Dodd-Frank Act ― Reforming Mortgage Industry
Sutherland Banking Insights
1|Confidential
September 2013
Dodd-Frank Act ― Reforming Mortgage Industry In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly referred to as Dodd-Frank) was passed to protect consumers and bring stability to the financial system in the US. The Act has established an independent bureau within the Federal Reserve, known as the Consumer Financial Protection Bureau (CFPB), to regulate the offering and provision of consumer financial products and services under federal consumer financial protection laws.
A new category of “qualified mortgages” is formed, which must meet certain criteria decreasing the risk of default. It may not contain terms that exceed 30 years or high-risk features that were prevalent earlier as interestonly payments or negative-amortization payments, where the principal of the loan increases. Creditors are required to consider eight factors to check whether the consumer has a reasonable ability to repay the loan before entering into any consumer credit transaction. The factors include current income and assets, employment status, credit history, the mortgage’s monthly payment, other loan payments (student loans, credit cards, etc.), monthly payments for such things as property taxes, other debt obligations and the borrower’s monthly debt-to-income ratio.
In January 2013, CFPB finalized several major rules affecting nearly all aspects of the mortgage process. They include Ability to Repay, Servicing, Loan Officer Compensation, High Cost Loan, and Appraisal and Escrow rules that affect origination, underwriting and servicing of mortgage loan. Brief details of some of these regulations are discussed below:
1. Ability-to-Repay and Qualified Mortgage Standards
2. Mortgage Servicing Rules Effective January 2014 In the aftermath of the financial crisis, the number of distressed borrowers rose steeply. Servicing industry was unable to handle this large number, which caused a substantial damage to borrowers. The Dodd-Frank Act imposed new requirements on servicers and gave the CFPB the authority to both implement the new requirements and also to adopt additional rules to protect the interest of consumers.
Effective January 2014 The intent of the final rule is to ensure that creditors give appropriate consideration to consumers’ ability to repay home loans when making lending decisions, and to strengthen underwriting practices in the credit industry. The final rule focuses on establishing factors for ability-to-repay determinations and uniform baselines for underwriting standards.
The bureau is particularly focused on the mortgage servicers as they handle approximately outstanding mortgages of USD 10 Tn.
Currently, Regulation Z, as amended by the Board of Governors of the Federal Reserve System in 2008, prohibits creditors from extending higher-priced mortgage loans without a regard for the consumer’s ability to repay. The final rule extends this requirement to all loans secured by dwellings, not just higher-priced mortgages.
The major focus of this regulation is to improve the information borrowers receive from their servicers, enhance the protections available to them to address servicer errors, and to form some standard servicing requirements that will provide additional protections for consumers
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who have fallen behind on their mortgage payments.
second appraisal at no cost to the consumer. This requirement for higher-priced homepurchase mortgage loans is intended to address fraudulent property flipping by seeking to ensure that the value of the property is legitimately increased.
The final rules cover nine major topics including: • • • • • • • • •
periodic billing statements, interest-rate adjustment notices for ARMs, prompt payment crediting and payoff statements, force-placed insurance, error resolution and information requests, general servicing policies, procedures, and requirements, early intervention with delinquent borrowers, continuity of contact with delinquent borrowers, and Loss mitigation procedures
However, the rule exempts several types of loans such as qualified mortgages, temporary bridge loans and construction loans, loans for new manufactured homes, and loans for mobile homes, trailers and boats that are dwellings. The rule also has exemptions from the second appraisal requirement to facilitate loans in rural areas and other transactions.
4. ECOA Valuations for Loans Secured by a First Lien on a Dwelling
3. TILA1 Appraisals for HigherPriced Mortgage Loans (HPML)
Effective January 2014 The Dodd-Frank amendment to the Equal Credit Opportunity Act (ECOA) states that lenders must automatically provide copies of any written appraisal reports and valuations developed in connection with an application for credit that is to be secured by a first lien on a dwelling. Currently, the rule requires the following disclosures upon an applicant’s request.
Effective January 2014 HPMLs are mortgages with an annual percentage rate that exceeds the average prime offer rate by a specified percentage. The rule allows a creditor to extend an HPML only if the following conditions are met: • • •
The creditor obtains a written appraisal; The appraisal is performed by a certified or licensed appraiser; and The appraiser conducts a physical property visit of the interior of the property
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The rule also requires creditors to disclose to applicants purpose of the appraisal and to provide consumers with a free copy of any appraisal report. Additionally, if the seller has acquired the property for a lower price during the prior six months and the price difference exceeds certain thresholds, creditors will have to obtain a
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The Truth in Lending Act
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It requires creditors to notify applicants within three business days of receiving an application of their right to receive a copy of appraisals developed. It requires lenders to provide applicants a copy of each appraisal and other written valuation promptly upon their completion or three business days before consummation (for closed-end credit) or account opening (for open-end credit), whichever is earlier. It allows applicants to waive the timing requirement for providing these appraisal copies. However, applicants who waive the timing requirement must be given a copy of all appraisals and other written valuations
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at or prior to consummation or account opening; or if the transaction is not consummated or the account is not opened, no later than 30 days after the creditor determines the transaction will not be consummated or the account will not be opened. The new rule prohibits creditors from charging for the copy of appraisals and other written valuations, but permits creditors to charge applicants reasonable fees for the cost of the appraisals or other written valuation unless the applicable law provides otherwise.
The rule prohibits dual compensation and also allows mortgage brokers to pay their employees or contractors commissions, although the commissions cannot be based on the terms of loans they originate.
6. High-Cost Mortgage and Home Ownership Counseling Effective January 2014 The Home Ownership and Equity Protection Act (HOEPA) amended the Truth in Lending Act back in 1994 to address the abusive use of high interest rates and fees associated with mortgage loans and refinancing. The final rule expands the tests for coverage under the HOEPA to capture a broader segment of mortgage loans as “high-cost mortgages”. The rule also adds protections for consumers in connection with high-cost mortgages, including a requirement that borrowers receive home ownership counseling before obtaining a highcost mortgage.
5. Loan Originator Compensation Requirements Effective January 2014 The rule addresses the causes of one of the reasons for the collapse of the mortgage industry, the routing of consumers to highpriced loans. Earlier compensation paid to loan officers and mortgage originators was structured to give loan originators strong incentives to steer consumers into more expensive loans. These loans were usually more profitable for the lenders and more expensive for the borrowers.
High-cost mortgages are subject to special disclosure requirements and restrictions on certain loan terms. In addition, consumers who obtain high-cost mortgages have enhanced remedies for violations of law. The final rule applies to all federally-related mortgage loans, including most types of mortgage loans secured by a consumer’s principal dwelling. It does not apply to reverse mortgages, loans to finance the initial construction of a dwelling, loans originated by a Housing Finance Agency as the creditor, and loans originated through the US Department of Agriculture’s Rural Housing Service Section 502 Direct Loan Program.
After the mortgage bubble, steps were taken to change the model under which loan officers, originators, and brokers were compensated. The new rule prohibits steering incentives. A loan officer or broker cannot be paid more if the consumer takes a loan with a higher interest rate, a prepayment penalty, or higher fees. They cannot be paid for convincing the consumer to buy additional services from the lender, broker, or an affiliate such as title insurance or mortgage life insurance. The loan officer or broker can be compensated by way of other models such as on the number or size of loans or the aggregate dollar volume of loans written within a stated time period.
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7. Escrow Requirements under Truth in Lending Act
compliance) to capture, integrate, analyze, and report enterprise-wide data that can transcend traditional compliance risk metrics.
Effective June 2013
Major banks in the US are hiring and spending huge amounts of money to handle compliance. For instance, the Bank of America mortgage business is recruiting thousands of loan officers and processors throughout the US to comply with the changing regulation in the mortgage business. In another example, JPMorgan Chase & Co has also announced to spend USD 4 Bn and add 5,000 extra employees to handle risk and compliance issues.
Currently, the regulation requires creditors to establish escrow accounts for higher-priced mortgage loans secured by a first lien on a principal dwelling. The new amended rule will implement statutory changes made by the Dodd-Frank Act to increase the length of the time for which a mandatory escrow account established for a higher-priced mortgage loan must be maintained. The rule also exempts certain transactions from the statute’s escrow requirement. It creates an exemption from the escrow requirement for small creditors that operate predominately in rural or underserved areas.
Conclusion The financial meltdown and housing bubble battered the US economy severely. As part of several countermeasures by the government, the Dodd-Frank act was passed to protect the interest of consumers and bring financial stability to the economy. Since 2010, the act has amended mortgage rules and regulations and laid down stricter norms, which affect the entire mortgage process.
Banks’ Approach to Address Compliance Banks in the US are hiring compliance people and are adopting new systems to face the changing regulatory compliance landscape. The primary challenge for the banks is to transform their compliance program from being technically-focused, reactive, and siloed to being principle-driven, proactive, and deeply integrated with the rest of the bank, especially the business lines.
The Act poses operational challenges to banks, credit unions, community banks and financial institutions. To adapt to the changing landscape of regulatory reforms in the mortgage industry, these institutions are updating their systems and also training their employees.
With the ever-increasing regulatory burden, community banks have deployed software to streamline their compliance to-do lists and handle the documentation and reporting required. In 2013, Evolve Bank & Trust, a community bank, implemented Advantage Systems’ ‘Accounting for Mortgage Bankers’ software to checks loan officers' commission against Dodd Frank rules. Moreover, banks are outsourcing functions where they can and are also paying for independent reviews and training. Many are purchasing GRC systems (governance, risk, and
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