the mortgage industry over the past few years.
The reason for these rules lies in the emotional nature of a home purchase. Once a buyer has mentally committed to buying a home, most will follow through even if fees rise or terms change between the initial disclosure and the closing table. While the vast majority of lenders treated borrowers with fairness and respect, a few unscrupulous lenders engaged in these deceptive practices, knowing that most borrowers would still sign the higher-cost loan, rather than walk away from their new home.
New lending regulations fall under two umbrellas—clarifying what constitutes a higher priced, high-cost or predatory loan and reforming the rules to disclose the costs of a mortgage. To avoid penalties for inadvertently funding a high-cost loan or messing up a disclosure, lenders must understand what the rules mean. More importantly, they need to implement systems to reduce the risk of funding a high-cost loan and improve the distribution of initial disclosures.
Defining higher priced loans
On Oct. 1, 2009, the Federal Reserve implemented a new section of Regulation Z designed to regulate the closed-end sub-prime mortgage market—the “higher-priced mortgage loan” (HPML) rule. The rule establishes triggers for categorizing loans as HPML and sets forth special rules and restrictions that apply to loans that fall into the category. The rule helps protect consumers from deceptive and abusive lending practices.
HPMLs are defined as a “mortgage where certain annual percentage rate (APR) thresholds are met.” An HPML occurs when the mortgage for a principal dwelling has an APR that exceeds the average prime offer rate for a comparable transaction by 1.5 or more percentage points for loans secured by a first lien on a dwelling, or by 3.5 or more percentage points for loans secured by a subordinate lien.
The thresholds are based on the “average prime offer rate” (APOR). The APOR is defined as an APR that is derived from average interest rates, points and other loan pricing terms currently offered to consumers by a representative sample of creditors for mortgages that have low-risk pricing characteristics. The APOR for a broad range of types of transactions is published in a table updated at least weekly, along with the methodology used to derive these rates.
In order to determine which loans are covered, one must look at the definitions of “consumer credit” and “principal dwelling.” “Consumer credit” is defined by the regulation as “credit offered or extended to a consumer primarily for family, or household purposes.” The meaning of “principal dwelling” is clarified in the commentary to Regulation Z and is generally understood to mean owner occupied real property. Thus loans that are not extended primarily for family or household purposes are excluded, and so are loans that are not occupied by the owner. Construction loans, reverse mortgages, bridge loans and home equity lines of credit are also excluded from the HPML regulation.
HPMLs are subject to the following restrictions:
►Repayment ability: Lenders are prohibited from extending credit based on the consumer’s collateral without regard to the consumer’s repayment ability.
►Prepayment penalties: Prepayment penalties are prohibited unless the penalty will not apply until two years following the closing. A penalty will not apply if the source for the prepayment funds is a refinancing by the lender or its affiliate.
►Escrows: A lender may not extend a mortgage secured by a first lien on a principal dwelling unless an escrow account for property taxes and mortgage insurance premiums is established before closing.
While this regulation is specifically targeting sub-prime loans, since there is no sub-prime mortgage market to regulate at this time, the actual impact is another compliance concern for all lenders.
Disclosing the costs of a loan
Since the beginning of the year, lenders have had to use the new Good Faith Estimate (GFE) for all mortgage transactions subject to the Real Estate Settlement Procedures Act (RESPA). The rule that mandates that GFEs must be delivered to the borrower no later than three business days after a lender receives an application has not changed. However, the contents of the document have changed significantly.
While the old GFE form was primarily concerned with disclosure of settlement costs to the borrower, the new GFE summarizes the loan terms and is geared toward aiding the borrower in shopping for settlement services.
The purpose of the GFE goes far beyond the disclosure of settlement charges currently being disclosed. This new document is intended to give the borrowers a disclosure of loan terms in addition to the settlement service charges.
Ultimately, the document gives the borrowers a tool to use in shopping for a loan. However, it has caused lenders to change the way they handle disclosures and comply with predatory lending rules.
Easing the compliance burden
The challenge lenders face is perfecting a process that eliminates the risk of failing to properly disclose the terms of the loan upfront and catches potential high-cost loan terms prior to closing.
For easing the cost and time spent on disclosures, lenders should look into eDisclosure systems. These systems are easy to implement and nearly all borrowers have the capabilities to receive, sign and return the disclosures.
More importantly, from a compliance standpoint, electronic disclosure systems offer monitoring and reporting on the status of all disclosures. These reports provide a paper trail to verify the receipt and acceptance of the disclosure.
On the back end, lenders should seek automated high-cost lending and predatory lending review systems that flag suspicious applications prior to reaching the closing table. This enables lenders to make corrections to loans that would trigger HPML regulations, as well as other predatory lending laws, in enough time to issue revised disclosures and ensure the loan closes correctly.
The best systems will pull data directly from the loan origination software (LOS) to eliminate time-wasting and risky data reentry. First Bank Mortgage from Augusta, Ga. implemented an automated document and high-cost loan software because the headaches associated with manual predatory lending checks became too much.
“The old system was very manual,” said Leslie Kromke, mortgage officer for First Bank Mortgage. “We literally had to enter everything from the final HUD report into the system, which created a huge margin of error. Since the final high-cost lending and predatory lending check is run at the closing table, we had to find a method that would not leave our customers wasting time waiting on a computer program to run.”
The lender now uses a Web-based tool that compares loan-level data to applicable laws, regulations and investor requirements. The system is also configurable for state and local regulations in addition to the federal laws. According to Kromke, the most significant benefits to using an automated system to manage predatory lending compliance are the speed and accuracy of the checks.
“The old system added more than five minutes to the end of each closing,” said Kromke. “With HCL/PredCheck, we can run the compliance checks and generate the reports in less than a minute.”
Kromke also said the improved accuracy saves the lender potential regulatory punishments or loans returned by investors.
“In addition to the regulatory agencies, investors run their own checks to ensure compliance with HCL and predatory lending laws,” said Kromke. “Our software makes it easy to generate the reports we need to prove compliance on all loans and improve our cash flow with increased sales on the secondary market.”
As First Bank Mortgage’s experience shows, lenders can still close profitable loans with the new rules affecting lenders today. Lenders must use technology that eliminates data entry, provides strong tracking and reporting capabilities and is updated to comply with new regulations at all levels. The ones who do will be able to close more loans and remove the fear of a high cost loan or improper disclosure slipping through the cracks.
Fred Gooch is general counsel and vice president of compliance for Idaho Falls, Idaho-based DocuTech Corporation, a provider of compliance services and documentation technology for the mortgage industry.