Hope You Like Plain Vanilla!
Mortgage Reform and Anti-Predatory Lending Act (Title XIV)
Financial Services Reform Alert

by Kristie D. Kully, Laurence E. Platt . July 8, 2010

K&L Gates published this alert prior to July 21, 2010, the date on which President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law. However, this alert discusses the final version of the bill that would eventually be signed into law.

Like the Saturday Night Live lunch counter from the late 1970s that, regardless of what the customers reasonably requested, offered only cheeseburgers, chips, and Pepsi, the Mortgage Reform and Anti-Predatory Lending Act (the Mortgage Reform Act) would essentially mandate that all flavors of mortgage loans besides “plain vanilla” will disappear from the menu.  And what about those consumers who want strawberry ice cream instead?  Sorry, the government has determined that it may be hazardous to your health. 

Capitol Hill watchers in the industry have long expected many of the provisions in the new Mortgage Reform Act, passed by the House of Representatives on June 30 as part of the comprehensive financial reform package called the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act).  The Mortgage Reform Act will, if and when enacted, change the way creditors offer, and consumers receive and pay for, residential mortgage loans in the future. What still comes as a surprise, however, is the extent to which makers and holders of non-plain vanilla mortgages are targeted for punishment through enhanced monetary damages, defenses to foreclosure, and risk retention requirements.  Only time will tell whether the mortgage finance industry will assume the risks and expand the menu of mortgage options.  

In this client alert, we summarize the many provisions in the Mortgage Reform Act that will regulate the origination process.[1]  First, we summarize the Mortgage Reform Act’s extension of the Truth in Lending Act (TILA) to control the actions and compensation of, and to impose liability on, mortgage loan originators; the requirement for creditors to consider a borrower’s ability to repay based on verified and documented information; the designation of plain vanilla “qualified” mortgage loans that escape that amorphous ability-to-repay scrutiny; and other expansions to TILA’s requirements and liability.  We then summarize the new consumer disclosures the Dodd-Frank Act will impose, many of which are confusingly duplicative (ironic when considering the efforts to consolidate consumer protection and to reform the mortgage process).  We also describe the Mortgage Reform Act’s amendments to the Real Estate Settlement Procedures Act (RESPA), the Fair Credit Reporting Act (FCRA), the Home Mortgage Disclosure Act (HMDA), and the Secure and Fair Enforcement for Mortgage Licensing Act (the S.A.F.E. Act).  

Other K&L Gates client alerts describe the abundant other provisions in the Mortgage Reform Act and the larger Dodd-Frank Act relating to residential mortgage lending, including the creation of the new gargantuan Consumer Financial Protection Bureau (the Bureau) within the Federal Reserve, the imposition of new mortgage loan servicing requirements, the dilution of federal preemption of state laws for national banks (and the remaining few entities with federal thrift charters) and their operating subsidiaries, the impact of the amendments to the Alternative Mortgage Transactions Parity Act, and the consequences of the new “skin in the game” requirements under the new risk retention rules.  In addition, other alerts from K&L Gates will address other aspects of financial reform in the Dodd-Frank Act.  Additional information is available on the K&L Gates web site specially dedicated to Financial Services Reform. 

These mortgage reform efforts have been under construction for over two years, and K&L Gates has issued several client alerts discussing the efforts of the House and Senate (as well as the Federal Reserve Board) to finalize new policies, and comparing those bills and rules as they progressed.[2]  In many, but not all, respects the Mortgage Reform Act within the Dodd-Frank Act is based on the provisions in the House bill with respect to mortgage loan originator anti-steering, but it reflects the Senate version in that it deleted the anti-flipping/net tangible benefit requirements and narrowed the remedies of monetary damages rather than rescission against assignees and securitizers.

We note that the provisions we describe below would not affect the preemptive effect (or lack thereof) of any of the founding statutes we discuss (TILA, RESPA, FCRA, HMDA).  While the Dodd-Frank Act will affect the preemption that federally chartered depository institutions and their subsidiaries enjoy, the Mortgage Reform Act itself would not affect the impact of those particular federal statutes on the applicability of state law.

Effective Date
First, as with a whole host of other federal consumer protection laws, the Mortgage Reform Act would (if enacted in its current form) be deemed an “enumerated consumer law” (along with the federal TILA, which it amends).  Thus, the authority for implementing its provisions would be assigned to (or transferred to) the new Bureau.  The regulations required in the Mortgage Reform Act would have to be finalized within 18 months of the designated date of transfer of authority and functions to the Bureau.  Those regulations then would become effective not later than 12 months after the regulations are issued in final form.  Based on the enormous quantity and substantive importance of the issues to be prescribed in regulations (by a brand new agency with a huge mandate, but without a director, an organization, office space, telephone system, etc.), it is clear that we will continue discussing many of these issues for many months/years.  

However, while certain provisions of the Mortgage Reform Act expressly require regulatory implementation and thus will become effective when the rulemaking process is complete, other provisions do not specifically require implementing regulations. The Act is less clear about the effective date of those provisions. On one hand, the Act says that any section of Title XIV “for which regulations have not been issued on the date that is 18 months after the designated transfer date shall take effect on such date.” This would seem to say that those provisions of Title XIV that do not specifically require the Board to adopt implementing regulations do not become effective until 18 months after the designated transfer date (which would be sometime between two years and two-and-one-half years after the President signs the bill), unless the Board or Bureau (as applicable) decides to adopt regulations to implement the provisions anyway, and specifies an earlier effective date in those regulations. On the other hand, others have asserted that the foregoing effective date applies only to those provisions of Title XIV for which the Bureau is required to issue regulations. This would mean that the provisions for which the Bureau is not required to issue regulations would be subject to the Dodd-Frank Act’s default effective date--which is the day after the President signs the bill. This would be a shocking result given the time it would take to implement the many statutory requirements in an orderly manner. We hope that the Board immediately clarifies this ambiguity in a way that would permit the changes to be carefully implemented.

Definition of "Mortgage Originator"
The Mortgage Reform Act would begin by expanding TILA to apply to mortgage originators, in addition to those persons that actually extend credit to consumers.  Federal law already has attempted to define a concept of a “mortgage originator” under the S.A.F.E. Act (which provides a federal standard for licensing and/or registration of mortgage originators).  The Mortgage Reform Act would not, however, adopt the S.A.F.E. Act definition.  Instead, for purposes of the prohibitions described in this client alert, and for other provisions of TILA, as amended, the definition of a “mortgage originator” would be any person (an individual or an organization) that, for direct or indirect compensation or gain, or in the expectation of direct or indirect compensation or gain:

1. Takes a “residential mortgage loan” application;
2. Assists a consumer in obtaining or applying to obtain a residential mortgage loan; or
3. Offers or negotiates terms of a residential mortgage loan.

Interestingly, an early version of the S.A.F.E. Act included the second prong, above (i.e., assisting a consumer), and a small number of states enacted that version.  However, that prong was removed before the S.A.F.E. Act was finally enacted.  Under the Mortgage Reform Act, a person “assists a consumer in obtaining or applying to obtain a residential mortgage loan” by, among other things, advising on residential mortgage loan terms (including rates, fees, and other costs), preparing residential mortgage loan packages, or collecting information on behalf of the consumer with regard to a residential mortgage loan.  (This definition appears in the S.A.F.E. Act, but the phrase is not otherwise used in that Act.  In fact, it becomes a struggle to differentiate this scope of “assisting” activities from the clerical or support activities that the S.A.F.E. Act – and the Mortgage Reform Act, and most state laws – otherwise exclude from mortgage loan originating.)

Similar to the S.A.F.E. Act, the Mortgage Reform Act would specify that any person who represents to the public, through advertising or other means of communicating or providing information (including the use of business cards, stationery, brochures, signs, rate lists, or other promotional items), that such person can or will provide any of the services or perform any of the activities described above, constitutes a mortgage originator and is subject to the applicable requirements and prohibitions of the Mortgage Reform Act.

