Why Haven’t Loan Officers Been Told These Facts?
Loan Presentation
Last week, the Journal dusted off the seminal interagency guidance on subprime mortgages. The FFIEC guidance was adopted by the CSBS as its “Subprime Statement.” The Subprime Statement integrates the gist of the corollary interagency “Guidance on Nontraditional Mortgage Product Risks.” From the Subprime Statement, “While the 2006 CSBS-AARMR Guidance on Nontraditional Mortgage Product Risks (NTM Guidance) may not explicitly pertain to products with the characteristics addressed in this Statement, it outlines prudent underwriting and consumer protection principles that providers also should consider with regard to subprime mortgage lending. This Statement reiterates many of the principles addressed in existing guidance relating to prudent risk management practices and consumer protection laws.”
From the CSBS, “In order to promote consistent application across the states, AARMR and CSBS are developing Model Examination Guidelines (MEGs) to implement the 2006 Guidance on Nontraditional Mortgage Product Risks (NTM Guidance) and the following Statement on Subprime Mortgage Lending. These guidelines are being developed as examination standards to assist state regulators to in determining proper compliance with the NTM Guidance and the Subprime Statement. The MEGs will also be published as a public document to guide mortgage providers and their auditors in reviewing transactions covered by the NTM Guidance and the Subprime Statement.”
The Subprime Statement demands that lenders ensure the consumer has appropriate options and is aware of the risks associated with subprime financing, e.g., changing payment loans, higher payments, higher fees, balloon payments, payment shock, and prepayment penalties.
How can a lender integrate what appears to be a dizzying array of requirements into everyday loan origination activities? In many cases lenders might consider a two-step loan manufacture. The two-step method may afford the lender several benefits such as:
- Evidence of best efforts to secure the optimal financing solution.
- Establishes a benchmark for prime financing (establishes risks attendant with subprime by comparison).
- Complies with Regulation B and FCRA section 615 adverse action requirements.
If you haven’t reviewed the Statement lately, it might be worth a gander. A few choice excerpts can be found below.
CSBS STATEMENT ON SUBPRIME MORTGAGE LENDING (Excerpted)
Fundamental consumer protection principles relevant to the underwriting and marketing of mortgage loans include providing information that enables consumers to understand material terms, costs, and risks of loan products at a time that will help the consumer select a product.
Communications with consumers, including advertisements, oral statements, and promotional materials, should provide clear and balanced information about the relative benefits and risks of the products. This information should be provided in a timely manner to assist consumers in the product selection process, not just upon submission of an application or at consummation of the loan. Providers should not use such communications to steer consumers to these products to the exclusion of other products offered by the provider for which the consumer may qualify.
Information provided to consumers should clearly explain the risk of payment shock and the ramifications of prepayment penalties, balloon payments, and the lack of escrow for taxes and insurance, as necessary. The applicability of prepayment penalties should not exceed the initial reset period. In general, borrowers should be provided a reasonable period of time (typically at least 60 days prior to the reset date) to refinance without penalty.
Similarly, if borrowers do not understand that their monthly mortgage payments do not include taxes and insurance, and they have not budgeted for these essential homeownership expenses, they may be faced with the need for significant additional funds on short notice. Therefore, mortgage product descriptions and advertisements should provide clear, detailed information about the costs, terms, features, and risks of the loan to the borrower.
These risks are increased if borrowers are not adequately informed of the product features and risks, including their responsibility for paying real estate taxes and insurance, which may be separate from their monthly mortgage payments. The consequences to borrowers could include: being unable to afford the monthly payments after the initial rate adjustment because of payment shock; experiencing difficulty in paying real estate taxes and insurance that were not escrowed; incurring expensive refinancing fees, frequently due to closing costs and prepayment penalties, especially if the prepayment penalty period extends beyond the rate adjustment date; and losing their homes.
