The failure of the subprime mortgage market is one of many causes of the overall economic crisis. It was inevitable that mortgage lending would be a subject of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Mortgage Reform and Anti-Predatory Lending Act
The Dodd-Frank Act is a massive piece of legislation, well in excess of 2,000 pages. The Mortgage Reform and Anti-Predatory Lending Act in Title XIV of the law devotes itself to the reform of broker compensation and lending practices. It is important to note that certain provisions of the Mortgage Reform and Anti-Predatory Lending Act are not yet in place. It will depend on the implementation of regulations as well as functions assigned to the Consumer Financial Protection Bureau.
Issues addressed in Title XIV include:
- A requirement for mortgage originators to meet licensing standards established under the Secure and Fair Enforcement for Mortgage Licensing Act (S.A.F.E. Act)
- A prohibition on steering
- A requirement to assess the repayment ability of borrowers
- The establishment of penalties for violations of loan origination standards
- The extension of protection offered for high-cost mortgages to a broader range of loans
- The establishment of an Office of Housing Counseling
- The creation of new requirements for loan servicers
- The creation of new requirements to protect the independent judgment of appraisers
In addition to the portions of the law that are directly applicable to mortgage lending, there are provisions that are intended to prevent a future collapse of the subprime market. These provisions appear in Title IX, Subtitle D- “Improvements to the Asset-Backed Securitization Process.” Finally, under Title X, the Dodd-Frank Act creates a federal agency known as the Bureau of Consumer Financial Protection to enforce fair lending laws and promote financial literacy.
Following is an overview of the sections of the Dodd-Frank Act that relate directly to mortgage lending and the creation of the Bureau of Consumer Financial Protection. Over the course of the next few years, mortgage professionals can anticipate additional rulemaking that relates to the many provisions of this law.
Definitions Related to the Mortgage Reform and Anti-Predatory Lending Act
We must understand the types of loans and originators that are subject to the provisions of the Mortgage Reform and Anti-Predatory Lending Act. For this reason, it is necessary to know how the law defines “residential mortgage loans” and “mortgage originator.”
The law defines “residential mortgage loans” as closed-end credit transactions secured by a mortgage, deed of trust, or other security interest on a dwelling or on residential real property that includes a dwelling (H.R. 4173 Section 1401 (5)).
The Mortgage Reform and Anti-Predatory Lending Act focuses primarily on the compensation and lending practices of individuals and entities defined as mortgage originators. The law defines a “mortgage originator” as a person who earns direct or indirect compensation for:
- Taking a residential mortgage loan application
- Assisting a consumer in obtaining a residential mortgage loan application
- Offering or negotiating the terms of a residential mortgage loan application
(H.R. 4173 Section 1401 (2))
Exemptions Under the Definition of Mortgage Originator
The following persons are exempt from the requirements that apply to mortgage originators:
Clerical Workers: An individual that performs clerical and administrative duties is not a mortgage originator.
Manufactured Home Employee: An employee of a retailer of manufactured homes which does not take mortgage applications or offer advice on loan terms is not a mortgage originator.
Licensed Real Estate Broker: Licensed individuals and entities that perform real estate brokerage activities are not mortgage loan originators unless compensated by a lender, mortgage broker, or mortgage originator.
Persons Providing Financing: A person, estate, or trust that is not a contractor and provides financing for three or fewer properties that he/she owns within a 12-month period is not a mortgage originator. The loans made by such persons must be fully amortizing, the borrowers must have a reasonable ability to repay the loans, and the interest rate must be fixed or adjustable after five years.
Creditors: Creditors are not mortgage originators unless the creditor is table funding the loan.
Servicers: Loan servicers and their employees are not mortgage originators. This exemption also applies to employees of loan servicers who renegotiate or modify loans for borrowers who are behind in their payments.
Employees of creditors are not exempt from the provisions of the Mortgage Reform and Anti-Predatory Lending Act. The definition of “mortgage originator” under the Mortgage Reform and Anti-Predatory Lending Act has the same type of broad scope as the definition of a “loan originator” under the loan originator compensation Final Rule. It includes all originators, whether their employer is a non-depository mortgage company, such as a mortgage broker, or a traditional depository lender, such as a bank.
One of the stated purposes of the Mortgage Reform and Anti-Predatory Lending Act is:
“…to assure that consumers are offered and receive residential mortgage loans that reasonably reflect their ability to repay the loans….” (H.R. 4173 Section 1402 (a)).
Achieving this purpose requires creditors to base lending decisions on
“…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…and all applicable taxes, insurance…and assessments.” (H.R. 4173 Section 1411 (a))
Determination of Ability to Repay (H.R. 4173 Section 1411 (a)(3))
To reach a reasonable and good faith determination of a borrower’s ability to repay, creditors must consider the loan applicant’s:
- Credit history
- Current income
- Expected income that the borrower is “reasonably assured of receiving.”
- Current obligations
- Debt-to-income ratio or the residual income the borrower will have after paying non-mortgage debt and mortgage-related obligations
- Employment status
- Financial resources other than the equity in the dwelling that will secure the loan
- A payment schedule that fully amortizes the loan during the term of the loan assessment of the ability to repay.
Income Verification (H.R. 4173 Section 1411 (a)(4))
The law also requires income verification, based on:
- W-2 form
- Tax returns
- Payroll receipts
- Records from the borrower’s bank or other financial institution
- Third party documents that provide reliable evidence of the borrower’s assets or income
IRS transcripts of tax returns or another method of third party verification, established by rules of the Board are sufficient for verification of income history that is made to determine repayment ability.
Special Requirements for Certain Nontraditional Loans
Nontraditional loans are rare to nonexistent in the current lending environment. In the past, borrowers who could not qualify for prime loans were able to qualify for loans such as interest-only and payment option loans. The Mortgage Reform and Anti-Predatory Lending Act includes provisions that discourage borrowers from pursuing nontraditional mortgages by making them meet higher standards in order to qualify for them.
For example, the law imposes qualifying standards on the following types of loans:
Certain Variable Rate Loans: The creditor must use a fully amortizing repayment schedule when determining a borrower’s ability to repay a variable rate loan that permits the deferral or repayment of any principal or interest.
Interest-Only Loans: The creditor must use the payment amount needed to amortize the loan by the end of the loan term when determining a borrower’s ability to repay a loan that requires payments of interest only.
Negative Amortization Loans: The creditor must consider any balance increase that can result from a negative amortization loan when determining a borrower’s ability to repay a negative amortization loan.