The Dodd-Frank Act includes significant revisions to the federal Truth in Lending Act affecting mortgage loan originations. Most of these provisions apply to “residential mortgage loans,” a new term defined to include all consumer closed-end loans secured by a dwelling other than home equity lines of credit and timeshares. “Residential mortgage loans” include closed-end reverse mortgages, although reverse mortgage loans are separately excluded from many of the new provisions.
Mortgage Originators: The Dodd-Frank Act regulates activities of mortgage originators, defined to exclude servicers or their employees who modify or refinance residential mortgage loans that are in default or have a reasonable likelihood of going into default. While the Dodd-Frank Act does not amend the SAFE Act, this definition suggests that servicers and their employees, agents, or contractors should not have to be licensed or registered under the SAFE Act.
The Act imposes a “duty of care” on mortgage originators, but this duty is limited to the requirement that mortgage originators be licensed or registered as required by the SAFE Act and that they add their unique identifiers to all loan documents. However, by incorporating into TILA the SAFE Act requirement that mortgage loan originators be registered or licensed, mortgage originators are now subjected to TILA penalties for failure to be properly licensed or registered.
The Act also regulates compensation to mortgage originators. The Act prohibits compensation to mortgage originators based on terms of the loan other than the amount of principal. For example, this would appear to prohibit paying compensation to a mortgage originator based on whether the loan has a fixed or adjustable rate, the lien position, whether the loan is for a purchase money transaction or a refinance or whether the loan is conforming or non-conforming. Additionally, no person other than the consumer can pay a mortgage originator any fee other than a bona fide third party charge, a fee that the mortgage originator then passes through to another service provider, unless the mortgage originator receives no compensation directly from the consumer, and the consumer does not pay any upfront discount points or origination points or fees other than bona fide third party charges. Nonetheless, a consumer can arrange for a mortgage originator’s fee to be paid by having it added to the principal amount of the loan or as part of the interest rate, provided that the amount of the fees paid to the mortgage originator do not vary based on the means of payment.
Finally, the Act directs the Federal Reserve Board to issue regulations prohibiting certain mortgage originator practices, including:
Note that rule writing authority for these provisions, as for all truth in lending regulations eventually will pass to the Consumer Financial Protection Bureau.
The above provisions do not limit the compensation a creditor may receive upon the sale of a consummated loan to a subsequent purchaser, or prohibit incentive payments to a mortgage originator based on the number of mortgage loans originated within a specified period of time.
A mortgage originator that violates any of the above requirements is subject to penalties under Section 130 of TILA, but not to exceed the greater of actual damages or three times the total amount of direct and indirect compensation involved in the violation, plus costs and attorneys fees. A creditor may also be subject to penalties for violating these rules, but creditors are not protected by the cap on damages that applies to mortgage originators.
Additionally, in a foreclosure or collection action, a consumer may assert a violation of the mortgage originator compensation provisions as a defense by recoupment or setoff in the amount of damages to which the consumer would be entitled for the violation. Any such claim may be raised against the creditor, assignee or other holder, and may be raised at any time, even if the statute of limitations for a private action for damages (which will now be three years for a violation of the mortgage originator compensation limits and certain other new requirements) has expired. If a claim for setoff or recoupment is brought after the three-year statute of limitations has expired, the amount of setoff or recoupment may not exceed the amount that would have been computed up to the day preceding the expiration of the statute of limitations.
Minimum Mortgage Standards: The Act establishes certain minimum standards for residential mortgage loans, the most notable of which is an ability to repay standard.
Ability to Repay: The Act requires creditors, in connection with a residential mortgage loan, to make a reasonable and good faith determination based on verified and documented information that, at the time of consummation, the consumer has a reasonable ability to repay the loan, including taxes, insurance and assessments. If the creditor knows or has reason to know that the consumer is obtaining multiple loans on the same dwelling, the creditor must base the ability to repay determination on the combined payments of all loans on the same dwelling.
The ability to repay determination must include consideration of credit history, current income, expected income that the consumer is reasonably assured of receiving, current obligations, debt-to-income ratio or residual income, employment status, and other financial resources (other than the equity in the dwelling or real property securing the loan). The creditor must verify income and assets using W-2 forms, tax returns, payroll receipts, financial institution records or other third party documents that provide reasonably reliable evidence of income or assets. Verification of income and assets on a refinancing may be waived by the relevant government agency for government guaranteed or insured loans provided certain conditions are met, including the consumer is not more than 30 days past due on the current mortgage, the total points and fees for the refinancing do not exceed 3% of the new total loan amount , the new interest rate is lower unless the borrower is refinancing from an ARM to a fixed rate, the new loan is fully amortizing, and the new loan does not have a balloon payment. The Act includes special instructions for nonstandard loans, including a requirement to use a fully amortizing repayment schedule for variable rate or interest-only loans, as well as a requirement to consider any balance increase caused by negative amortization.
“Points and fees” are those closing costs (plus future prepayment penalties) as defined for purposes of the revised high-cost mortgage (or Section 32) test. The use of the term “total loan amount” is confusing. This term is used in the current high-cost mortgage test to denote an amount that can be much less than the actual principal amount of the loan. The new high-cost mortgage test dispenses with this somewhat deceptive term and uses instead the term “total transaction amount,” which is not defined. It is not clear whether the term “total loan amount” as used in this setting refers to term as defined for purposes of the current high-cost mortgage definition or to the terms typical meaning of the principal balance of the mortgage loan.
The Act includes a safe harbor with regard to determining a consumer’s ability to repay if the loan is a qualified mortgage. Although this provision is termed a “safe harbor and rebuttable presumption” in the title to the section, the statutory language does not place any conditions on the safe harbor. A qualified mortgage means:
The Act gives the Federal Reserve Board authority to modify the definition of qualified mortgage to include loans of smaller amounts, and loans with balloon payments if certain requirements are met, including that the loan is extended by a creditor that operates primarily in rural or underserved areas, whose total annual mortgage originations do not exceed a limit to be set by the Board, who retains the balloon loan and who meets any other criteria set by the Board. The FHA and VA may also revise the definition of a qualified mortgage as it applies to loan products insured or guaranteed by these agencies.
Additionally, in a foreclosure or collection action, a consumer may assert a violation of the ability to repay provisions as a defense (but only by recoupment or setoff in the amount of damages to which the consumer would be entitled for the violation). Any such claim may be raised against the creditor, assignee or other holder, and may be raised at any time, even if the statute of limitations for a private action for damages (currently three years) has expired. If a claim for setoff or recoupment is brought after the three year statute of limitations has expired, the amount of setoff or recoupment may not exceed the amount that would have been computed up to the day preceding the expiration of the statute of limitations.
Prepayment Penalties: The Act imposes a prohibition on prepayment penalties for any residential mortgage loan that is not a qualified mortgage. For purposes of this prohibition, a qualified mortgage does not include:
Prepayment penalties are also limited on qualified mortgages as follows: during the first year of the loan, a prepayment penalty may not exceed 3% (note: a qualified mortgage with a prepayment charge in excess of 2% of the amount prepaid would be a high-cost mortgage loan under the Dodd-Frank Act) of the outstanding loan balance, during the second year of the loan, a prepayment penalty may not exceed 2% of the outstanding loan balance, and during the third year of the loan a prepayment penalty may not exceed 1% of the outstanding loan balance. Prepayment penalties are prohibited after the third year of the loan. Additionally, if a creditor offers a loan with a prepayment penalty, the creditor must also offer a loan that does not have a prepayment penalty.
Insurance Premium Financing: The Act prohibits creditors from financing insurance premiums on residential mortgage loans or HELOCs that are secured by the consumer’s principal dwelling. This prohibition does not apply to insurance premiums or debt cancellation or debt suspension fees that are calculated and paid in full on a monthly basis. These types of premiums are not considered to be financed by the creditor. The prohibition also does not apply to credit unemployment insurance if the premiums are reasonable, the creditor does not receive compensation, and the premiums are not paid to an affiliate of the creditor.
Arbitration: The Act prohibits pre-dispute mandatory arbitration agreements in connection with residential mortgage loans and open end consumer credit plans secured by the consumer’s principal dwelling. The Act also prohibits a waiver of any statutory cause of action in connection with residential mortgage loans and open end consumer credit plans secured by the consumer’s principal dwelling.
Negative Amortization: The Act includes provisions affecting the ability of creditors to make a loan that will result in negative amortization. These provisions apply to all closed and open-end mortgage secured by a dwelling, but do not apply to reverse mortgage loans.
Before making a loan that will result in negative amortization, the creditor must give the consumer a notice stating that the transaction may result in negative amortization, describing negative amortization, and informing the consumer that negative amortization increases the principal balance of the account and reduces the consumer’s equity in the dwelling or real property.
If, in the case of a first-time borrower, a creditor makes a residential mortgage loan that is not a qualified mortgage loan, the creditor must obtain from the borrower documentation to demonstrate that the consumer received homeownership counseling from a HUD-approved counselor.
Anti-Deficiency Disclosure: If a residential mortgage loan is subject to anti-deficiency protection under state law, the creditor or mortgage originator must notify the consumer of that fact prior to consummation. Additionally, if a consumer applies for a refinancing that would affect anti-deficiency protection available under state law, the creditor or mortgage originator must provide a notice to the consumer explaining the protections of the state anti-deficiency law and the implications of losing that protection before any refinancing agreement is consummated.
Partial Payments: In connection with residential mortgage loans, creditors must disclose, prior to settlement, their policy regarding acceptance of partial payments. If a creditor accepts partial payments, it must disclose how those payments will be applied and whether those payments will be placed in escrow.
Expanded Civil Penalties Under TILA: The Act would amend section 130(a) of TILA to expand civil penalties as follows:
Expanded State Attorneys General Enforcement: Currently under TILA, state attorneys general have authority to enforce only the HOEPA provisions. The Dodd-Frank Act will expand the enforcement authority of state attorneys general under TILA to include the following provisions:
Section 129B – Mortgage originator compensation
Section 129C – Minimum mortgage standards
Section 129D – Escrow or impound account requirements
Section 129E – Prompt crediting of home loan payments
Section 129G – Prompt payoff balance request
Section 129H – Property appraisal requirements
We note that TILA currently provides a three-year statute of limitations for actions brought by a state attorney general.
Extended Statute of Limitations Under TILA: The statute of limitations for a private action for damages has been extended to three years for:
Lender Rights in the Context of Borrower Deception: The Dodd-Frank Act provides that creditors are not liable if a borrower is convicted of obtaining the mortgage loan by actual fraud.
New Closing Disclosures Under TILA: The Act will require the following additional disclosures to be provided with the existing TILA disclosures at consummation:
For ARMs with escrow accounts:
For all residential mortgage loans:
Appraisals: The Act includes extensive provisions with respect to appraisals.
Written Appraisals: Appraisal regulation has been organized and expanded under the Act. The Act amends TILA to require lenders to obtain written appraisals in connection with “higher-risk mortgages.” A certified or licensed appraiser would be required to conduct a physical property visit of the interior of the property. A second appraisal is required at no cost to applicant if the higher-risk mortgage will finance the purchase of the property from a person within 180 days of that person’s purchase of the property at a price lower than the current sale price of the property. Applicants are entitled to one free copy of each appraisal at least three days prior to closing. The FRB, OCC, FDIC, NCUA, FHFA, and CFPB are charged with writing regulations implementing this section.
Appraisal independence: This provision becomes effective immediately on passage of the Act and requires the Board to prescribe interim final regulations no later than 90 days after enactment. When the final interim regulations are issued, the Home Valuation Code of Conduct will sunset. The new appraisal independence provision prohibits the following:
A person with an interest in a real estate transaction, including a mortgage broker, lender, or banker, may ask an appraiser to consider additional information such as comparable properties; may provide further detail or explanation for the appraiser’s value conclusion; and may correct errors in the appraisal report.
Lenders must compensate fee appraisers (not an employee of the mortgage originator) at a rate that is customary and reasonable for appraisal services performed in the market area of the property being appraised. In the case of a complex appraisal, the fee may be increased to reflect increased time, difficulty and scope of work.
Appraisal Management Companies: The Act requires the FRB, OCC, FDIC, NCUA, FHA and CFPB to jointly propose rules establishing minimum requirements to be applied by a state in the registration of appraisal management companies.
Automated Valuation Models (AVMs): The Act requires the FRB, OCC, FDIC, NCUA, FHA and CFPB, in consultation with the Appraisal Subcommittee and Appraisal Standards Board, to jointly propose rules implementing quality control standards for AVMs.
Broker Price Opinions (BPOs): The Act prohibits use of a BPO as the primary basis for valuation of property that will be the borrower’s principal dwelling.
Equal Credit Opportunity Act Appraisal Provision: The Act amends ECOA to add a provision requiring a creditor to provide an applicant with a copy of all written appraisals and valuations developed in connection with the application for a loan that is or will be secured by a first lien on the dwelling. The appraisal must be provided no later than 3 days before closing on the loan, whether the creditor grants or denies the application.
RESPA: The Act provides that the HUD-1 Settlement Statement may include, in the case of an appraisal coordinated by an appraisal management company, a clear disclosure of the fee paid to the appraiser by such company and the administration fee charged by such company.
Effective Date: Except for the appraisal independence regulations, which must be issued 90 days from enactment, regulations implementing the mortgage origination provisions must be issued in final form within 18 months of the designated transfer date. The designated transfer date is the date on which the CFPB accepts functions from the other federal agencies. The designated transfer date is to be established within 12 months after the passage of the Act; although the date can be delayed for up to another six months. Any regulations must take effect within 12 months after date of issuance.
The statutory provisions take effect when the regulations become effective; however, if a regulation to implement a provision has not been issued (presumably in proposed form) within 18 months after enactment, then the relevant provision becomes effective 18 months after enactment, even though there are no regulations interpreting the provision. Finally, although the CFPB is ultimately given rulemaking authority for most of the regulations that implement Title XIV, the Federal Reserve Board could issue regulations implementing these provisions prior to the designated transfer date.
Robert A. Cook is a partner in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Robert at 410-865-5401 or by email at rcook@hudco.com.
Meghan S. Musselman is an associate in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Meghan at 410-865-5403 or by email at mmusselman@hudco.com.
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