A TWO-STEP ORIGINATION
The first step in two-step manufacture is the application for prime financing. Just like any prospective borrower, based on the applicant’s needs, the lender assists the applicant by furnishing examples of the very best financing available. Then, you fight like hell to get the prospect the best-identified financing. In this way, the lender accomplishes two goals.
1) When presenting subprime loans, the lender should inform the consumer whether there is a pricing premium attached to the subprime financing. The concept is that the lender is responsible for ensuring that the consumer understands the price and risks of subprime financing compared to prime financing. When pursuing the prime loan solution, the lender establishes the prime benchmark necessary for the consumer to grasp the cost and risks of the subprime loan.
B) The lender pursues the consumers’ interests by demonstrating its “best efforts” to secure the financing. Two-step manufacture is extra work, less efficient, and therefore less profitable. However, a jump to subprime without a reasonable attempt at prime financing might look bad for the lender.
If you are confident that there is no chance that the prospect will qualify for prime financing and are willing to risk it, you might bypass the first step. However, this jump to subprime may not make much sense because the approach could preclude an adverse action notice. Absent the attempt at prime financing and an ensuing adverse action notice, your jump to subprime might weaken a defense against inappropriate steering.
Either way, one step or two steps, ensure you provide the prime benchmark to inform the applicant about the cost and risks associated with subprime.
STEERING DEFINED
12 CFR § 1026.36(e)(1) (Reg Z) Directing or “steering” a consumer to consummate a particular credit transaction means advising, counseling, or otherwise influencing a consumer to accept that transaction.
12 CFR §1026.36(e)(1) A loan originator shall not direct or “steer” a consumer to consummate a transaction based on the fact that the originator will receive greater compensation from the creditor in that transaction than in other transactions the originator offered or could have offered to the consumer unless the consummated transaction is in the consumer’s interest.
AVOIDING THE APPEARANCE OF INAPPROPRIATE STEERING
Avoid the perception of unlawful steering; the subprime loan must clearly be in the applicant’s best interests—structure subprime lender compensation beneath prime lender compensation.
Steering prohibitions apply to payments made to all loan originators. This prohibition includes payments made to mortgage brokers from lenders and payments made by a company acting as a mortgage broker to its employees/sponsee who are loan originators.
15 USC §1639b(c) (TILA PROHIBITIONS)
The Bureau shall prescribe regulations to prohibit mortgage originators from steering any consumer from a residential mortgage loan for which the consumer is qualified that is a qualified mortgage to a residential mortgage loan that is not a qualified mortgage.
12 USC 5531(a) (Consumer Credit Protection Act) The Bureau may take any action authorized to prevent a covered person or service provider from committing or engaging in an unfair, deceptive, or abusive act or practice under Federal law in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service.
5531 (c) (paraphrased) The CFPB shall have authority under this section to declare an act or practice unfair in connection with the provision of a consumer financial product or service should the act or practice cause or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers (such as an unreasonable overpayment for financing).
5531(d) (paraphrased) The CFPB shall have authority under this section to declare an act or practice abusive in connection with the provision of a consumer financial product or service if the act or practice materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service (such as a failure to reasonably identify product risks relative to prime financing).
The CFPB shall have the authority to declare an act or practice abusive in connection with providing a consumer financial product or service if the act or practice takes unreasonable advantage of the consumer. Keep in mind that the CFPB delegates UDAAP enforcement authority to the states. Meaning your state regulator or attorney general is more than able to prosecute enforcement actions under UDAAP.
Taking unreasonable advantage of a consumer includes:
- Leveraging the applicant’s ignorance of product risks and pricing against them.
- Failing to make appropriate and cogent loan presentations which limit the consumer’s ability to protect their interests in selecting or using a consumer financial product or service.
- Betraying the consumer’s reliance on a covered person to act in their best interests.
Another thing to keep in mind is that under UDAAP the individual offender and those that abet, tolerate, or assist in UDAAP violations are subject to enforcement actions.
Next week, the Journal unpacks the Regulation Z mortgage broker steering safe harbor.
And don’t forget, the Loan Officer School’s 2022 CE tackles these challenges head-on in a simple hands-on presentation.
Behind the Scenes
The Trilogy of Terror “Meets” the Duty to Serve
Window Dressing or Substance?
It has come to our attention that the FHFA and its way-ward GSEs have been hard at work in compliance with the HERA Duty to Serve requirements. Among other complaints about the GSEs policies under the FHFA administration, the Journal decried the gentrification of the mortgage industry. Of course, no one would place that blame exclusively at the feet of any person including the GSEs or the FHFA. However, these persons are so significant in shaping the mortgage industry and homeownership opportunities that they tend to suck the air out of the room when they make a move. Furthermore, the GSEs have lacked sufficient alacrity in bringing solutions to underbanked communities. So we have complained about policies that widen the American wealth gap.
Consequently, as you may recall, the Journal suggested that the GSEs and their minders have come up short in implementing HERA section 1129 requirements to serve underserved markets. It’s tough to whip your balance sheet into shape while pursuing less profitable enterprises, like making low balance, high maintenance mortgages available to underbanked communities.
One more gripe. Did you get a load of the Hee Haw-inspired, corrugated tin roof house on the FNMA report cover? The only thing missing is the Dueling Banjos soundtrack. Oy vey, talk about stereotypes. The Journal is disappointed with FNMA’s visual characterization of rural housing. What next? A toothless moonshiner in bibs grinning over his still? Source of income, white-lightning, and coon-skin caps. Perpetuating myths and stereotypes about rural living is unhelpful.
How about we give the work product from the dedicated folks at the GSEs a fair look. What do these plans for serving underserved markets entail? Might there also be some opportunities for third-party originations? Starting with rural underbanked communities, what are GSEs planning?
First, in FNMA’s 2022-2024 Underserved Markets Plan (think they have a section on gig workers – NO!) there is a mountain of promises and aspirational goals to sort through. This week, we have a few excerpts from the report. In the report, FNMA identifies the market and then defines some of the challenges to affordable homeownership. Let’s take a look.
From FNMA’s Report
The Rural Housing market includes an estimated 74 million people in the United States, or 23% of the U.S. population. Rural areas in the U.S. exhibit a combination of housing and socio-demographic attributes that require a focused approach from Fannie Mae and Freddie Mac (“the Enterprises”) in order to meet housing finance needs like increased liquidity, strategic partnerships, and technical assistance.
FHFA defines a rural area as: (1) a census tract outside of a metropolitan statistical area (MSA) as designated by the Office of Management and Budget; or (2) a census tract in an MSA but outside of the MSA’s Urbanized Areas and outside of tracts with a housing density of more than 64 housing units per square mile as designated by the U.S. Department of Agriculture. FHFA additionally defines high-needs rural regions as rural tracts located in: Middle Appalachia, the Lower Mississippi Delta, colonias (colonias are rural communities within the US-Mexico border region that lack adequate water, sewer, or decent housing, or a combination of all three), and persistent poverty counties.
With higher rates of manufactured housing and homeownership, housing in rural areas is distinct from housing nationwide. Single-family ownership comprises 81% of property type in rural regions versus 76% nationwide. Single- family homes are also more affordable in rural areas, where the median home value of owner-occupied homes is $166,344 versus $217,500 nationwide. Manufactured housing represents a greater share of housing type in rural areas and is especially prevalent in high-needs rural regions for both owners and renters. Rural households are less likely to rent than households in metro areas. However, in high-needs, rural-persistent poverty areas, the rental occupancy rate is significantly closer to the national average.
Affordable homeownership opportunities are similarly limited by the lack of affordable mortgage capital and liquidity in rural communities. Loans originated in rural and high-needs rural communities are more likely to be held in portfolio than in metro areas. Loans originated in rural communities may not conform to secondary market standards, requiring lenders to often retain these loans within their portfolio. With limited access to the secondary market, lenders are unable to efficiently replenish capital and sometimes unable to offer low-cost, fixed-rate loans.
Borrowers in high-needs rural regions experience challenges in securing financing for home purchases. The number of lenders serving high-needs rural regions has declined significantly in recent decades. As described above, lenders that do operate in high-needs rural regions often retain the loans they originate in their portfolio instead of selling them into the secondary market, thereby limiting liquidity and availability of mortgage financing. There is an opportunity to increase liquidity by increasing loan purchases in high-needs rural regions.
Unlike in the prior Plan cycle, we have excluded refinance loans from our loan purchase targets, focusing exclusively on PMM loans. Fannie Mae will continue to support refinance loans for LMI borrowers in this market. However, these loans will not be included in our three-year Plan because of the inherent volatility of the refinance business in a shifting interest rate environment, which may place more weight on market forces beyond our control.
Many Americans rely on homeownership as a means of wealth-building. While homeownership can be an effective asset-building mechanism, lack of financing options, credit and down payment challenges, and rural geographical locations potentially restrict opportunity for underserved households. Moreover, racial inequality in housing and mortgage markets over many decades also continues to exacerbate a wealth gap, resulting in lower homeownership rates for households of color.
We will address one or more of the primary barriers that have limited homeownership opportunities for borrowers and communities that have been historically denied access to mainstream sources of credit. Additionally, we commit to evaluating and, if appropriate, developing a special purpose credit program (SPCP) that is targeted to the needs of residents of designated areas in a high-needs rural region.
Next week the Journal unpacks FNMA’s three-year plan. Hint, the focus is on purchase money mortgages.
Tip of the Week – Spanish Language Helps
The CFPB’s Statement Regarding the Provision of Financial Products and Services to Consumers with Limited English Proficiency (LEP)
Stakeholders have received numerous admonishments over the years in relation to serving folks with limited English proficiency. In addition to the LEP guidance provided by HUD, the CFPB has repeatedly weighed in on this important topic.
From the CFPB
The Dodd-Frank Act emphasizes the Bureau’s role in ensuring “fair, equitable, and nondiscriminatory access to credit.” Consistent with that purpose, the Bureau encourages financial institutions to promote access to financial products and services for all consumers by better serving LEP consumers. In providing such assistance and serving LEP consumers, financial institutions must also comply with Dodd-Frank Act prohibitions against engaging in any unfair, deceptive, or abusive act or practice (UDAAP)and the ECOA.
This Statement provides guidance on how financial institutions can provide access to credit in languages other than English in a manner that is beneficial to consumers, while taking steps to ensure financial institutions’ actions are compliant with the ECOA, the prohibitions against UDAAPs, and other applicable laws.
The CFPB has made available numerous Spanish language artifacts suitable for loan manufacture.
How should you use these Spanish language aids and what requirements must you follow when providing aids in a language other than English?
Implementation of LEP artifacts may introduce compliance risks. For example, the lender providing Spanish language artifacts could mislead the applicant into believing their entire loan process may be conducted in Spanish. Spanish language originators and settlement agents are common. Yet, what if the applicant claims they went with the lender because they were led to believe the loan manufacture in total would be conducted in Spanish, including the loan agreements and security instruments? And what about loan servicing? What if the borrower claims they went with the lender because of Spanish loan servicing?
Therefore, at application, the consumer should understand the possible limits of Spanish language assistance. More on this subject next week.
From the CFPB
Financial institutions may mitigate certain compliance risks by providing LEP consumers with clear and timely disclosures in non-English languages describing the extent and limits of any language services provided throughout the product lifecycle. In those disclosures, financial institutions may provide information about the level of non-English language support as well as communication channels through which LEP consumers can obtain additional information and ask questions.
See the CFPB’s full statement here:
https://files.consumerfinance.gov/f/documents/cfpb_lep-statement_2021-01.pdf
Loan Artifacts in Spanish: