Compliance Article
09/14/2007
|
|
Therese G. Franzén is a founding Partner of the firm of Franzén and Salzano, P.C. in Atlanta, Georgia. She is Vice-Chair of the Consumer Financial Services Committee of the Section of Business Law, American Bar Association, and immediate past Chair of the Debt Collection Practices and Bankruptcy Subcommittee. Leslie Howell is a Partner at Franzén & Salzano, P.C., where she manages the firm's legislative practice and assists clients with secondary marketing transactions.
Introduction
Since the 1990s, there has been a rise in subprime mortgage lending. Although the increase in subprime mortgage lending has made it possible for many individuals who previously would have been denied credit to achieve homeownership, subprime mortgage lending practices and subprime mortgage products pose heightened risks to lenders and borrowers and have resulted in increased instances of borrowers defaulting on their loan payments and foreclosure.
According to the Mortgage Bankers Association Chairman's statement to the U.S. Congress, the subprime mortgage meltdown is due to a "confluence of factors," including an overcapacity in the mortgage market (i.e. an increase in supply) to which capital markets have responded by tightening guidelines (i.e. a decrease in demand), the drop in home price appreciation, and the increase in unemployment, particularly the loss of manufacturing jobs in the mid-west. Certainly a significant part of the equation is the housing market, as it has become more and more difficult for financially troubled borrowers to sell their home quickly and for a profit.
Mortgage loans are usually bundled and sold as securities to investors. In the case of non-prime loans, investors wanted the higher returns that came with these higher risk securities. Starting about a year ago, and escalating since then, investors started making buy back demands. Investors typically retain the right to require the originator to repurchase loans where the borrower pays late, or misses, one of the initial payments on the loan (an "early payment default"). Following the dramatic increase in early payment defaults within the last year, many originators were unable to meet their buy back demands. As a result, some of the biggest players in the mortgage industry, particularly in the non-prime sector, have closed their doors.
In an effort to address the emerging risks associated with certain subprime mortgage products and certain lending practices that may be deemed "predatory," federal and state regulators and legislatures have adopted a number of initiatives in recent months. Below is a summary of state law changes, pending federal predatory lending legislation and federal regulatory developments addressing subprime mortgage products.
Final Subprime Guidance
The federal financial regulatory agencies issued a final Statement on Subprime Mortgage Lending on June 29, 2007. In response to the federal financial regulatory agencies' Statement on Subprime Mortgage Lending, the Conference of State Bank Supervisors (CSBS), the American Association of Residential Mortgage Regulators (AARMR), and the National Association of Consumer Credit Administrators (NACCA) developed a Statement on Subprime Mortgage Lending to apply to residential mortgage providers not regulated by the federal financial regulatory agencies. The state agency statement essentially mirrors the federal interagency statement, but has been modified to address issues particular to non-depository residential mortgage providers.
In general, the Statement addresses issues relating to subprime mortgage lending practices in connection with adjustable-rate loans containing certain features, and discusses risk management and consumer compliance policies and procedures which should be implemented to respond to these concerns. The Statement includes a list of credit risk characteristics that are generally displayed by subprime borrowers. The Statement provides that "subprime" refers to the credit characteristics of the individual borrower, including payment delinquencies, charge-offs, judgments, bankruptcies, or reduced payment capacity.
The Statement focuses on certain adjustable-rate mortgage products typically offered to subprime borrowers with teaser rates, no or high payment caps upon adjustment, stated income loans, prepayment penalties, and product features likely to result in frequent refinancing to maintain payment affordability.
In addition to the increased risks associated with these products, there is a concern that borrowers do not fully understand the risks and consequences associated with them, making it more likely that the product could result in payment shock to the borrower. While borrowers may be able to afford their initial monthly payment, they are more likely to have difficulty in making the monthly payment after the initial rate adjustment, or they might not be aware of their responsibility to pay taxes and insurance, especially if such payments are not escrowed.
The Statement outlines prudent underwriting standards lenders should follow in order to mitigate the credit risks associated with subprime mortgage lending. Perhaps most importantly, the Statement provides that qualifying standards should include an analysis of the borrower's ability to repay the debt by its final maturity at the fully indexed rate, assuming a fully amortizing repayment schedule.
State Adoption of Subprime Guidance
The following twenty-eight state mortgage regulators have stated their intention to expedite implementation of the Statement: Alabama, Arizona, California, Connecticut, Delaware, District of Columbia, Georgia, Hawaii, Idaho, Indiana, Iowa, Kentucky, Massachusetts, Michigan, Mississippi, Missouri, Nebraska, New Hampshire, New Jersey, New York, North Carolina, North Dakota, Pennsylvania, Rhode Island, South Dakota, Vermont, Washington, and Wyoming.
Suitability Standard Bill Introduced in U.S. Senate.
On May 3, Sen. Chuck Schummer (D – N.Y.) and two co-sponsors introduced the "Borrower's Protection Act of 2007" (S. 1299) that would establish a fiduciary relationship between a mortgage broker and borrower. It would prohibit mortgage originators from steering borrowers to loans "that are not reasonably advantageous to the consumer."
The bill would require, among other things, that brokers
- verify the "reasonable ability" of a borrower to repay a loan,
- document the borrower's income using specified means,
- not make a loan exceeding a debt-to-income ratio to be set by rule by the Department of Veteran's Affairs, and
- utilize escrow accounts to pay taxes and insurance fees.
The bill would make a lender liable for the acts and omissions made by the mortgage broker regarding a mortgage loan acquired by the lender from the broker.
Federal Predatory Lending Initiatives in 2007
Two predatory lending bills introduced in Congress in 2007 continue to promote uniform national standards in mortgage lending and propose heightened involvement and regulatory oversight by the federal government. The "Predatory Mortgage Lending Practices Act" (introduced by Rep. Tubbs Jones (OH)) proposes a federal certification requirement for mortgage lenders and brokers providing services in connection with subprime federally mortgage related loans. Applicants for certification would be required to pass a written exam that would cover federal law relative to the Truth in Lending Act, the Fair Credit Reporting Act, the Equal Opportunity Act, the Real Estate Settlement Procedures Act, and other federal legislation, as well as appropriate subprime lending practices and illegal and inappropriate predatory lending practices.
The "Fair Mortgage Practices Act of 2007" (introduced by Rep. Bachus (AL)) proposes the creation of a national system for licensing or registering residential mortgage loan originators. The bill also proposes amendments to the Truth in Lending Act which would create new disclosure requirements for credit transactions secured by the principal dwelling of the consumer.
State Law Developments
Illinois
In early 2007, the Governor of Illinois directed the Department of Financial and Professional Regulations to immediately suspend the Illinois Predatory Lending Database Pilot Program (HB 4050). On March 21, 2007, the Governor issued a press release announcing proposed amendments to the rules for the Predatory Lending Database. The Governor has also directed the Department of Financial and Professional Regulation to designate the pilot area to be all of Cook County once the proposed rules are approved and final. Most significantly, the proposed rules require counseling for mortgage applicants if their loan will contain certain provisions. The proposal removes the requirement that applicants with certain FICO scores receive credit counseling.
Maine
Maine significantly amended its high-rate, high fee mortgage loan restrictions, effective January 1, 2008. The legislation restricts certain activities relative to residential mortgage loans that are not high-rate, high-fee loans. Most notably, a "subprime mortgage loan" may not be extended to a borrower unless a reasonable creditor would believe at the time the loan is closed that the borrower will be able to make the scheduled payments associated with the loan. Further, creditors may not "flip" loans by refinancing when the new loan does not have a reasonable, tangible net benefit.
Prior to this legislation, Maine's high-rate, high-fee mortgage provisions tracked federal Section 32 thresholds and definitions. Under the new legislation, these existing provisions are repealed and replaced with new thresholds and definitions. For instance, the new points and fees threshold for loans of $40,000 or more is five percent.
Minnesota
Minnesota enacted, effective August 1, 2007, HF 1004, which prohibits making a residential mortgage loan without verifying the borrower's reasonable ability to pay not only principal and interest, but also real estate taxes, homeowners' insurance, assessments, and mortgage insurance premiums. For loans in which the interest rate may vary, the reasonable ability to repay must be determined based on a fully indexed rate over the full amortization period. Stated income loans and negative amortization are prohibited. "Churning" is prohibited, but the legislation does not limit the prohibition on churning to refinance loans made within a certain time period, and also does not elaborate on what constitutes a reasonable, tangible net benefit to the borrower.
Nevada
Effective October 1, 2007, Nevada amended its unfair lending practices provisions and established new provisions relative to mortgage fraud. Under prior Nevada law, certain lending practices were prohibited for federal Section 32 loans (i.e. high-cost under HOEPA). This legislation extends these prohibitions so they are now applicable to not just Section 32 loans, but are more broadly applicable to "home loans." Among other practices deemed as "unfair lending practices," the legislation prohibits making a low or no document home loan without determining, using commercially reasonable means, that the borrower has the ability to repay the home loan.
North Carolina
North Carolina amended its high cost home loan statute effective January 1, 2008. The "points and fees" calculation was amended to include all mortgage broker compensation paid from any source, including compensation paid in a table-funded transaction. Therefore, yield spread premiums must now be included in the points and fees calculation. The legislation provides that a bona fide sale of a loan in the secondary mortgage market is not considered a table-funded transaction. A mortgage broker that brokers a high-cost home loan in violation of the statute will be jointly liable with the lender.
This legislation creates a new section relative to "rate spread home loans." In determining ability to repay a rate spread home loan according to its terms when the loan has an adjustable rate feature, the lender must take into consideration any balance increase that may accrue from any negative amortization provision. The lender must calculate the monthly payment amount for principal and interest by assuming (a) the loan proceeds are fully disbursed on the date of the loan closing; (b) the loan is to be repaid in substantially equal monthly amortizing payments of principal and interest over the entire term of the loan, with no balloon payment; and (c) the interest rate over the entire term of the loan is a fixed rate equal to the fully indexed interest rate at the time of the loan closing, without considering any initial discounted rate. Further, the legislation prohibits prepayment fees on a rate spread home loan.
Rhode Island
Effective May 1, 2007, the Rhode Island Department of Business Regulation adopted the final version of Banking Regulation 3, which implements Rhode Island's 2006 "Home Loan Protection Act." Among other things, the final regulation amends the criteria that may be used to show a tangible net benefit. Those criteria that were amended in the final regulation concern the new monthly payment, cash out in excess of costs and fees, and the reduction in the current interest rate.
Conclusion
Increased foreclosures and decreased credit availability continue to threaten the American dream of homeownership. As the credit crunch and foreclosures continue to adversely impact families and neighborhoods, additional state and federal regulation impacting the mortgage industry should be expected for months to come.
Wiz Sentinel®, from Wolters Kluwer Financial Services | PCi, provides a multitude of compliance checks to monitor and manage complex legislative requirements and meet the due diligence requirements of the secondary market. Learn more about Wiz Sentinel.
