Sean Kulczycki

Creation of the Bureau of Consumer Financial Protection

One well-publicized and controversial aspect of the Reform Act was the creation of the Bureau of Consumer Financial Protection (the Bureau). As an independent bureau within the Federal Reserve System (the Fed), its purpose is to regulate the offering and provision of consumer financial products or services under specific federal consumer financial laws enumerated in the Reform Act. In general, they include laws (and implementing regulations) covered in a financial institution’s consumer compliance examination.

The most significant functions assigned to the Bureau are the responsibility for supervising “covered persons” and issuing rules, orders and guidance implementing federal consumer financial law. The Reform Act provides the Bureau with exclusive authority to examine banks, savings associations and credit unions with total assets of more than $10 billion for purposes of assessing compliance with the requirements of federal consumer financial laws. To the extent that the Bureau and another federal agency have authority to enforce a federal consumer financial law, the Bureau has been granted primary authority with respect to financial institutions it examines.

For financial institutions with total assets of $10 billion or less, the primary federal regulator will retain “exclusive authority (relative to the Bureau) to enforce [federal consumer financial laws].” However, the Bureau does have authority to require information from these financial institutions “as necessary to support the role of the Bureau….”

In addition to creating the Bureau, the Reform Act also creates the Office of Fair Lending and Equal Opportunity within the Bureau. The stated functions of the office are to provide “oversight and enforcement of federal laws intended to ensure the fair, equitable and nondiscriminatory access to credit for both individuals and communities that are enforced by the Bureau.”

Supervision of Savings Associations

As was expected, the Reform Act has resulted in consolidation of existing regulatory agencies through the elimination of the Office of Thrift Supervision (OTS). Supervision of federal savings associations will be transferred to the Office of the Comptroller of the Currency (OCC) and supervision of state savings associations to the Federal Deposit Insurance Corporation (FDIC). Supervision of savings and loan holding companies and any subsidiaries will be transferred to the Fed. Each of these transfers will be effective one year after the date of enactment; however, a provision exists whereby this may be extended to 18 months. Effective 90 days after the transfer of supervision, the Reform Act states that “the Office of Thrift Supervision and the position of the Director of the Office of Thrift Supervision are abolished.”

While the OTS will be abolished, Section 316(b) of the Reform Act states all orders, resolutions, determinations, agreements and regulations, interpretive rules, other interpretations, guidelines, procedures and other advisory materials issued by the OTS and in effect the day before the transfer date shall continue in effect and shall be enforceable by the applicable federal banking agency. OTS regulations will be reviewed by the remaining federal banking agencies, and each agency will be required to publish a list of the regulations it will enforce by the date supervision is transferred.

Changes Affecting Mortgage Lending

In addition to the aforementioned structural changes, the Reform Act devotes an entire title (Title XIV – Mortgage Reform and Anti-Predatory Lending Act of 2007) to changes in the laws and regulations affecting mortgage lending. Not surprisingly, most of these changes are being implemented through modifications and additions to the Truth in Lending Act (TILA). While the Bureau will be required to write detailed regulations to implement these changes, the framework for these changes has been established by the Reform Act.

Changes Affecting Mortgage Loan Officers

Several significant changes in the Reform Act are directed at mortgage loan officers, referred to as “mortgage originators,” rather than the entities for which they work. One such change imposes a “duty of care” on mortgage originators, requiring that they be “qualified and, when required, registered and licensed as a mortgage originator in accordance with applicable State or Federal law, including the Secure and Fair Enforcement for Mortgage Licensing Act of 2008 (SAFE Act).”

The Reform Act also requires that the Fed prescribe regulations that prohibit mortgage originators from participating in certain conduct, including steering consumers to residential mortgage loans for which they lack “a reasonable ability to repay” or which have “predatory characteristics,” steering any consumer from a “qualified mortgage” (as defined by TILA) to a loan that is not a qualified mortgage, abusive or unfair lending practices, mischaracterizing a consumer’s credit history or appraisal and discouraging a consumer from seeking a loan from another mortgage originator under certain circumstances.