Although not fully clear on this point, the Mortgage Reform Act would appear to clarify that the definition of “mortgage originator” (and the new requirements and restrictions applicable to those individuals and organizations) does not generally include the creditor, but does include the creditor in a table-funded transaction for certain purposes.  Specifically, the creditor in a table-funded transaction (i.e., the person whose name appears as the payee on the initial loan documents, although the funds for the transaction are simultaneously provided by the loan purchaser) would appear to be subject to the Mortgage Reform Act’s restrictions on mortgage originator compensation and related remedies for violations, summarized below. 

Contrary to the S.A.F.E. Act, however, the Mortgage Reform Act takes a welcome step by expressly excluding from the definition of “mortgage originator” servicers and their employees, agents and contractors, including those who offer or negotiate terms of a residential mortgage loan for purposes of renegotiating, modifying, replacing and subordinating principal of existing mortgages where borrowers are behind in their payments, in default, or have a reasonable likelihood of being in default or falling behind.[3]  The Mortgage Reform Act defines “servicer” consistently with RESPA, as the person responsible for the servicing of a loan.  As we have indicated in past client alerts,[4] the applicability of the S.A.F.E. Act’s licensing and/or registration requirements to servicing individuals is a topic of continuing controversy, ambiguity, and lack of uniformity.  While requiring licensing of individuals who work for servicers to perform loan modifications and other loss mitigation activities presents a significant hurdle to the nationwide effort to prevent costly foreclosures and keep troubled borrowers in their homes, it appears those individuals will at least not be subject to the Mortgage Reform Act’s new requirements described herein for individuals and entities who actually originate mortgage loans.  Perhaps the Bureau, which will assume the role of implementing the S.A.F.E. Act, will take a cue from this Mortgage Reform Act definition and clarify that the S.A.F.E. Act does not require servicing individuals to be licensed as originators.

As indicated above, the definition of “mortgage originator” would be tied to, and limited by, the term “residential mortgage loan.”  The Mortgage Reform Act would define “residential mortgage loan” more narrowly than the S.A.F.E. Act.  The Mortgage Reform Act provides that a “residential mortgage loan” is any consumer credit transaction that is secured by a mortgage, deed of trust, or other equivalent consensual security interest on a dwelling or on residential real property that includes a dwelling.  The definition excludes a consumer credit transaction under an open end credit plan.  The definition also excludes, for purposes of many of the Mortgage Reform Act’s new requirements, an extension of credit relating to a timeshare plan.  Thus, the requirements described in this client alert applicable to mortgage originators would apply only in the context of consumer credit transactions that are closed-end, dwelling secured mortgage loans.

Mortgage Loan Originator Qualification and Unique Identifier Disclosure
The Mortgage Reform Act would require that mortgage originators be qualified and registered/licensed in accordance with applicable state or federal law, including the S.A.F.E. Act.  As indicated above, the S.A.F.E. Act applies only to individuals, but obviously many states impose licensing or other qualification requirements upon organizations that conduct mortgage loan origination activities as defined in the Mortgage Reform Act.  This provision will now create a federal violation for failure to comply with those state laws.

Additionally, the Nationwide Mortgage Licensing System and Registry (NMLS) and the S.A.F.E. Act have mandated the assignment of “unique identifiers” – a number assigned to licensees such as mortgage loan originators that identifies the originator and stays with him or her if (for example) an individual moves from one company to another.  The Mortgage Reform Act (like many states[5]) requires that mortgage loan originators include on all loan documents any unique identifier of the mortgage originator provided by the NMLS.  The law does not define specifically which loan documents must include the originator’s identifying number, whether the documents must include the number of both an originating entity and an originating individual or individuals, or whether compliance with a similar state law may constitute compliance with the federal requirement.  However, as with the qualification requirement described in the previous paragraph, failure to include the identifier on all loan documents is now a violation of the federal TILA and thus subject to the civil damages and other enforcement actions under that law (in addition to any sanctions, penalties, or licensing impairment available under state law).

The Mortgage Reform Act states that these requirements are “subject to regulations.”  Thus, it would appear that the effective date for these requirements may be down the road, once the Bureau is up-and-running, has issued final regulations, and those regulations have become effective.

Prohibition on Steering Incentives – Mortgage Originator Compensation
The law would prohibit mortgage originators from receiving from any person, and prohibits any person from paying to a mortgage originator, directly or indirectly, compensation that varies based on the terms of the loan (other than the amount of the principal).  This prohibition applies in connection with a residential mortgage loan; while the provision itself refers to “any mortgage loan,” the definition of “mortgage originator” is, as explained above, limited to “residential mortgage loans,” i.e., a closed-end, dwelling secured mortgage loan.  Further, based on the definition of “mortgage originator,” this compensation restriction would surprisingly apply both to payments by lenders to independent mortgage brokers and payments by lenders to their employee sales force.

Additionally, in a subsection called “Restructuring of Financing Origination Fee,” the Mortgage Reform Act curiously might be read, subject to exceptions described below, to prohibit a mortgage originator from receiving compensation from any person besides the consumer, presumably even if the originator’s compensation is not based on the loan terms (e.g., it is a flat fee or a percentage of the loan amount).  As mentioned above, since “mortgage originator” includes both retail loan officers and independent mortgage brokers, an overly aggressive reader might try to construe this provision to prohibit employer lenders from paying their employee loan officers, which obviously would be an absurd and unintended result; the exceptions to this prohibition reinforce the notion that this section is intended to address the payment by lenders of “back end fees,” like yield spread premiums, to independent mortgage brokers.

While there are no exceptions to the prohibition against compensation that varies with the loan terms (other than the loan amount), there are two exceptions to the prohibition against receiving compensation from someone besides the consumer:

1. The originator may pass along bona fide third party charges that are not retained by the creditor, mortgage originator, or an affiliate of the creditor or mortgage originator; 
2. The originator may receive an origination fee or charge other than from the consumer if the originator does not receive any compensation directly from the consumer; and the consumer does not make an upfront payment of discount points, origination points, or fees, however denominated (other than bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or originator).  The Board[vi] may provide an exception or waiver to these requirements in the interest of consumers and the public.

The law also prohibits any person from paying compensation to a mortgage originator, other than the consumer, or a person who does not know and has no reason to know that a consumer has directly compensated or will directly compensate a mortgage originator, unless one of the exceptions above applies.

The Mortgage Reform Act stresses, however, that it is not intended to prohibit incentive payments to a mortgage originator based on the number of residential mortgage loans originated within a specified period of time (although, obviously, RESPA would still apply).  Further, it is not intended to restrict a consumer’s ability, at his or her option, to finance, through principal or rate, any permitted origination fees or costs, or the mortgage originator’s right to receive those fees or costs (including compensation) from any person, subject to the criteria and requirements described above, so long as those fees or costs do not vary based on the terms of the loan (other than the amount of the principal) or the consumer’s decision about whether to finance those amounts.  

On the other hand, it stresses that it must not be construed to permit any yield spread premium (YSP) or other similar compensation that would, for any mortgage loan, permit the total amount of direct and indirect compensation from all sources permitted to a mortgage originator to vary based on the terms of the loan (other than the amount of the principal).

Finally, the Mortgage Reform Act would provide that its mortgage originator compensation rules are not intended to address the amount of compensation a creditor receives upon the sale of a consummated loan to a subsequent purchaser.  As a mortgage originator appears to be defined to include a creditor in a table-funded transaction for this purpose, it would appear that this rule of construction applies to sales of closed mortgage loans by funding loan purchasers and subsequent assignees.

Thus, it appears the following options for mortgage loan originator compensation would remain available under the new law (assuming they comply with other applicable law):

• A flat fee, paid by the consumer;
• A fee that varies based on the principal loan amount, paid by the consumer;
• A fee, paid by the consumer, based on any factor other than the loan terms (e.g., loan type);
• An origination fee or charge from someone other than the consumer, so long as the fee does not vary based on the terms of the loan (other than the amount of the principal), the originator receives no compensation from the consumer, and the consumer otherwise does not make an upfront payment for origination fees.

The bottom line is that YSPs now must RIP (rest in peace), unless the borrower chooses to finance a predetermined, fixed amount of total broker compensation through a higher interest rate.  This would enable, for example, no-points loans.  The key is that the total broker compensation has to be fixed and paid entirely by either the borrower or the mortgage lender in the case of third party originations.  Retail lenders, on the other hand, could structure loans where part of their compensation is paid at closing by the consumer and part is paid through increased principal or interest rate.  Moreover, variable compensation paid to a retail loan officer by the employer will be restricted if the compensation formula is tied to the interest rate on the loan.

Prohibition Against Steering by Mortgage Originators
The Mortgage Reform Act would require the Board to prescribe regulations to prohibit several acts or practices that generally constitute, according to the law, improper steering of consumers to “bad” loans by mortgage originators.  Interestingly, the inclusion of creditors in table-funding transactions into the definition of mortgage originators does not appear, by its terms, to apply to this subsection of the Act.  In summary, the Board must prohibit, by regulation, the following by mortgage originators: 

1. Steering any consumer to a residential mortgage loan for which the consumer lacks a reasonable ability to repay (in accordance with regulations); 
2. Steering any consumer to a residential mortgage loan that has predatory characteristics or effects (such as equity stripping, excessive fees, or abusive terms); the law does not provide any additional guidance as to which characteristics are “predatory,” nor does it provide guidance as to which characteristics are benign but have “predatory” effects;
3. Steering any consumer away from a “qualified” residential mortgage loan for which the consumer is qualified, to a residential mortgage loan that is not a “qualified” mortgage;
4. Mischaracterizing the credit history of a consumer or the residential mortgage loans available to a consumer; 
5. Mischaracterizing or suborning the mischaracterization of the appraised value of the property securing the extension of credit; 
6. Discouraging a consumer from seeking a home mortgage loan secured by a consumer’s principal dwelling from another mortgage originator, if the mortgage originator is unable to suggest, offer, or recommend to a consumer a loan that is not more expensive than a loan for which the consumer qualifies.

The Mortgage Reform Act does not provide any guidance as to what type of activity constitutes “steering.”  The Department of Housing and Urban Development (HUD) issued a proposed rule to solicit comments on implementing the S.A.F.E. Act for state licensed loan originators, and provided some indications that HUD may view nearly any activity of a loan originator to constitute “steering.”  HUD indicates that it considers a mortgage loan originator as any individual who takes any action that makes a prospective borrower more likely to accept a particular set of loan terms or an offer from a particular lender, where the individual may be influenced by a duty to or incentive from any party other than the borrower.  Thus, according to HUD’s proposal, any time an individual has a contractual duty to recommend one lender or product, that individual is a mortgage loan originator.  Thus, whether under the Mortgage Reform Act a mortgage originator may conduct any activity in the course of its business that does not constitute steering (thus essentially prohibiting mortgage loans that are not “qualified,” as discussed below) is an open question.

Once again, as this provision requires the Board/Bureau[7] to prescribe regulations to prohibit the enumerated activities, it would appear they will become effective upon the effective date of those future regulations.

“Unfair” Rulemaking Authority
In spite of any criticisms of federal regulators for lax scrutiny and enforcement leading up to the subprime mortgage crisis, the Mortgage Reform Act would provide the Board broad authority to deem mortgage practices and products unfair and to prohibit them.  In a sweeping (albeit confusing) sentence, the Act would provide that the Board shall, by regulations, prohibit or condition terms, acts, or practices relating to residential mortgage loans that the Board finds to be abusive, unfair, deceptive, predatory, necessary, or proper to ensure that responsible, affordable mortgage credit remains available to consumers in a manner consistent with the purposes of the new expansive TILA, or necessary or proper to effectuate those purposes, to prevent circumvention or evasion thereof, or to facilitate compliance with those provisions, or are not in the borrower’s interest.  (This rulemaking authority applies to all residential mortgage loans but not to timeshare financing.)

The Board has already addressed certain unfair practices through rulemaking, which we described in a prior alert,[8] and it asserted it has the authority under Section 129(l)(2) of TILA to address unfair mortgage loans.  Moreover, our alert on the Bureau notes that the Bureau would independently have the authority to issue regulations outlawing unfair and deceptive acts and practices by covered persons.  Nonetheless, this new provision of the Mortgage Reform Act appears to make the Board responsible for ensuring the availability of affordable mortgage credit – a phrase that resonates with the purposes behind the government sponsorship of Fannie Mae and Freddie Mac (and even the creation of HUD and FHA).

The Board also must prescribe regulations to prohibit abusive or unfair lending practices that promote disparities among consumers of equal credit worthiness but of different race, ethnicity, gender, or age.  The law does not provide any definition as to what practices the Board must prohibit.  Of course, discrimination is already prohibited under the Fair Housing Act and the Equal Credit Opportunity Act (although those laws prohibit discrimination that has occurred based on one’s status as a member of a protected class, while this provision appears to be forward-looking to disparities that might occur in the future).  It may stretch the bounds of optimism to hope that the new Bureau will fulfill its statutory mandate by simply creating a cross-reference to the existing requirements and regulations under those authorities.

Mortgage Loan Originator Liability for Violations
The new law amends TILA to provide liability for mortgage loan originators that fail to comply with the applicable new requirements above.  Section 130 of TILA generally addresses civil liability for violations by a “creditor” (i.e., the person who regularly extends credit subject to a finance charge and to whom the obligation is initially payable).  The Mortgage Reform Act provides that for purposes of providing a cause of action for any failure by a mortgage originator that is not a creditor to comply with the new requirements (i.e., qualification requirements, unique identifier requirements, anti-steering, restructuring of compensation), Section 130 will be applied with respect to any such failure.  The Mortgage Reform Act simply requires one to imagine that the term “creditor” in that section is replaced by “mortgage originator.”  

The maximum amount of any liability of a mortgage originator to a consumer for this purpose is the greater of actual damages or an amount equal to 3 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 costs to the consumer of the action, including a reasonable attorney’s fee.  We expect that the Bureau will interpret how this cap on liability will dovetail with the ceilings in class actions and individual actions contained in Section 130 of TILA.  We discuss below an important amendment that allows a consumer to assert a defense alleging a violation of the mortgage originator compensation restrictions or the ability to repay requirements (although this particular defensive right does not apply to other requirements, such as the enumerated anti-steering prohibitions), without regard for the statute of limitations.  (We also discuss other amendments related to liability and enforcement.)

Ability to Repay / Verification and Documentation
The Mortgage Reform Act would amend TILA to provide that all creditors must consider a borrower’s ability to repay.  (A creditor in a table-funded transaction would appear to be the creditor for purposes of this requirement, since the definition of “mortgage originator” appears to extend the definition to include table-funded creditors only in the case of the restrictions on compensation.)  Specifically, the Board is authorized to issue regulations prohibiting a creditor from making a residential mortgage loan (thus, a closed-end, dwelling secured mortgage loan, excluding for this purpose a reverse mortgage and a temporary or bridge loan with a term of 12 months or less) unless the creditor makes a reasonable and good faith determination based on verified and documented information that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan according to its terms, and all applicable taxes, insurance (including mortgage guarantee insurance), and assessments.  If the creditor knows, or has reason to know, that one or more residential mortgage loans secured by the same dwelling will be made to the same consumer, the creditor must determine the borrower’s repayment ability of the combined payments of all loans on the same dwelling according to the terms of those loans.

The creditor’s reasonable and good faith determination of a consumer’s ability to repay the loan would have to include consideration of the following in connection with the consumer:

• Credit history, 
• Current income,
• Expected income the consumer is reasonably assured of receiving, 
• Current obligations,
• Debt-to-income ratio, or the residual income the consumer will have after paying non-mortgage debt and mortgage-related obligations, 
• Employment status,
• Other financial resources other than the consumer’s equity in the dwelling or real property that secures repayment of the loan. 

Thus, in determining a consumer’s ability to repay, nothing in the Mortgage Reform Act expressly prohibits a creditor from relying solely on automated underwriting tools, assuming one can demonstrate that the required elements are considered in the model.  There are (as yet) no relative weighting requirements of the various elements as long as one can show that each required element has been considered. 

