Mortgage 101
Reg B Appraisal Rule Tutorial
The Equal Credit Opportunity Act and Regulation B were enacted to prevent illegal discrimination from occurring in a credit transaction. As a result, the law contains many provisions that regulate lender conduct during all stages of a credit transaction.
One important provision found within the law relates to appraisal reports. Under the law, lenders have an obligation to provide applicants and borrowers with a copy of the “appraisal report” used in connection with the transaction. This tutorial will review what the law requires in this area, and identify how and when appraisals must be provided.
Appraisal requirement
The use of appraisal reports has been a concern for the regulators. Problems have surfaced whereby lenders have used the appraisal process as a way to discriminate against applicants with property located in minority neighborhoods. To avoid making the loan, these lenders would under-appraise the property and then deny the application by stating that the collateral was insufficient to support the loan amount. On the surface, the credit decision process appeared fair, yet in reality, many creditworthy applicants were being denied credit on discriminatory grounds
To address this discriminatory use of appraisals, Reg B was amended to require lenders to provide applicants with a copy of their appraisal report. Armed with this information, the applicant was now in a better position to determine whether their credit denial was legitimate and challenge those situations where it appeared discrimination was playing a role.
When do the appraisal rules apply?
The general rule under Reg B is that an applicant must receive a copy of their appraisal report if the loan will be secured by a dwelling. Under this rule, coverage is determined by how the loan is secured and not by loan purpose. Any consumer or business loan secured by a residential structure may be subject to the Reg B appraisal requirements. For purposes of the appraisal rules, a residential structure is any type of one-to-four unit dwelling, whether that dwelling is attached to the real estate or not. Therefore, the rules apply to houses, condominiums, manufactured homes and the like. It is important to note that the lien priority is irrelevant. The rules apply to purchase money loans as well second mortgages or other subordinate liens.
What is an “appraisal report”?
For purposes of Reg B, an “appraisal report” is defined to include all documents relied upon by the lender to determine the value of the dwelling used to secure the loan. According to this definition, the law applies to formal, third party appraisals as well as more informal, internal valuations and any corresponding lender notes. Essentially, any documentation used to value the property securing the loan may be considered an “appraisal report” for purposes of Reg B.
When must an appraisal report be given?
Under the law, there are two options for providing copies of the appraisal report to the borrower. The first option allows for the routine delivery of the appraisal report. The second option allows for delivery upon the request of the applicant.
Option 1—Routine delivery of appraisal report
Under this option the lender would automatically provide a copy of the appraisal report to the applicant, regardless of whether the credit application is approved, denied or withdrawn. With this option, the applicant is not required to make a request for a copy of the appraisal. In addition, there are no special notice requirements or timing rules for the lender to comply with. The supplemental material to Reg B simply suggests that the appraisal may be given to the applicant when the report is completed or at a later date such as when the credit decision is made.
Option 2—Delivery of appraisal report upon request
Under this option, delivery of the appraisal report is only made upon the written request of the applicant. Here, the lender must provide written notice to the applicant of their right to receive a copy of the appraisal. This notice must be provided no later than when the credit decision is communicated. Under the law, it is acceptable to include this notice on other documentation such as the application for credit or the Notice of Action Taken.
In terms of content, the appraisal notice that is sent to the applicant must contain specific pieces of information. First, it needs to explain to the applicant/borrower that their request for a copy of the appraisal report must be made in writing. In addition, the notice must identify the lender’s mailing address. Finally, the notice must provide a timeframe for making the request. The notice itself does not need to be in a form the applicant can keep and may be incorporated into other documentation.
In addition to the notice requirements, there are stringent timing rules that must be followed, too. Once the credit decision has been made, the applicant/borrower has 90 days to request a copy of their appraisal. The lender is not required to honor requests made after the 90-day timeframe. If the applicant/borrower does make a timely request for a copy of the appraisal, the lender has 30 days to provide the report. The 30-day timeframe is triggered after the latest of the following events: the lender receives a request for the appraisal, the lender receives the appraisal report or the lender receives reimbursement for the appraisal report.
Penalties
When it comes to enforcement of the Reg B appraisal rules, the law does contain penalty provisions for noncompliance. The penalties include administrative enforcement by your regulator as well as civil liability provisions which could result in money damages. In addition, there is the risk of Fair Lending claims. Supervisory agencies who find patterns or practices of discouraging or denying applications on discriminatory grounds must refer those cases to the Department of Justice. In light of these penalty provisions, it is important to carefully follow the Reg B appraisal rules.
Other compliance considerations
Beyond Regulation B, there are a number of other compliance related issues to consider when using appraisal reports.
Remember state law. There are a number of state laws that regulate the appraisal process. Such laws may require certain disclosures and place limitations on reimbursement for the cost of the report.
Consider other federal laws. On the federal level, there are other laws that may impact the appraisal process. Laws such as RESPA contain stringent provisions regarding kickbacks and relationships with third party service providers that must be followed.
Watch for third-party discriminatory activity. If you believe an appraiser, realtor, etc. is acting on a discriminatory basis, investigate and stop doing business with that provider if necessary. Unfortunately, there have been cases that have held lenders responsible for the discriminatory practices of appraisers.
Flood Hazard Determination Tutorial
With the increase in flood disasters across the United States, it is critical that lenders understand and comply with the federal flood insurance regulations. In a nutshell, this particular law requires that lenders evaluate property used to secure a loan and determine whether or not flood insurance is necessary. Although the compliance obligations surrounding flood insurance determinations can be burdensome, the end result means better protection against losses for both the borrower and the lender.
This tutorial will focus on the flood hazard determination process and consider the steps lenders must take when deciding whether or not flood insurance is required It will summarize the flood insurance regulations and provide a high level perspective on what this law is all about. In addition, this tutorial will address a number of important lessons related to the determination process that hopefully will assist you in complying with law. Finally, this tutorial will consider the penalties for noncompliance and discuss what the regulators expect when making flood determinations.
Flood Insurance Summary
Currently, the flood insurance determination process is regulated by both federal statute and implementing federal regulations. The flood regulations were released as part of an interagency effort by the banking regulators and are virtually identical. Therefore, regardless of charter, every financial institution must follow the same type of rules.
In general terms, the flood insurance regulations contain three basic requirements for lenders. First, the law requires that the lender must make a flood hazard determination. This is to establish whether property securing a loan is located in a flood hazard area. Second, the lender must provide a notice to the borrower, prior to closing, regarding the flood determination. Finally, if the property is located in a flood zone, the lender must require flood insurance before the loan is closed and disbursed.
Each of the flood insurance requirements is important and interconnected in that one builds on the other. In order to prevent a domino effect of problems, it is important that the first step, making the flood determination, is handled properly. Under the law, the outcome of the determination controls whether or not flood insurance will become part of the lending transaction.
Flood insurance Compliance Lessons
When it comes to flood insurance, the general rule is that lenders may not make any loan, secured by any structure located in a flood hazard area, unless insurance is in place for the term of the loan. So, if a determination reveals that the property being used as collateral is located in a flood hazard area, then a loan secured by that property can only be made if flood insurance is obtained.
Although the general rule regarding determinations and insurance appears to be fairly straightforward, it is not necessarily that simple. Built into the rule are several subtle compliance lessons that every lender should know.
Lesson 1: The flood hazard determination process applies to most real estate loans. Under the law, the flood determination process applies to any type of loan regardless of loan purpose or priority. Unlike other lending laws, loan purpose does not dictate whether or not you must comply with the flood determination requirements. Therefore, the law applies to consumer, commercial and agricultural transactions
In addition, lien priority is irrelevant for purposes of conducting a flood determination. Under the law, there are numerous events, referred to as "tripwires" that will trigger the need for a flood determination. These events or tripwires include not only first and second mortgages, but also loan increases, extensions and renewals. Practically speaking, flood determinations must be conducted for purchase money home loans, home equity loans and lines of credit as well as loan refinancings and workouts.
Lesson 2: Flood determinations are required for any loan secured by a building. The type of property securing the loan conditions the requirement that a flood determination be conducted. Under the law, a flood determination is only required for loans that are secured by a building. The law provides a definition for the term "building" that includes any walled and roofed structure in any condition. The definition would cover not only residential homes but also mobile homes, agricultural buildings as well as commercial buildings. Generally speaking, regardless of the condition of the structure, if it has four walls and a roof, the flood determination process applies
Also, it is important to note that since coverage is tied to a building, loans secured by vacant land are not to the flood determination process. Flood insurance is intended to protect against damage to structures, and not bare land.
Lesson 3: The Standard Flood Hazard Determination Form must be used to document the determination. In order to bring uniformity to the flood determination process, the federal government requires that lenders document the determination by using their form. The Standard Flood Hazard Determination Form is an official form issued by the Federal Emergency Management Agency or FEMA. The purpose of the determination form is to document whether or not a building is in a special flood hazard area and whether flood insurance is available.
Tips when using the SFHD form. The determination form contains an expiration date, so it is important to verify that you are using the most current revision. Also, Section D of the form relates specifically to determinations and simply involves checking a "Yes" or "No" box. Keep in mind that the actual determination process is considerably more complicated than the form suggests.
Making a determination. When it comes to making a determination, there are basically three steps to follow. First, you must correctly identify the real estate involved. Locating the property in question involves obtaining not only a complete street address but also a legal description of the property. This amount of detailed information is necessary to actually pinpoint where on the flood map the property is located.
The next step in the determination process is to actually review the flood maps published by FEMA and locate the property in question. Because flood maps are difficult to read, it may be necessary to consider other sources, in conjunction with the flood map, to actually locate the property you are looking for. Such sources might include tax maps, engineering surveys, etc.
Finally, the third step in the flood determination process is to visually inspect the site location. This is particularly important when the property in question rests in more than one flood zone. Not every flood zone requires flood insurance. This means you need to physically determine where the building is located on the property and whether any portion of the building is situated in a zone where insurance would be required.
Lesson 4: Flood determinations may be made by third party service providers. Because the flood determination process is extremely technical, the law does allow lenders to outsource and use third party mapping providers. For many lenders, there simply is not the time or the expertise to engage in a flood map study. It is not practical and from a compliance standpoint, it is not worth the risk.
Tips when outsourcing the determination process. If you choose to outsource the flood determination process, there are some issues to keep in mind. First, make certain that you use a flood determination provider that guarantees the accuracy of their work. The contract between you and the third party should include a clause that addresses the third party's guarantee of their work and any limitations on that guarantee. Also, verify that the third party's fees are reasonable.
The law does permit you to pass flood determination fees on to the borrower and exclude such fees from the finance charge, but only to the extent those fees are reasonable. Be certain to evaluate the relationship between the fees charged and the services provided. Investigate any discrepancies and consider terminating your relationship with the service provider if fees are out of line.
Lesson 5: Flood determinations must be completed prior to closing. According to the flood determination regulations, a completed flood determination form must be included in the loan file at the time of closing. This requirement is a common area for examiner review, so it is important to audit your loan files and verify that determination forms are in place and dated properly.
Flood Insurance Penalties
The flood insurance regulations do contain penalty provisions for noncompliance with the law's requirements. Examiners are required to impose civil money penalties if there is a finding of a pattern or practice of violations.
Common violations to watch for include:
- Failure to use the current Determination Form,
- Failure to make a determination in loan refinances and renewals, and
- Failure to follow the law in commercial loan transactions.
Because the regulators do take flood compliance very seriously, it is important to address violations quickly and not let them turn into a "pattern or a practice".
Loan Refinancing Tutorial
Whether it is to take advantage of market conditions, obtain additional funds or for some other reason, your borrowers may request modifications to their loan obligations. While most lenders appreciate the business that is generated by a loan refinancing, such transactions do come with a price. From a compliance perspective, loan refinancings can be complex and trigger a number of regulatory requirements.
This tutorial will focus on the compliance aspects of a closed-end loan refinancing by the original lender under Regulation Z. This tutorial does not address the situation where a new lender refinances a loan made by another lender. It will review the Reg Z definition of a refinancing, the circumstances that create a refinancing and the legal requirements for such transactions. In addition, this tutorial will discuss the compliance impact of other federal laws that maybe triggered when a refinancing takes place.
Reg Z Coverage
Before considering how Reg Z treats loan refinancings, it is important to understand the rules on coverage. As a consumer protection law, coverage under Reg Z is limited. Under the rules, only “consumer credit” transactions are regulated. This involves loans made to individuals, for personal, family, or household purposes. Because Reg Z focuses only on consumers, loans made for business or agricultural purposes are exempt. Therefore, the Reg Z rules regarding loan refinancings only apply to those transactions that involve consumer credit.
Definition of a Refinancing
According to Reg Z, a refinancing occurs when an existing obligation is satisfied and replaced by a new obligation involving the same borrower. So unlike a loan modification or extension, where the original terms are simply amended, a refinancing involves starting over with a new note. See 12 CFR 226.20
Although this definition appears fairly straight forward, it can get confusing in the real world. One of the biggest compliance pitfalls is simply understanding when a refinancing has occurred. The Reg Z definition is not very detailed and requires that attention be paid to the facts surrounding each transaction.
The following examples are intended to further illustrate the definition of a refinancing.
Example: Roberta has several outstanding loans including a small, car loan and some credit card debt. Roberta’s original lender has agreed to consolidate her loans and replace them with one, new loan. Does Roberta’s debt consolidation meet the definition of a refinancing?
Yes. Each of Roberta’s outstanding loans was satisfied and replaced by a new loan. Since the original transactions were cancelled and replaced by a new one, a refinancing for purposes of Reg Z has occurred.
Example: Carl and Joan are experiencing some financial problems. The couple would like to restructure the payment schedule on their home loan. They sign an agreement with their lender that defers several payments and extends the maturity date. They agree to pay a fee to the lender for making these changes. Is this a refinance for purposes of Reg Z?
No. While many of the critical terms have changed, this transaction does not rise to the level of a refinance. Since the original loan was not satisfied and replaced by a new loan, the transaction does not meet the Reg Z definition of a refinancing.
Example: Barb has a single pay note that is about to come due. Her lender has agreed to renew the note for another term. A new note is prepared for Barbs signature. Is this a refinance subject to Reg Z?
No. Under the law, a renewal of a single pay loan does not meet the definition. Although a new note was created, this would still not be treated as a refinance.
As these examples illustrate, the Reg Z definition for the term “refinancing” is technical. When deciding whether or not a refinancing has occurred, it is important to carefully focus on the facts of the transaction.
Reg Z Compliance Requirements
Because Reg Z treats a refinancing as a new transaction, the law requires that the borrower be given a new set of disclosures. At the time of the refinancing, you must once again disclose items such as the finance charge, the APR and the payment schedule using the terms of the new transaction.
With respect to the finance charge, it is important to remember that any unearned finance charges from the old obligation must be reflected in the new disclosure, or be refunded to the borrower at the time the old note is cancelled.
Also note that even though the terms of a refinancing are often identical to those of the original loan, you still must provide a new disclosure statement.
Right of Rescission
The right of rescission may apply in a refinance involving someone’s home. Under Reg Z, the right of rescission is triggered if the refinanced loan is secured by a principal dwelling and involves the advance of new money. This means that before any new money can be advanced, the borrower must be given a Notice of Right to Rescind. The notice provides for a 3-day “cooling off” period during which time the borrower may elect to cancel the transaction.
However, the right to rescind is limited to the new money advanced. The borrower remains obligated for the original loan amount. The following example illustrates how the right of rescission might be triggered in a refinancing.
Example:The Garcias want to remodel their home. Their original lender has agreed to refinance their first mortgage and provide them with a new loan that includes an additional $10,000 of new money to cover the construction costs. Will the Right of Rescission be triggered as part of this refinance?
Yes. Because the Garcia’s home is pledged for their loan refinancing and because new money is advanced, the right of rescission will apply. However, the right to rescind only applies to the new funds advanced. So, only the 10,000 of new money is rescindable. The Garcias will not have the right to rescind the original loan amount.
It is important to remember that Reg Z requires a special notice form when the right of rescission occurs in a refinance. Failure to provide the proper notice could result in a compliance violation.
RESPA
The Real Estate Settlement Procedures Act or RESPA, may also impact loan refinancings. This particular law only applies to loans secured by residential real estate. With respect to refinancings by the original lender, RESPA relies on the Reg Z definition of a refinancing. Lenders involved in a refinancing subject to RESPA must provide the borrower with a new good faith estimate and a settlement statement. Again, your disclosures must reflect the terms of the new transaction and must be provided even if those terms are identical to what was originally disclosed.
HMDA
The Home Mortgage Disclosure Act, or HMDA, also may come into play. Among other things, this particular law requires lenders to record transaction data for government reporting purposes. Refinancings that are secured by a residential dwelling or extended for home purchase or home improvement purposes are subject to HMDA. As a result, these refinancings must be reported on the Loan Application Register, or HMDA-LAR. HMDA data from this register is closely scrutinized by both examiners and the public, so it is important that reportable refinancings are handled properly.
Reg B/Fair Lending
Finally, Regulation B and fair lending issues must be considered in a loan refinancing.
Government monitoring requirements. Refinancings of residential property will require the collection of government monitoring data at application. Under the law, for certain transactions you must collect the race or national origin, sex, marital status and age of the applicant. It is important to have procedures in place to comply with this requirement, or the unique requirements of your regulator when it comes to this type of data collection.
Prohibition on discrimination. Reg B prohibits discrimination in all aspects of a credit transaction, including decisions to refinance. The terms and conditions of your refinances should be tied to legitimate standards of creditworthiness, without regard to marital status, race, gender, or other prohibited factors. Given the current climate, it makes sense to periodically audit your refinancing loan files. Verify that your decisions to deny a refinancing request are not based on discriminatory factors.