Most alarming to mortgage originators may be the liability provisions created by the Reform Act. These provisions provide consumers with a cause of action and make mortgage originators personally liable for violations of the aforementioned prohibitions related to prohibited conduct and duty of care. The maximum liability of a mortgage originator is limited to the greater of the actual damages or an amount equal to three times the total amount of direct and indirect compensation or gain accruing to the mortgage originator in connection with the residential mortgage loan involved in the violation, plus the consumer’s costs for the action, including reasonable attorney’s fees.

Elimination of Yield Spread Premium

Another significant change created by the Reform Act has been characterized as the elimination of the “yield spread premium.” Under the Reform Act, TILA is modified to state that “no mortgage originator shall receive from any person and no person shall pay to a mortgage originator, directly or indirectly, compensation that varies based on the terms of the loan (other than the amount of the principal).” While this has been characterized as the elimination of yield spread premiums, it may be more properly characterized as the elimination of the payment of overages, since it applies only to “mortgage originators” and does not prohibit a financial entity from receiving yield-based compensation if it is not passed on to the mortgage originator.

This change to TILA has a companion change that places additional restrictions on how mortgage originators may be compensated. These changes allow a mortgage originator to be paid by a third party or by the consumer, but not by both. The Fed has been given authority to grant waivers or exemptions to this rule, which appears likely due to the significant differences in how mortgage originators are compensated at bank and non-bank lenders. It is also important to note that the abovementioned mortgage originator liability provisions also apply to these compensation provisions.

Minimum Standards for Residential Loans

Since the recent financial crisis was largely attributed to mortgage loan defaults, it is not surprising that the Reform Act creates certain minimum standards for residential loans. In doing this, the Reform Act adds a new section to TILA stating that “no creditor may make a residential mortgage loan unless the creditor makes a reasonable and good-faith determination based on verified and documented information that … the consumer has a reasonable ability to repay the loan according to its terms …” The Reform Act also prescribes verification and documentation requirements similar to those required for loans designated as “higher priced mortgage loans” under current provisions of Regulation Z. However, the Reform Act goes further than current regulatory guidance and prescribes the manner in which to calculate the monthly principal and interest payments. Despite these requirements, there is no specific mention of whether acceptable payment thresholds will be established for determining whether or not a borrower has the ability to repay a loan. However, the Fed is required to write regulations implementing these provisions, and such thresholds could be established.

The primary exception to the aforementioned requirements is for loans that meet the definition of a “qualified mortgage,” as defined within the Reform Act. A “qualified mortgage” is defined as a mortgage that meets the following criteria:

• Periodic payments do not result in an increase or deferral of principal payments.
• There are no balloon payments, unless provided for by a permissible regulation of the Fed.
• Borrower income and financial resources are verified and documented.
• For fixed-rate loans, the underwriting is based on a payment schedule that fully amortizes the loan over the loan term and takes into account all applicable taxes, insurance and assessments.
• For adjustable-rate loans, the underwriting is based on maximum rate permitted during the first five years and on full amortization with considerations of taxes, etc.
• The loan complies with any guidance issued by the Fed relating to repayment ratios.
• Points and fees do not exceed 3 percent of the total loan amount, subject to allowances made by the Fed for “smaller loans.”
• The term of the loan does not exceed 30 years.
• For reverse mortgages, the loan is consistent with any standards established by the Fed.

Expansion of HOEPA Coverage & Requirements

Financial institutions have been complying with the Home Ownership and Equity Protection Act (HOEPA) since its passage in 1994. HOEPA provisions are implemented by Sections 226.32 and 226.34 of Regulation Z and contain additional disclosure requirements and restrictions for covered loans. However, for most financial institutions, the HOEPA requirements have been of limited significance, since its prohibitions target “high-cost mortgages” for which the thresholds were rarely exceeded. In addition, loans for the purchase of a primary residence and open-end lines of credit were excluded from coverage. The Reform Act makes several changes to HOEPA coverage requirements, significantly expanding its reach. First, the Reform Act expands the definition of “high-cost mortgages” to include loans for the purchase of a consumer’s primary residence as well as open-end lines of credit. In addition, the Reform Act lowers the thresholds for the “interest rate test” and “points-and-fees test” used to determine applicability of the rule.

With respect to the interest rate test, a loan secured by a first mortgage will be considered a high-cost mortgage if the annual percentage rate (APR) at consummation exceeds the average prime offer rate (APOR) for a comparable transaction by more than 6.5 percentage points (more than 8.5 percentage points if the dwelling is personal property and the loan amount is less than $50,000). The previous threshold was eight percentage points over a Treasury security of comparable maturity. For subordinate lien loans, the threshold has been adjusted to 8.5 percentage points over the APOR, down from 10 percentage points over the Treasury security yield.

While the interest rate thresholds have been lowered by 1.5 percentage points, the change in indices to the APOR from the comparable Treasury offsets a substantial portion of this difference. Over the past 12 months, the APOR for a 30-year fixed rate loan as of the 15th of each month has averaged approximately 1.37 percentage points over the 30-year constant maturity Treasury.

Regarding the points-and-fees test, the threshold for coverage has been lowered from the greater of 8 percent of the total loan amount or $400 to 5 percent of the transaction amount for loans of $20,000 or more and to the lesser of 8 percent of the transaction amount or $1,000 in the case of a transaction for less than $20,000.

In addition, the Reform Act has created a third test that includes residential mortgages whose credit transaction documents permit the creditor to charge or collect prepayment fees or penalties more than 36 months after the transaction closing or if such fees or penalties exceed, in the aggregate, more than 2 percent of the amount prepaid.

Mandatory Escrow Provisions

The Reform Act adds a new section to TILA that requires creditors to establish escrow accounts for closed-end consumer credit transactions secured as a first lien on a consumer’s principal dwelling. However, certain loans will be exempt from these provisions if the APR does not exceed certain thresholds. For loans with principal balances under the Freddie Mac conventional loan limit (currently $417,000), the threshold is 1.5 percentage points over the APOR. For loans with principal balances over the Freddie Mac conventional loan limit, the threshold is 2.5 percentage points over the APOR. Loans with APRs under these thresholds will not be subject to the mandatory escrow provision. The Fed also may, by regulation, exempt certain creditors, including financial institutions operating predominantly in rural or underserved areas, institutions that are below an established mortgage origination volume, institutions that retain the mortgage servicing and those below specified asset thresholds. In general, any escrow account required to be established must be maintained for a period of five years.

Property Appraisal Requirements

The TILA modifications also include the addition of property appraisal requirements. The new section to TILA added by the Reform Act states “a creditor may not extend credit in the form of a higher-risk mortgage to any consumer without first obtaining a written appraisal of the property to be mortgaged.” A “higher-risk mortgage” is defined as a residential mortgage secured by a principal dwelling that is not a “qualified mortgage” as defined above and that has an APR that exceeds specified thresholds. The threshold is 1.5 percentage points over the APOR in the case of a first-lien residential mortgage loan, with a principal balance less than or equal to the Freddie Mac conventional loan limit (currently $417,000) and 2.5 percentage points above the APOR in the case of a first-lien residential mortgage loan having an original principal balance in excess of the Freddie Mac conventional loan limit. For subordinate lien loans, the threshold is 3.5 or more percentage points.

Where the purpose of a loan is to finance the purchase or acquisition of mortgaged property from a person within 180 days of that person’s acquisition of the property, at a price that was lower than the current sale price, the creditor is required to obtain a second appraisal from a different appraiser. The cost of the second appraisal may not be charged to the applicant. A creditor is required to provide one copy of each appraisal conducted in accordance with these provisions to the applicant, without charge, at least three days prior to the transaction closing date.

In addition to the aforementioned appraisal requirements, the Reform Act adds a new section to TILA addressing appraisal independence. The Fed is required to prescribe interim final regulations addressing these appraisal requirements no later than 90 days after the date of enactment. However, each of the regulatory agencies may participate in the final rulemaking.

Other Truth in Lending (TIL) Changes

Not all of the changes created by the Reform Act will have the sweeping effect of those above. Some additional requirements affecting mortgage loans are described below:

• Changes to TIL Disclosure Statement. The Reform Act makes several changes to the information required to be included on the TIL disclosure statement required by Section 226.18 of Regulation Z. For variable-rate loans with escrow accounts, the TIL disclosure must include the monthly payment of principal and interest as well as the monthly payment, including the amount due for taxes, insurance and assessments. This information also must be disclosed assuming a fully indexed rate. For all residential mortgage loans, the TIL disclosure statement also will have to include specific information regarding settlement charges, fees paid to mortgage originators and the amount of interest due over the life of the loan as a percentage of the original principal balance.
• Periodic Statements for Closed-End Residential Mortgage Loans. The Reform Act amends TILA to require periodic statements on residential mortgage loans. An exception is provided for fixed-rate mortgage loans if the borrower receives a coupon booklet containing substantially the same information required in the periodic statements.

• Six-Month Notice before ARM Reset. The Reform Act requires lenders to send a notification to borrowers with adjustable-rate mortgage loans six months prior to the first rate adjustment. The notice must include any index or formula used in making the adjustments along with a source of information about the index or formula, an explanation of how the new rate and payment will be determined, a good-faith estimate of the amount of the payment after the adjustment, a list of alternatives to the interest rate increase, and names, addresses and telephone numbers of counseling agencies and the state housing finance authority for the state in which the consumer resides.
• Escrow Accounts for Certain Mortgage Loans. The Reform Act makes escrow accounts mandatory in certain instances. In those cases where an escrow account is established, the required payment schedule on the TIL disclosure must include payments to the escrow account. In those cases where an escrow account is not established, the Reform Act requires that a creditor or servicer provide “a timely and clearly written disclosure to the consumer that advises the consumer of the responsibilities of the consumer and implication for the consumer in the absence of any such account.”

Additional Reporting Requirements under the Home Mortgage Disclosure Act (HMDA)

In addition to the changes to TILA, the Reform Act adds significantly more detail to the information required to be reported under HMDA. Some of the additional data required to be collected and reported include age, value of collateral, term of any introductory interest rate period, term of the loan in months, “channel” through which application was made, applicant’s credit score, a loan originator identification number, a universal loan identifier, a parcel number that corresponds to the pledged collateral and any other information that may be deemed appropriate by the Bureau. The Reform Act specifies that institutions will not be required to report new data “before the first January 1 that occurs after the end of the nine-month period beginning on the date on which regulations are issued by the Bureau in final form …”

Restrictions on Force Placed Insurance

The Real Estate Settlement Procedures Act (RESPA) also has been modified to include certain restrictions on the force placement of hazard insurance policies. These restrictions require that the servicer provide two written notices to the borrower and that there be no demonstration of hazard insurance coverage during the 15-day period after the sending of the second notice. In addition, within 15 days of receipt by a servicer of confirmation of a borrower’s existing insurance coverage, a servicer is required to terminate the force placed insurance and refund to the consumer all force placed insurance premiums or related fees paid by the borrower during any period in which the borrower’s insurance coverage and the force placed insurance coverage were each in effect.

This article addressed many, but not all, of the changes that will affect a financial institution’s compliance program. Consult your BKD advisor for more information on how the Dodd-Frank Reform Act could affect you or your business.