Paradoxically, although the Mortgage Reform Act would require consideration of “expected income the consumer is reasonably assured of receiving,” the Act also would permit a creditor to consider the “seasonality and irregularity” of income (if documented), including income from a small business, in the underwriting of and scheduling of payments.  Given the significant penalties for violating the ability to repay requirements, lenders may be reluctant to consider any non-regular income unless and until the Board/Bureau clarifies this seemingly inconsistent language.  Moreover, when the Board issued its ability to pay regulations for higher-priced mortgage loans in July 2008, it addressed public concerns regarding whether lenders were required somehow to consider the financial stability of an applicant’s employer and its industry in determining reasonable assurance of expected future income.  The Board responded at that time by including commentary in its rules examples such as a creditor that might have knowledge of a likely reduction in income or employment (e.g., a consumer’s written application indicates that the consumer plans to retire within 12 months or transition from full-time to part-time employment).  The Board clarified that it did not intend to place unrealistic requirements on a creditor to speculate or inquire about every possible change in a borrower’s life circumstances.  The Board also has stated that any reliance on expected income must be reasonable and based on reasonably reliable evidence.

The creditor also would have to verify amounts of income or assets on which it relies to determine repayment ability, including expected income or assets, by reviewing the consumer’s Internal Revenue Service Form W–2, tax returns, payroll receipts, financial institution records, or other third party documents that provide reasonably reliable evidence of the consumer’s income or assets.  To the extent the creditor considers the consumer’s income history in making a determination, the creditor must verify that income based on IRS transcripts of tax returns, or a method that quickly and effectively verifies income documentation by a third party subject to rules prescribed by the Board.   If the recent bad experiences of servicers trying to obtain verification documents from borrowers seeking loan modifications under the Home Affordable Mortgage Program (HAMP) are any indication, one should expect delays in the timing of loan approvals.  Nonetheless, while it is not clear that the Board/Bureau will require the borrower to submit tax returns in every case, we have come a long way from stated income or reduced documentation loans to a place where serious documentation must be obtained for every transaction.

The Mortgage Reform Act would provide certain guidance as to how the creditor must calculate the monthly payment amount for principal and interest on an applicable loan for determining the borrower’s ability to repay.  Specifically, the creditor must make the following assumptions:

1. The loan proceeds are fully disbursed on the date of loan consummation;
2. The loan is to be repaid in substantially equal monthly amortizing payments for principal and interest over the entire term of the loan with no balloon payment, unless the loan contract requires more rapid repayment (including balloon payment), in which case the calculation must be made in accordance with regulations prescribed by the Board, with respect to any loan with an annual percentage rate (APR) that does not exceed the higher-priced mortgage loan thresholds (specified below);
   
   For loans that require more rapid repayment or a balloon payment, and with an APR that exceeds the higher-priced mortgage loan thresholds, the creditor must use the contract’s repayment schedule; and
3. The interest rate over the entire term of the loan is a fixed rate equal to the fully indexed rate at the time of the loan closing, without considering the introductory rate.

(The APR thresholds for a higher-priced mortgage loan are, for first-lien mortgage loans, an APR that exceeds the average prime offer rate for a comparable transaction, as of the date the interest rate is set, by 1.5 or more percentage points; or by 3.5 or more percentage points for a subordinate-lien residential mortgage loan.)

A creditor must determine the ability of the consumer to repay using a payment schedule that fully amortizes the loan over the term of the loan, taking into consideration any balance increase that may accrue from any negative amortization.  For variable rate loans that allow or require the consumer to defer the repayment of any principal or interest, the creditor must nonetheless use a fully amortizing repayment schedule to determine the consumer’s ability to repay.  For interest-only loans (that permit or require the payment of interest only), the creditor must use the payment amount required to amortize the loan by its final maturity.  

The statute provides for special considerations when attempting to refinance an existing hybrid loan into a standard loan to be made by the same creditor that would result in lower monthly payments.  If the mortgagor has not been delinquent on any payment on the existing hybrid loan, the creditor may consider the mortgagor’s good standing, whether the mortgagor is likely to default upon a reset of the existing loan, and whether the new “standard” loan would prevent that default.  Under those circumstances, the creditor may offer rate discounts and other favorable terms to the mortgagor that would be available to new customers with high credit ratings.  The law does not provide any guidance as to what constitutes a “standard” loan, other than its new category of “qualified” mortgage loans, or a guess that it simply means a loan that is not a hybrid.  The law addresses “hybrid adjustable rate mortgages” (ARM) in connection with a new reset disclosure requirement (addressed in a separate K&L Gates client alert).  In that context, a “hybrid ARM” means a consumer credit transaction secured by the consumer’s principal residence with a fixed interest rate for an introductory period that adjusts or resets to a variable interest rate after such period.

With respect to loans made, guaranteed, or insured by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), the Department of Agriculture, or the Rural Housing Service, those agencies may exempt “streamlined refinancings” (i.e., non-cash out refinancings) from this new income verification requirement as long as the following conditions are met:

1. The consumer is not 30 days or more past due on the prior existing residential mortgage loan;
2. The refinancing does not increase the principal balance outstanding on the prior existing residential mortgage loan, except to the extent of fees and charges allowed by the relevant agency;
3. Total points and fees (as defined in TILA), other than bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator, payable in connection with the refinancing do not exceed 3 percent of the total new loan amount;
4. The interest rate on the refinanced loan is lower than the interest rate of the original loan, unless the borrower is refinancing from an adjustable rate to a fixed-rate loan, under guidelines that the relevant agency established or may establish;
5. The refinancing is subject to a payment schedule that will fully amortize the refinancing in accordance with the regulations prescribed by the department or agency making, guaranteeing, or insuring the refinancing;
6. The terms of the refinancing do not result in a balloon payment; and
7. Both the residential mortgage loan being refinanced and the refinancing satisfy all of the relevant agency’s requirements.

As indicated above, this ability to repay requirement is “in accordance with regulations prescribed by the Board.”  That appears to indicate that it will become effective upon the effective date of future final regulations.

Presumption of Ability to Repay / “Qualified Mortgage” Loans
The Mortgage Reform Act would provide that a creditor under a residential mortgage loan, and any assignee of the loan subject to liability under TILA, may presume that the loan has met these new ability to repay requirements if the loan is a qualified mortgage.  A “qualified mortgage” means any residential mortgage loan (again, a closed-end, dwelling secured loan) for which all the following apply:

1. The regular periodic payments for the loan may not:
   1. Result in an increase of the principal balance; or
   2. Except for certain balloon loans, described below, allow the consumer to defer repayment of principal;
2. The terms of the loan do not result in a balloon payment (i.e., a scheduled payment that is more than twice as large as the average of earlier scheduled payments), except under certain circumstances;
3. The income and financial resources relied upon to qualify the obligors on the loan are verified and documented;
4. In the case of a fixed rate loan, the underwriting process 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;
5. In the case of an adjustable rate loan, the underwriting is based on the maximum rate permitted under the loan during the first 5 years, and a payment schedule that fully amortizes the loan over the loan term and takes into account all applicable taxes, insurance, and assessments;
6. The loan complies with any guidelines or regulations the Board establishes relating to debt-to-income ratios or alternative measures of ability to pay regular expenses after payment of total monthly debt, taking into account the borrower’s income levels and such other factors the Board establishes;
7. The total points and fees (defined below) payable in connection with the loan do not exceed 3 percent of the total loan amount (the Board is required to prescribe a points and fees threshold for “smaller loans” to meet the requirements of this presumption, considering the potential impact on rural areas and other areas where home values are lower); and
8. The loan term does not exceed 30 years, except as such term may be extended under certain circumstances, such as in high-cost areas.

Interestingly, the law adopts a new definition of “points and fees” for this purpose, relying upon a modification of the standard TILA “points and fees” definition, but excluding either of the two following amounts (depending upon the loan’s interest rate):  (I) up to and including 2 bona fide discount points[9] payable by the consumer in connection with the mortgage, but only if the interest rate from which the mortgage’s interest rate will be discounted does not exceed by more than 1 percentage point the average prime offer rate; or (II) if the interest rate from which the mortgage’s interest rate will be discounted does not exceed by more than 2 percentage points the average prime offer rate, and unless 2 bona fide discount points have been excluded under clause (I), above, up to and including 1 bona fide discount point payable by the consumer in connection with the mortgage.  Nonetheless, the definition of “points and fees” relies in the first instance upon the definition used for HOEPA loans, which as explained below, has been expanded to include all mortgage broker compensation (both direct and indirect, paid by a consumer, the creditor, or any other source), upfront premiums for credit insurance and similar products, and maximum prepayment penalties (but would exclude FHA and certain other mortgage guaranty insurance premiums).

In spite of the exclusion of balloon loans from the definition of a “qualified mortgage,” the Board is authorized to issue regulations providing that a certain very limited set of balloon loans do qualify.  The Board’s regulations may provide that a balloon loan is a “qualified mortgage” if the creditor determines that the consumer can make all scheduled payments (except the balloon payment) out of income or assets other than the collateral; the underwriting is based on a fully amortizing payment schedule, considering taxes, insurance, and assessments; and it otherwise generally meets the criteria described above.  In addition, a “qualified” balloon mortgage must be made by a creditor that operates predominantly in rural or underserved areas; together with all affiliates, has total annual mortgage loan originations that do not exceed a limit set by the Board; retains the balloon loans in portfolio; and meets any asset size threshold and any other criteria the Board establishes.

The Board can prescribe regulations that revise, add to, or subtract from the criteria that define a qualified mortgage, in its furtherance of the availability of responsible, affordable mortgage credit.  However, unlike the definition of “qualified residential mortgage loans” in the risk retention sections of the Dodd-Frank Act, the Mortgage Reform Act’s ability to repay requirement does not provide a categorical exemption for government insured or guaranteed mortgage loans.  Nevertheless, the Act would require HUD, VA, the Department of Agriculture, and the Rural Housing Service to prescribe rules, in consultation with the Board, defining the types of loans they insure, guarantee, or administer, as the case may be, that are “qualified mortgages,” and those rules may revise, add to, or subtract from the criteria used to define a qualified mortgage upon a finding that the rules are consistent with the Act’s purposes, will prevent circumvention or evasion, or will facilitate compliance.

Prohibitions Against “Bad” Loan Terms
The Mortgage Reform Act then provides a familiar litany of prohibitions against loan terms that policymakers have determined are just not good for anybody – not for borrowers with costly mortgage loans, and now, not for borrowers under any mortgage loans.  Below, we summarize some of the Act’s largely predictable targets for scorn.  These prohibitions do not expressly require implementation by regulation, and thus it is unclear, as described above, when they would become effective.

Prohibition Against Prepayment Penalties. The Mortgage Reform Act provides that only lower priced, fixed-rate, “qualified mortgages” may contain a penalty fee for prepaying all or part of the principal.  Thus, loans such as those with an adjustable rate, or those with an APR that exceeds certain higher-priced mortgage loan thresholds, must not contain a prepayment penalty.  For this purpose, the only loans in which a creditor may impose a prepayment penalty are fixed-rate loans with an APR that does not exceed the average prime offer rate for a comparable transaction, as of the date the interest rate is set:  (I) by 1.5 or more percentage points, for first lien residential mortgage loans with an original principal amount that is equal to or less than the Freddie Mac maximum limits; or (II) by 2.5 or more percentage points, for first lien loans with an original principal obligation amount that exceeds Freddie Mac’s maximum limits; or (III) by 3.5 or more percentage points, in the case of subordinate lien residential mortgage loans.

Of course, even for fixed-rate, lower-priced qualified mortgage loans, the Mortgage Reform Act imposes restrictions on the creditor’s imposition of a prepayment fee.  First, in a fixed-rate, lower-priced qualified mortgage, as specifically described above, a creditor must not offer a consumer a product that has a prepayment penalty without offering the consumer a loan product that does not have a prepayment penalty.  Second, the Act restricts the amount of a prepayment penalty, based upon when the prepayment occurs.  In a fixed-rate, lower-priced qualified mortgage as described above, the loan must not contain a prepayment penalty in excess of the following limitations:

1. For a prepayment within the first year, 3 percent of the outstanding loan balance;
2. For a prepayment within the second year, 2 percent of the outstanding loan balance;
3. For a prepayment within the third year, 1 percent of the outstanding loan balance; and
4. After the end of the 3-year period, no prepayment penalty may be imposed on a qualified mortgage.

Single Premium Credit Insurance. If any creditors are still considering offering single premium credit insurance, the Mortgage Reform Act prohibits a creditor from financing, directly or indirectly, in connection with any residential mortgage loan or with any open-end credit plan secured by the principal dwelling of the consumer, any credit life, credit disability, credit unemployment, or credit property insurance, or any other accident, loss-of-income, life, or health insurance, or any payments directly or indirectly for any debt cancellation or suspension agreement or contract, except if the insurance premiums or debt cancellation or suspension fees are calculated and paid in full on amonthly basis.  This prohibition does not, however, apply to credit unemployment insurance for which the unemployment insurance premiums are reasonable, the creditor receives no direct or indirect compensation in connection with the unemployment insurance premiums, and the unemployment insurance premiums are paid pursuant to another insurance contract and not paid to an affiliate of the creditor.

Prohibition Against Mandatory Arbitration. No residential mortgage loan and no open end credit plan secured by the consumer’s principal dwelling may include terms that require arbitration or any other nonjudicial procedure as the method for resolving any controversy or settling any claims arising out of the transaction.  However, the consumer and the creditor or any assignee may still agree to arbitration or any other nonjudicial procedure as the method for resolving any controversy at any time after a dispute or claim under the transaction arises.  Nonetheless, no provision of any such loan, and no other agreement between the consumer and the creditor relating to such a loan, may be applied or interpreted to bar a consumer from bringing an action in a court of competent jurisdiction.

New Disclosures
The Mortgage Reform Act would also impose a number of new disclosure requirements.  These new disclosure requirements do not expressly require regulations for implementation, and thus it is unclear when they would become effective  As you will see, nobody said that mortgage reform necessarily means mortgage simplification, because in many cases the information to be provided is already covered by other mandated disclosures under existing federal consumer credit laws.  We describe those new disclosures applicable to the servicing of a loan (as opposed to those required to be provided at or near the time of origination) in a separate client alert.  However, below we summarize the new origination-related disclosure requirements.

Disclosure of Partial Payment Policies. In the case of any residential mortgage loan (other than a timeshare loan), a creditor must disclose prior to settlement (or at the time a person becomes a creditor), the creditor’s policy regarding the acceptance of partial payments; and if partial payments are accepted, how they will be applied to the mortgage loan and whether they will be placed in escrow.  This is an odd requirement since it merely discloses the originating lender’s requirements and does not bind assignees and their servicers.

Disclosure for Closed-End Variable Rate Loans. Section 128(a) of TILA provides disclosure requirements for all closed-end consumer credit transactions.  The Mortgage Reform Act adds new required disclosures for those transactions that are residential mortgage loans.  

First, for a variable rate residential mortgage loan for which an escrow or impound account will be established for the payment of all applicable taxes, insurance, and assessments, the creditor must disclose the following information:

1. The amount of initial monthly payment due under the loan for the payment of principal and interest, and the amount of such initial monthly payment including the monthly payment deposited in the account for the payment of all applicable taxes, insurance, and assessments; and
2. The amount of the fully indexed monthly payment due under the loan for the payment of principal and interest, and the amount of such fully indexed monthly payment including the monthly payment deposited in the account for the payment of all applicable taxes, insurance, and assessments.

Second, in the case of any residential mortgage loan (fixed or variable rate), the creditor must disclose the aggregate amount of settlement charges for all settlement services provided in connection with the loan, the amount of charges that are included in the loan and the amount of such charges the borrower must pay at closing, the approximate amount of the wholesale rate of funds in connection with the loan, and the aggregate amount of other fees or required payments in connection with the loan.  This is a terribly confusing requirement that appears to have survived through the House’s contributions to the Dodd-Frank Act.[10]  First, it appears to duplicate some of the disclosure requirements under RESPA to be included in the HUD-1 Settlement Statement.  Then, if not settlement charges, what other fees or charges are required to be disclosed?  Finally, what does it mean to disclose the “wholesale rate of funds”?  The bill would not include any guidance as to its meaning, although it apparently goes to a criticism that RESPA requires the disclosure of YSPs, but not the spread a lender receives between the rate the borrower will pay and the lender’s cost of funds (or the amount the lender will earn in connection with the loan in the secondary market).  

Third, for any residential mortgage loan, the creditor must disclose the aggregate amount of fees paid to the mortgage originator in connection with the loan, the amount of such fees paid directly by the consumer, and any additional amount received by the originator from the creditor.  However, this information is already generally required in the HUD-1 under RESPA.  Perhaps the consolidation of rulemaking authority within the new Bureau will finally force the issue of compatible and nonduplicative mortgage disclosures, as the Bureau is tasked with combining the TILA and RESPA disclosures into a single, integrated disclosure form.

Fourth, for any residential mortgage loan, the creditor must disclose the total amount of interest that the consumer will pay over the life of the loan as a percentage of the principal of the loan.  That amount must be computed assuming the consumer makes each monthly payment in full and on-time, and does not make any over-payments.  Again, this information is generally provided to the consumer in his or her TILA disclosure.

Disclosure Regarding Escrow Payments. For first-lien, closed-end dwelling secured loans (other than reverse mortgage loans), for which an impound, trust, or other type of account has been or will be established for the payment of property taxes, hazard and flood (if any) insurance premiums, or other periodic payments or premiums with respect to the property, the information required to be provided under Section 128(a) of TILA with respect to the number, amount, and due dates or period of payments scheduled to repay the total of payments must take into account the amount of any monthly payment to the escrow account.  The amount must reflect the taxable assessed value of the real property securing the transaction after the consummation of the transaction, including the value of any improvements on the property or to be constructed on the property (whether or not such construction will be financed from the proceeds of the transaction), if known, and the replacement costs of the property for hazard insurance, in the initial year after the transaction.  How will the lender know what the taxable assessed value of the real property securing the loan would be after the transaction?

Disclosure and Counseling for Negative Amortization Loans. In connection with an open- or closed-end dwelling-secured mortgage loan, other than a reverse mortgage, that provides or permits a payment plan that may at any time result in negative amortization, a creditor must, before the loan transaction is consummated, provide the consumer with a statement that the transaction will or may result in negative amortization, which would increase the outstanding principal balance and reduce the consumer’s equity in the property.

In the case of a first-time borrower with respect to a residential mortgage loan that is not a qualified mortgage, the borrower must receive homeownership counseling from a HUD-certified counselor and provide the creditor with documentation of that counseling.

Anti-Deficiency Protection Disclosure. In the case of any residential mortgage loan (i.e., closed-end, dwelling secured) that is, or upon consummation will be, subject to protection under an anti-deficiency law, the creditor or mortgage originator must provide a written notice to the consumer, before the loan is consummated, describing the law’s protection and the significance for the consumer of the loss of such protection.  Similarly, if a creditor or mortgage originator provides an application to a consumer, or receives an application from a consumer, for any type of refinancing for such a loan subject to anti-deficiency law protection, that would cause the loan to lose that law’s protection, the creditor or mortgage originator must provide a written notice to the consumer describing the anti-deficiency protection and the significance for the consumer of the loss of such protection before any agreement for the refinancing is consummated.  For this purpose, an “anti-deficiency law” is a law of any state that provides that, in the event of foreclosure on the residential property of a consumer securing a mortgage, the consumer is not liable for any deficiency between the foreclosure sale price and the loan’s outstanding balance.

RESPA Special Information Booklet. The Mortgage Reform Act also revises RESPA’s Special Information Booklet, now called the Home Buying Information Booklet, intended to help consumers applying for federally related mortgage loans to understand the nature and costs of real estate settlement services.  The law requires the Bureau Director to revise the booklet at least once every 5 years, and to prepare the booklet in various languages and cultural styles to be understandable and accessible to homebuyers of different ethnic and cultural backgrounds.  The Director must distribute the booklets to all lenders that make federally related mortgage loans, and to lenders’ lists of homeownership counselors.  Then the lender is obligated to provide the consumer the booklet in the version that is most appropriate for him or her.  

The law provides a list of loan terms and practices, and consumer rights and obligations that the booklet must, at a minimum, explain.  The booklet also must provide a list and explanation of questions a consumer should ask regarding the loan, including whether the consumer will have the ability to repay the loan, whether the consumer sufficiently shopped for the loan (an interesting question for a consumer to ask his or her prospective creditor), whether the loan terms include prepayment penalties or balloon payments, and whether the loan will benefit the borrower.  When the lender provides the consumer the booklet, the lender also must provide a list of certified homeownership counselors.  

Credit Scores. The Dodd-Frank Act would also amend FCRA to require creditors that make adverse decisions based on information in an applicant’s credit report to disclose the applicant’s credit score and other information.  Specifically, when a consumer report user takes an adverse action on the basis of consumer report information, or when such a person offers credit on materially less favorable terms than the most favorable available terms, as specified in FCRA, the person must disclose the following (in addition to other required information):

1. A numerical credit score used in taking the action; 
2. The range of possible credit scores under the model used; 
3. The key factors (up to 4) that adversely affected the consumer’s credit score in the model used;
4. The date on which the credit score was created; and 
5. The name of the person or entity that provided the credit score or the credit file upon which the credit score was created.

As with many of the new disclosures in the Mortgage Reform Act, this requirement is somewhat repetitive.  FCRA already requires any person who makes or arranges loans and who uses a consumer credit score in connection with an application initiated or sought by a consumer for a residential mortgage loan to provide the information above “as soon as reasonably practicable.”[11]  The Board also has established extensive regulations (effective in January) to implement risk-based pricing disclosure requirements that address credit score disclosures.[12]  Thus, this new requirement may mean the consumer receives duplicative credit score disclosures that serve only to confuse.

Broad Disclosure Rulemaking Authority. In addition, the Board may amend or create exemptions from disclosure requirements for any class of residential mortgage loans, if the Board determines that it is in consumers’ and the public interest.  It is unclear if this applies only to disclosure requirements imposed under TILA, or under other disclosure regimes (RESPA, ECOA, FCRA, etc.).

Liability and Enforcement
As mentioned above, the Mortgage Reform Act adds civil liability exposure under TILA for mortgage loan originators for violations of requirements and restrictions newly applicable to those individuals or entities, similar to the liability to which creditors are currently exposed, although subject to different limits in damages.  In addition, the Mortgage Reform Act makes other “enhancements” to TILA liability and enforcement exposure for mortgage lending.  

In a nutshell, if a creditor makes a non-“qualified” loan that falls outside the protection of the S.A.F.E. harbor described above (e.g., because the points and fees exceed 3 percent), the creditor and its assignees are subject to the borrower’s claims of a violation by the creditor of certain requirements up to the point the creditor or assignee attempts to collect or foreclose.  In addition, the loan can much more easily fall into HOEPA territory (and its accompanying exposure to liability for creditors and assignees), due to the expanded triggers for those loans.

Civil Liability Limits. The law raises the limits on statutory damages for class actions in Section 130(a) of TILA, particularly for larger institutions.  Currently, that section provides (among other provisions for statutory and actual damages) that a creditor who fails to comply with TILA is liable for an amount, in the case of a class action, of up to the lesser of $500,000 or 1 percent of the creditor’s net worth.  This law raises that limit to the lesser of $1,000,000 or 1 percent of the creditor’s (or mortgage originator’s) net worth.  (Congress raised the limits for individual actions in the Housing and Economic Recovery Act of 2008, to an amount from $400 to $4,000; the Mortgage Reform Act would leave those limits on individual actions in place.)  

In addition, the law makes available so-called “enhanced” damages (an amount equal to the sum of all finance charges and fees paid by the consumer) for the new restrictions on mortgage originator compensation and the requirements for determining a consumer’s ability to repay.  (Enhanced damages presently are available under TILA only for violations of HOEPA with respect to “high-cost” loans and for certain violations in connection with “higher-priced mortgage loans.”)  Even under the Mortgage Reform Act, the enhanced damages provisions would not apply to the anti-steering restrictions on mortgage originators that do not involve compensation (e.g., prohibitions on steering borrowers to loans with predatory characteristics or that promote disparities), the new substantive restrictions on bad loan terms, the new disclosure requirements described above, or the qualification requirements for mortgage originators.

Extension of Statute of Limitations for Section 129 Violations. The general limitations period for civil actions under TILA is one year from the date of the occurrence of the violation.  However, the law amends Section 130(e) by making an exception for actions with respect to violations of TILA related to HOEPA loans, as well as the new requirements and prohibitions of the Mortgage Reform Act (restrictions on compensation, prohibitions against steering, requirements for determining ability to repay, prohibitions against prepayment fees, single premium credit insurance, and mandatory arbitration, and disclosures regarding anti-deficiency law protection and partial payment policies).  For actions in connection with violation of those provisions, the new limitations period will be 3 years (except in the case of certain alleged violations which the consumer may assert as a defense to a collection or foreclosure action, as addressed below).

Defense to Foreclosure or Collection. While the final version of the Mortgage Reform Act appears to have rejected the House’s provisions regarding the right of consumers to assert rescission against assignees for violation of the ability to repay requirements, it did add a form of assignee liability.  It amended Section 130 of TILA to provide an outlet for defenses in recoupment when a creditor or assignee attempts to collect or foreclose.  The new provision states that when a creditor, assignee, or other holder of a residential mortgage loan (or anyone acting on their behalf) initiates a judicial or nonjudicial foreclosure of the loan or any other action to collect the debt in connection with the loan, a consumer may assert a defense, by recoupment or set-off, alleging a violation by a creditor of the mortgage originator compensation restrictions or the ability to repay requirements without regard for the statute of limitations (described above).  As with the limitation on the right to pursue enhanced damages, this defensive right would not apply to the anti-steering restrictions on mortgage originators not involving compensation (e.g., prohibitions on loans with predatory characteristics or that promote disparities), the new substantive restrictions on bad loan terms, or the new disclosure requirements described above.  The amount available to the consumer in recoupment or set-off is generally limited to the amount to which the consumer would otherwise be entitled in civil damages under Section 130(a) (e.g., actual damages, statutory damages, and enhanced damages) for a valid claim brought in an original action against the creditor (within the applicable statute of limitations), plus the costs to the consumer of the action and a reasonable attorney’s fee.

Lender Rights Upon Borrower Deception. The law provides relief from liability for creditors and assignees to an obligor under Section 130 of TILA if the obligor or a co-obligor has been convicted of obtaining the residential mortgage loan by actual fraud.

Authority of State Attorneys General. TILA has historically afforded state attorneys general the authority (or the co-authority) to enforce a violation of Section 129 on “high-cost” loans under HOEPA.  The Mortgage Reform Act would expand that co-authority to include the requirements described in this client alert (along with many other new requirements).  

Authority of the Bureau. Otherwise, as one might guess, the Bureau is afforded general authority to commence a civil action to enforce a violation under TILA, to impose a civil penalty or to seek other permissible relief.[13]  Our alert on the Bureau provides greater details of the wide array of administrative remedies available to the Bureau.

HOEPA Revisions
The law also makes substantial changes to HOEPA.  Since essentially nobody knowingly makes, finances, sells, purchases, services, or securitizes HOEPA loans (called “high-cost mortgages” under the Act’s new definition), due to the onerous liability that attaches to those loans and follows them into the secondary market, we have chosen not to describe all those changes.  

High-Cost Mortgage Triggers. However, the Mortgage Reform Act amends the high-cost thresholds or financial triggers that cause a loan to be considered a high-cost mortgage, aligning them somewhat with the definitions of the newly-minted category of higher-priced mortgage loans, and adding some non-cost substantive triggers that will put another nail in the coffin for prepayment fees.  We describe those changes below because the points and fees definition for “qualified mortgages” relies upon the high-cost mortgage definition, simply because the industry generally seeks to avoid triggering the high-cost thresholds.  

In particular, the high-cost mortgage basket will for the first time include purchase money loans.  Otherwise, a high-cost mortgage means a consumer credit transaction that is secured by the consumer’s principal dwelling, other than a reverse mortgage transaction, if the loan exceeds the following thresholds:

1. For a first mortgage on the consumer’s principal dwelling, the APR at consummation of the transaction will exceed by more than 6.5 percentage points (or 8.5 percentage points, if the dwelling is personal property and the transaction is for less than $50,000) the average prime offer rate for a comparable transaction; or
2. (For a subordinate or junior mortgage on the consumer’s principal dwelling, the APR at consummation of the transaction will exceed by more than 8.5 percentage points the average prime offer rate for a comparable transaction; or
3. For a transaction of $20,000 or more, the total points and fees payable in connection with the transaction, other than bona fide third party charges not retained by the mortgage originator, creditor, or an affiliate of the creditor or mortgage originator, exceed 5 percent of the total transaction amount; or
4. For a transaction for less than $20,000, the lesser of 8 percent of the total transaction amount or $1,000 (or such other dollar amount as the Board sets); or
5. The loan documents permit the creditor to charge or collect prepayment fees or penalties more than 36 months after the transaction closing, or those fees or penalties exceed, in the aggregate, 2 percent of the amount prepaid.

For purposes of determining whether a loan exceeds the APR threshold, the creditor must generally use the interest rate in effect on the date of consummation of the transaction, but for transactions in which the rate of interest varies solely in accordance with an index, the creditor must use the interest rate determined by adding the index rate in effect on the date of consummation of the transaction to the maximum margin permitted at any time during the loan agreement.  For other transactions with an interest rate that may change for any reason, the creditor must use the interest charged on the transaction at the maximum rate that may be charged during the term of the loan.

The Mortgage Reform Act also would change the range of discretionary authority of the Board to adjust the APR thresholds.  The law provides that the Board may increase or decrease the APR threshold, but it may not go below 6 percentage points or above 10 percentage points for first-lien loans; and it may not go below 8 percentage points or above 12 percentage points for subordinate-lien loans.

The Act would amend the calculation of a loan’s total points and fees by providing that the calculation may exclude certain mortgage guaranty insurance premiums – specifically, the calculation may exclude any government agency insurance premium; any amount that is not in excess of the amount payable under FHA policies in effect at the time of origination in connection with upfront premiums (12 U.S.C. § 1709(c)(2)(A)), provided that the premium, charge, or fee is required to be refundable on a prorated basis and the refund is automatically issued upon notification of the satisfaction of the underlying mortgage loan; and any premium paid by the consumer after closing.  In addition, the law provides that a creditor may exclude certain bona fide discount points from the points and fees calculation.  

However, the Act would clarify that all mortgage broker compensation must be included in the total points and fees calculation, including both direct and indirect compensation, paid by a consumer, the creditor, or any other source.  This would include compensation paid to the creditor in a table-funded transaction.  Since the anti-steering provisions prohibit back end compensation except where such compensation is the sole source of broker compensation, this change should not lead to a material expansion of loans subject to the high-cost mortgage restrictions.

The law also would clarify that the calculation must include premiums or other charges payable at or before closing for any credit life, credit disability, credit unemployment, or credit property insurance, or any other accident, loss-of-income, life or health insurance, or any payments directly or indirectly for any debt cancellation or suspension agreement or contract, except that insurance premiums or debt cancellation or suspension fees calculated and paid in full on a monthly basis shall not be considered financed by the creditor.  Points and fees also must include the maximum prepayment fees and penalties that may be charged or collected under the terms of the credit transaction; and all prepayment fees or penalties that are incurred by the consumer if the loan refinances a previous loan made or currently held by the same creditor or an affiliate of the creditor.

As noted above, we do not discuss the amendments to the prohibitions and restrictions applicable to HOEPA loans, as again, those loans largely have disappeared.  To the extent the thresholds for those loans have expanded, we predict a larger set of loans will disappear.

New Cure Provisions Applicable to High-Cost Mortgages. One other interesting addition to the high-cost mortgage world, however, is a new cure provision that would allow a creditor or assignee of a high-cost mortgage to avoid liability by setting the loan straight.  The Mortgage Reform Act would add a provision to HOEPA stating that a creditor or assignee in a high-cost mortgage that, when acting in good faith, fails to comply with any requirement under HOEPA (i.e., Section 129 of TILA) will not be deemed to have violated that requirement if the creditor or assignee establishes that it quickly notified the consumer and fixed the situation.  Specifically, the creditor or assignee must, in order to avoid liability, ensure that the consumer is notified of or discovers the violation, appropriate restitution is made, and whatever adjustments necessary are made to the loan to either, at the consumer’s choice, make the loan satisfy TILA/HOEPA requirements, or change the terms of a high-cost mortgage in a manner beneficial to the consumer so that the loan will no longer be a high-cost mortgage.  The deadline for fixing the loan is short – the creditor or assignee has 30 days from loan closing (if prior to the institution of any action).  However, in the case of an unintentional violation or bona fide error, the creditor or assignee has 60 days from the creditor’s discovery or receipt of notification of the violation or error (and prior to the institution of any action).  One can expect, however, that the Bureau will follow in the Board’s footsteps by construing what constitutes an unintentional violation or bona fide error very narrowly.  Nonetheless, if discovered quickly, this cure provision may help the unwitting makers or purchasers of high-cost mortgages.

HMDA Additions
The Dodd-Frank Act also would add to HMDA new data itemization elements for the mortgage loans that applicable institutions originate or purchase.  Currently, HMDA requires applicable institutions to itemize the data they maintain according to the number and dollar amount of FHA loans, non-principal residence loans, and home improvement loans; and the number and dollar amount of loans and completed applications involving mortgagors or applicants grouped according to census tract, income level, racial characteristics, and gender.  The Dodd-Frank Act would require itemization by age, as well.  

It also would require itemization of the number and dollar amount of mortgage loans grouped according to measurements of the following:

1. The total points and fees payable at origination in connection with the mortgage (taking into account the new HOEPA definition of that phrase);
2. The difference between the APR associated with the loan and a benchmark rate or rates for all loans;
3. The term in months of any prepayment penalty; and
4. Such other information as the Bureau may require.

The Act also would require applicable institutions to itemize the number and dollar amount of mortgage loans and completed applications grouped according to measurements of the following:

1. The value of the real property pledged or proposed to be pledged as collateral;
2. The actual or proposed term in months of any introductory period after which the rate of interest may change;
3. The presence of contractual terms or proposed contractual terms that would allow the mortgagor or applicant to make payments other than fully amortizing payments during any portion of the loan term;
4. The actual or proposed term in months of the mortgage loan;
5. The channel through which application was made, including retail, broker, and other relevant categories;
6. As the Bureau may determine to be appropriate, the loan originator’s unique identifier;
7. As the Bureau may determine to be appropriate, a universal loan identifier;
8. As the Bureau may determine to be appropriate, the parcel number that corresponds to the real property pledged or proposed to be pledged as collateral;
9. The credit score of mortgage applicants and mortgagors; and
10. Such other information as the Bureau may require.

The Bureau is required to consult with the other appropriate agencies to develop regulations that, among other requirements, require the collection of data as described above with respect to loans sold by each reporting institution, and the disclosure of the class of the purchaser of such loans.  

While it is somewhat of a relief to note that institutions will not be required to report the new data described above before the beginning of the calendar year that is 9 months after the Bureau issues final regulations, these new elements will require significant systems and procedures adjustments.

S.A.F.E. Act Amendments
The Mortgage Reform Act would also amend the S.A.F.E. Act, which as mentioned above requires the licensing and/or registration of individual mortgage loan originators (as defined in the S.A.F.E. Act).  The Dodd-Frank Act would transfer to the Bureau the authority to administer the S.A.F.E. Act.  This means that the Bureau will be charged with developing and maintaining a system for registering with the NMLS individual mortgage loan originator employees of a depository institution, regardless of the institution’s size, employees of a subsidiary that is owned and controlled by a depository institution and regulated by a federal banking agency, and employees of an institution regulated by the Farm Credit Administration (FCA).  While the S.A.F.E. Act required the federal banking agencies to develop such a system by July 2009, the agencies and the NMLS have not yet been able to complete it.  The new law extends the deadline for developing the NMLS registration system for those mortgage loan originator employees for another year (July 2011), which unfortunately still could occur before the Bureau is operational.

In addition, the S.A.F.E. Act in 2008 gave HUD the authority to determine whether a state had implemented a S.A.F.E. Act-compliant licensing system for state mortgage loan originators (i.e., those individual loan originators who are not employees of depository institutions, owned-and-controlled subsidiaries, or FCA-regulated institutions).  If HUD determined that the state failed to do so, then HUD was required to establish a back-up licensing system.  The Dodd-Frank Act would transfer HUD’s authority in this regard to the Bureau. 

The new law also would give the Bureau additional S.A.F.E. Act authority related to mortgage loan originator net worth, surety bond, or recovery fund requirements.  Specifically, the Bureau would be authorized to promulgate regulations setting minimum net worth or surety bond requirements for residential mortgage loan originators and minimum requirements for recovery funds paid into by loan originators.  In issuing those regulations, the Bureau once again would be tasked with promoting the availability of affordable “good” loans, by factoring in the need to provide originators adequate incentives to originate affordable and sustainable mortgage loans, as well as the need to ensure a competitive origination market that maximizes consumer access to affordable and sustainable mortgage loans.

As indicated above, the Mortgage Reform Act would depart from the S.A.F.E. Act by providing its own (substantially broader) definition of “mortgage originator.”  For purposes of the new TILA requirements applicable to mortgage originators, those requirements apply not just to individuals, but also to entities.  It also would apply not only to originators that take applications or offer or negotiate loan terms, but to persons that in any way assist a borrower in obtaining or applying for a residential mortgage loan.  However, the Mortgage Reform Act would clarify a nagging source of ambiguity that persists under the S.A.F.E. Act, by expressly excluding from the definition of “mortgage originator” servicers and their employees, agents and contractors, including those who offer or negotiate terms of a residential mortgage loan for purposes of renegotiating, modifying, replacing and subordinating principal of existing mortgages where borrowers are behind in their payments, in default, or have a reasonable likelihood of being in default or falling behind.  Since neither HUD nor the federal banking agencies have finalized their rulemakings to clarify whether they intend to impose loan originator licensing on servicer employees, perhaps the Bureau will follow the lead of Congress and exclude them when it takes over those agencies’ authority in this regard.

We note also that a S.A.F.E. Act amendment that had been included in the House’s version of the financial reform package does not appear in the current conference version of the Dodd-Frank Act.  The dropped provision would have allowed a state loan originator supervisory authority to grant exceptions, on a case-by-case basis, to the ban on individuals who have been convicted of fraud, dishonesty, breach of trust, or money laundering.  Currently, the S.A.F.E. Act prohibits such individuals from ever obtaining a loan originator license in any state.  That authority to make exceptions on a case-by-case basis did not, however, make it into the current version of the Mortgage Reform Act.

Conclusion
Although we have anticipated many of the Mortgage Reform Act’s provisions for months, the Act nonetheless will rock the foundations of the residential mortgage loan industry – the delivery channels for those loans, the variety of and innovation in those loans, and likely even the cost of those loans.  Significant work is ahead for the Bureau to shape the rules for the next generation.  Congress has given the Bureau an incredible amount of authority to hammer out the recipe for the future of residential mortgage loans, but it appears the industry will only feasibly be able to offer plain vanilla.  Consumers may want strawberry, or even rocky road.  In the end, as consumers, the industry, and other agencies continue to voice their concerns and demands, Supreme Court Justice Breyer may be the final authority on how to define a plain vanilla mortgage and the Mortgage Reform Act’s other ambiguous provisions.

 

Notes:

[1] As indicated above, the Dodd-Frank Act, which has been making its way through Congress over the past year, is not yet law.   The bill that emerged from the conference committee on June 25 passed the House of Representatives on June 30.  Senate Majority Leader Harry Reid stated that the Senate will vote on the measure when the Senate returns from recess on July 12.  Although the vote is likely to be close—supporters may get exactly the 60 they need to avert a filibuster—Chairmen Dodd and Frank are publicly confident that the President will sign the bill by mid-July.

Contacts:
Kristie D. Kully, +1.202.778.9301, kris.kully@klgates.com
Laurence E. Platt, +1.202.778.9034, larry.platt@klgates.com

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This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer.