Hot Issues Alerts - U.S. Financial Reform: Mortgage Reform & Lending Provisions
from The Metropolitan Corporate Counsel, September 2010
By Ira Gerlin and Jon Zefi, EisnerAmper LLP
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act") which aims, among other matters, to prevent practices that led to the breakdown in the mortgage lending market as well as to protect consumers applying for mortgages.
In this release, we comment on the increased regulation - under the Mortgage Reform and Anti-Predatory Lending Provisions within the Act - which will impact both mortgage lenders and consumers.
Mortgage Reform & Anti-Predatory Lending Provisions of the Act
General Purposes & Approach
A. Residential Mortgage Loan Origination Standards
- Defines a residential mortgage loan as any consumer credit transaction that is secured by a mortgage, deed, trust or other security interest on residential real property.
- Assures that consumers are offered and receive residential mortgage loans on terms that reasonably reflect ability to repay and that are understandable and not unfair or abusive in nature.
- Prohibits a mortgage originator - any person who receives compensation for assisting a consumer in obtaining or negotiating loan terms - from receiving from a consumer compensation that varies based upon the terms of the loan.
- Prohibits a mortgage originator from recommending a residential mortgage loan which the consumer lacks ability to repay or has characteristics such as excess fees or equity stripping . A violation of this Ability to Repay standard can be raised as a foreclosure defense by the borrower against the lender without regard to an otherwise applicable statute of limitations.
- Prohibits a mortgage originator from mischaracterizing the credit history of a consumer or the residential mortgage loans available to the consumer.
Observation: The Act requires the U.S. Secretary of Housing and Urban Development (HUD) to conduct a comprehensive study to determine statutory and regulatory requirements to provide for widespread use of shared appreciation mortgages to strengthen local housing markets, provide new opportunities for affordable homeownership, and enable homeowners at risk of foreclosure to refinance or modify their mortgages.
B. Minimum Standards for Residential Mortgage Loans
- Establishes a national underwriting standard for residential loans. In particular, the lender must make a reasonable and good faith determination, including by verification of documentation, that at the time the loan is consummated the consumer has the ability to repay the loan as well as taxes, insurance and other assessments.
- Requires that, where the consumer already has another residential mortgage secured by the same residence, the lender make a reasonable and good faith determination, based upon verifiable documentation, that the consumer has the ability to repay the combined loans.
- Requires that verification of ability to repay include credit history, current earned income, as well as other sources of income, including W-2s, tax returns, payroll receipts and other third party documentation.
- Requires a creditor to use a fully amortizing repayment schedule to determine a consumer's ability to repay a variable rate residential mortgage loan that allows or requires deferring the repayment of any principal or interest.
- Requires a creditor to use the payment amount required to amortize the loan through its final maturity to determine a consumer's ability to repay a residential mortgage loan that permits or requires payment of interest only.
- Prohibits specified practices including: 1) certain prepayment penalties; 2) single premium credit insurance; 3) mandatory arbitration or another non-judicial procedure (except for reverse mortgages); 4) residential mortgage loan terms that waive a statutory cause of action by the consumer; and 5) mortgages with negative amortization (except reverse mortgages), unless certain disclosures are made and a first-time borrower receives homeownership counseling.
- Requires a creditor or mortgage originator, before loan closing or refinancing, to disclose the protection provided by a state anti-deficiency law and its significance for the consumer upon the loss of that protection. (A state anti-deficiency law generally shields a consumer mortgagor from liability for any deficiency, in excess of a foreclosure sales price, for the outstanding balance of the mortgage loan.)
- Requires periodic statements on any residential mortgage loan for each billing cycle setting forth the amount of principal, current interest rate, date on which the interest rate may reset or adjust, amount of any prepayment fees, description of late payment fees, telephone number and email address for questions and addresses, and telephone numbers and email addresses of counseling agencies available to the consumer.
- Doubles civil monetary penalties for certain violations.
Observation: While the Act requires extensive creditor verifications and consumer protections as noted above, it generally shields a creditor, assignee, or issuer of debt securitized by residential consumer mortgage loans from liability and rescission in the case of borrower fraud or deception.
C. Residential Mortgage Servicing
- Requires the creditor to establish an escrow or trust account for payment of taxes, insurance (flood, mortgage or hazard) or any other periodic payments required. The lender must disclose to the borrower, prior to loan closing, the amounts and use of funds in the escrow account.
- Requires such escrow account to remain in existence for at least five years or until sufficient equity exists so that private mortgage insurance is no longer required or unless the underlying mortgage is terminated.
- Requires certain disclosures to consumers who waive escrow services.
Observations: Home loan payments must be credited on day of receipt, and an accurate payoff balance notice must to be sent to the consumer within seven business days after request.
D. High Cost Mortgages
- Defines a high cost mortgage as a consumer loan secured by a principal residence or certain other property where interest rates exceed certain thresholds. A first mortgage is a high cost mortgage generally if the Annual Percentage Rate of interest (APR) exceeds the average prime offer rate by more than 6.5 percent. If the transaction is for personal property worth less than $50,000, the APR must exceed the prime offer rate by 8.5 percent or more. High cost mortgages also include mortgages in which points and fees are greater than 5 percent for transactions of $20,000 or more. Mortgages that allow a creditor to charge or collect prepayment fees for more than 36 months after the transaction closing or where the fees or penalties exceed 2 percent of the amount prepaid are also considered high cost.
- Prohibits balloon payments, if more than twice as large as the average of earlier scheduled payments, for high cost mortgages. (A balloon payment mortgage is a mortgage which does not fully amortize over the term of the note, leaving a balance due at maturity).
- Prohibits charging late payment fees in excess of 4 percent of the amount of the payment due on a high cost mortgage, unless the loan documents specifically authorize the charge.
- In the case of a refinancing in connection with a high cost mortgage, prohibits financing of prepayment fees or penalties payable by the consumer, if the new creditor is also the holder of the note being refinanced.
- Prohibits the charging of any fee to a consumer to modify, renew, extend or amend a high cost mortgage.
Observation: Borrowers must receive pre-loan counseling and certification by a HUD certified counselor before a creditor can extend credit under a high cost mortgage.
E. Appraisal Requisite
- Prohibits extending credit on a high cost mortgage to any consumer without first obtaining a written appraisal of the property to be mortgaged. The appraisal must be performed by a certified or licensed appraiser who conducts a physical visit of the mortgaged property, including its interior, and the additional requirements below apply to the appraisal.
- Requires a free copy of the appraisal to be provided to the applicant before closing of the transaction.
- Requires that, at the time of the initial mortgage application, the applicant be provided with a statement by the creditor that any appraisal prepared for the mortgage is for the sole use of the creditor and that the applicant may choose to have a separate appraisal conducted at the expense of the applicant.
- Requires that the appraisal be performed by an appraiser licensed or certified within the state where the property is located.
- Prohibits any certified or licensed appraiser from having a direct or indirect interest, financial or otherwise, in the property or transactions involving the appraisal.
Observation: A creditor who knows at or before the loan closing of a violation of the appraisal independence standards may not extend credit based upon such appraisal.
F. Office of Housing Counseling
- Establishes within HUD the Office of Housing Counseling, whose director shall have primary responsibility for all activities and matters relating to both homeownership and rental counseling.
Observation: The Act requires the HUD Secretary to prescribe counseling procedures for homeownership and rental counseling and to provide certification of computer software programs for consumers to evaluate different residential mortgage loan proposals.
Regulations to implement the key Mortgage Reform and Anti-Predatory Lending Provisions of the Act will be developed over a fairly lengthy period, reflecting varying effective dates for different provisions and allowing in many cases a transition period for affected institutions to meet new requirements.
Jon Zefi is a Partner and Ira Gerlin is a Senior Tax Manager in the newly formed partnership between Eisner LLP and Amper LLP.
If you wish to discuss financial implications or related aspects of these provisions, please contact the authors. In addition, you are strongly urged to consult qualified legal and other professional advisers to learn the full impact of the Act.