Insights

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) created the Bureau of Consumer Financial Protection (the “Bureau”) to provide a “one-stop shop” for all consumers, particularly consumers obtaining loans or other services from mortgage originators, brokers, lenders and services. Congress also gave the Bureau responsibility for enforcing the federal Truth in Lending Act (“TILA”), the primary consumer credit law with which all consumer-purpose mortgage creditors must comply. In advance of the transfer of enforcement of TILA to the Bureau, the Federal Reserve Board (the “Board”) released a series of final and proposed rules that will significantly affect mortgage creditors. We summarize the developments below.

Final Rules on Loan Originator Compensation Practices

The Board issued its final rules to protect mortgage borrowers from unfair, abusive, or deceptive lending practices that can arise from loan originator compensation practices. The new rules apply to mortgage brokers and to the companies that employ them, as well as to mortgage loan officers employed by depository institutions and other lenders. The final rule bans compensation to a loan originator based on the interest rate or other loan terms. This ban will prevent loan originators from increasing their own compensation by raising the consumers’ loan costs, such as by increasing the interest rate or points. Loan originators can continue to receive compensation based on a percentage of the loan amount. The final rule thus bans yield-spread premiums, the side payments mortgage brokers have historically received in exchange for guiding consumers toward higher-priced mortgage loans that have raised intense ire and concern from consumer advocates and regulators alike.

The final rule also prohibits a loan originator that receives compensation directly from the consumer from also receiving compensation from the lender or from another party. The new rule seeks to ensure that consumers who agree to pay the originator directly do not also pay the originator indirectly through a higher interest rate, thereby paying more in total compensation than they realize. Additionally, the final rule prohibits loan originators from directing or “steering” a consumer to accept a mortgage loan not in the consumer’s interest in order to increase the originator’s compensation. The rule will preserve consumer choice by ensuring that consumers can choose from loan options that include the loan with the lowest rate and the loan with the least amount of points and origination fees, rather than the loans that maximize the originator’s compensation.

The final rules take effect April 1, 2011.

Final Rules on Consumer Notification of Mortgage Loan Sales or Transfers

The Board issued its final rule to implement the requirement that consumers receive notice when their mortgage creditor sells or transfers their mortgage loan. The new disclosure requirement took effect in May 2009 upon enactment of the Helping Families Save Their Homes Act. Under that Act, a purchaser or assignee that acquires a mortgage loan must provide the required disclosures to consumers in writing within 30 days. To provide compliance guidance and greater certainty on the new requirements, the Board published interim rules in November 2009, which took effect immediately. To allow covered parties time to make any necessary operational changes, they may continue to follow the November 2009 interim rules until the mandatory compliance date for the final rules, which is January 1, 2011.

Interim Rule Revising Disclosure Requirements for Closed-end Mortgages

The Board issued an interim rule to revise the disclosure requirements for closed-end mortgage loans under Regulation Z, implementing provisions of the Mortgage Disclosure Improvement Act (“MDIA”) that require lenders to disclose how borrowers’ regular mortgage payments can change over time.

The MDIA, which amended TILA, seeks to ensure that lenders alert mortgage borrowers to the risks of payment increases before they obtain mortgage loans with variable rates or payments. Accordingly, under the interim rule, lenders’ cost disclosures must include a payment summary in the form of a table, stating the initial interest rate together with the corresponding monthly payment; for adjustable-rate or step-rate loans, the maximum interest rate and payment that can occur during the first five years and a “worst case” example showing the maximum rate and payment possible over the life of the loan; and the fact that consumers might not be able to avoid increased payments by refinancing their loans.

The interim rule also requires lenders to disclose certain features, such as balloon payments, or options to make only minimum payments that will cause loan amounts to increase. Lenders must comply with the interim rule for applications they receive on or after January 30, 2011, as specified in the MDIA. Lenders have the option, however, of providing disclosures that comply with the interim rule before that date. The Board also solicits comment on the interim rule for 60 days after publication in the Federal Register before considering the adoption of a permanent rule.

Proposed Rule to Enhance Consumer Protections and Disclosures for Home Mortgage Transactions

The Board has proposed enhanced consumer protections and disclosures for home mortgage transactions that include significant changes to Regulation Z. The proposal would:

• Improve the disclosures consumers receive for reverse mortgages and impose rules for reverse mortgage advertising to ensure advertisements contain accurate and balanced information;
• Prohibit certain unfair practices in the sale of financial products with reverse mortgages;
• Improve the disclosures that explain a consumer’s right to rescind certain mortgage transactions and clarify the responsibilities of the creditor if a consumer exercises the right; and
• Ensure that consumers receive new disclosures when the parties agree to modify the key terms of an existing closed-end mortgage loan.

In addition, the Board proposed amendments pertaining to all types of mortgages that would:

• Ensure that, for all mortgage loans, consumers have time to review their loan cost disclosures before they become obligated for fees – by requiring lenders to refund the fees if the consumer decides to withdraw the application within three days after they receive the disclosures; and
• Clarify that when a consumer requests information from their loan servicer about the owner of the loan, the servicer must provide the information within a reasonable time, which generally would be 10 business days.

The first phase of the Board’s regulatory review of mortgage lending rules started with the publication of two proposals in August 2009 that would significantly improve the disclosures for closed-end home mortgage loans and open-end home equity lines of credit. After considering the comments received on the current proposal, the Board plans to issue final rules that will combine the 2009 and 2010 proposals.

The comment period for this proposed rule ends 90 days after its publication in the Federal Register, which we expect shortly.

Proposed Rule to Revise Escrow Account Requirements for Jumbo Mortgages

This proposed rule intends to revise the escrow account requirements for higher-priced, first-lien “jumbo” mortgage loans that exceed the conforming loan-size limit for purchase by Freddie Mac. The proposed rule, which implements a provision of Dodd-Frank, would increase the annual percentage rate (“APR”) threshold used to determine whether a mortgage lender must establish an escrow account for property taxes and insurance for first-lien jumbo mortgage loans.

In July 2008, the Board issued final rules requiring creditors to establish escrow accounts for first-lien loans if a loan’s APR equals or exceeds by 1.5 percentage points the applicable prime offer rate. Under Dodd-Frank, which amended TILA, the escrow requirement will apply for jumbo loans only if the loan’s APR is 2.5 percentage points or more above the applicable prime offer rate. The APR threshold for non-jumbo loans remains unchanged. Dodd-Frank incorporates into TILA the Board’s regulatory requirement for escrow accounts and revises the APR threshold, but also includes other provisions, such as new disclosure requirements. This proposal would implement only Dodd-Frank’s change to the APR threshold. The Board will implement other provisions of Dodd-Frank concerning escrow accounts in a separate rulemaking.

The Board seeks comment on the proposed rule, including the appropriate implementation date, for 30 days after publication in the Federal Register, which we expect shortly.

Catherine M. Brennan is a partner in the Maryland office of Hudson Cook, LLP. Cathy can be reached at 410-865-5405 or by email at cbrennan@hudco.com.