CFPB's Supervisory Highlights: Where Do Mortgage Lenders Fall Short in Compliance?

Recently the CFPB issued its 2015 Summer Supervisory Highlights to highlight the areas of compliance concerns revealed through its examination of supervised entities.

With respect to mortgage loan origination, the CFPB highlighted following compliance failures it noticed during its supervisory examination of mortgage lenders:

1.  Loan Originator Compensation Rule

In complying with the Truth-in-Lending Act and Regulation Z, mortgage lenders are required to establish and maintain written policies and procedures designed to ensure and monitor employees' compliance with TILA and Reg. Z.  The key component of the Loan Originator Compensation Rule under Reg Z is the prohibition against varying loan originator compensation based on loan terms.  Varying loan originator compensation based on loan terms may cause loan originators to steer consumer to costlier mortgage loans.

The CFPB noted that mortgage lenders written policies and procedures, if any, do not specifically instruct employees on how to comply with such policies and procedures.  In other words, the policies and procedures are defective, incomplete, incomprehensive, or impractical.

In my experience, I have seen lengthy written policies and procedures that either summarize or regurgitate laws or regulations.  Such policies and procedures do not meet lenders' needs because they have little practical value.  If written policies and procedures were purchased "off the shelf" without regard to the the lender's unique size and operational characteristics, they are hardly effective in accomplishing the ultimate goal of establishing and maintaining written policies and procedures -- to ensure and monitor compliance by each and every loan originator and officer of the entity.  Therefore, written policies and procedures must be tailor made, and they must address not only what the law is but also how to spot and avoid a violation.    

2.  Common RESPA Violations

A.  Untimely GFE

RESPA mandates that a lender must provide a good faith estimate of the fees and charges associated with a mortgage loan within three business days after the lender's receipt of a loan application.  Unfortunately, due to technical glitches or inadequate training of loan originators, many lenders fail to comply with this strict timeline consistently.

Lenders should be mindful that the same three-day requirement will apply to mortgage loan applications received by lenders on or after October 3, 2015, and they must deliver a Loan Estimate instead of the GFE in connection with covered loan transactions.

B.  Untimely Revised GFE

With respect to fees subject to the 0% or 10% tolerance, lenders may issue a change of circumstance disclosure and revised GFE within three business days of receiving the information constituting a change of circumstance.  This time restriction is critical to reset the applicable tolerance baseline.  Once the TRID Rule becomes effective, the same time restriction will apply to properly document a legitimate change of circumstance.

C.  Failure to Include All Fees on the GFE

The CFPB also noticed that lenders often fail to include all fees on a GFE.  This failure may cause an inaccurate estimate of fees to be paid by consumers at closing.

Under the TRID Rule, the disclosure of all fees and charges on the Loan Estimate is subject to the good faith standard.  Good faith requires a lender to accurately estimate and disclose loan-related fees and charges based on the best information available to the lender at the time of disclosure.  Good faith may require a lender to exercise due diligence to obtain information in order estimate certain fees and charges, including fees related to optional services, such as home warranty or inspection.

3.  Failure to Provide the Homeownership Counseling Disclosure

Effective since January 10, 2014, lenders are required to provide a list of homeownership counseling agencies within three business days of receiving a loan application for a RESPA-covered mortgage loan.  The disclosure must contain a list of at least 10 counseling agencies located nearest to the borrower's location (current residence zip code).  The list of counseling agencies must be accompanied by the following pieces of information related to each agency: name, phone number, street address, city, state, zip code, website URL, email address, services provided, and languages spoken.

These supervisory highlights offer lenders an opportunity to review  their own policies and procedures, and initial disclosures with respect to the above areas to determine whether they are in compliance with the applicable regulations.

Loan Originator Compensation - What to Avoid?

Prohibited Loan Originator Compensation Practices

-- Illegally Funded Employee Expense Accounts

            The CFPB’s Loan Originator Compensation Rule (“Rule”) prohibits compensation to loan originators based on the term of a loan transaction or terms of multiple transactions, but it permits compensation based on a fixed percentage of loan amount.  A compensation plan based on a fixed percentage (or basis points) of a certain loan amount may also be subject to a fixed floor or ceiling.  To attract talented loan originators or to increase production of existing originators, some mortgage lenders may attempt to introduce additional compensation mechanisms into their compensation scheme.  While some mechanisms designed to incentivize loan originators are legal, others, such as bonuses paid from individual employee expense accounts that are funded through loan-related profits resulting from origination charges or retained interest rebates, are illegal according to the CFPB.  Although the Rule does not expressly prohibit individual employee expense accounts, the CFPB has clearly shown that it believes some compensation or bonus mechanisms tied to individual employee expense accounts violate the Rule, and that they can create significant legal liability for mortgage lenders and their executives. 

1.         The CFPB’s Allegations  

In two recent enforcement actions against Franklin Loan Corporation (“Franklin”) and RPM Mortgage, Inc. (“RPM”), respectively, the CFPB targeted the lenders’ compensation plans, which allegedly contained the following features: (1) upfront commission based on a fixed percentage of the loan amount; and (2) additional compensation paid from individual employee expense accounts.  With respect to the employee expense accounts, the CFPB alleged that both Franklin and RPM: (1) established employee expense accounts for each loan originator; (2) deposited funds into the expense accounts only for closed loan with a profit; (3) the profit per loan is calculated by deducting the expenses from the revenue related to each loan; (4) the expenses related to each loan may include the loan originator’s upfront commission for the loan and/or other operating expenses allocated to the branch level; and (5) the revenue on each loan may include origination fees, net interest rebate, and other income tied to the interest rate.  The CFPB further alleged that Franklin paid quarterly bonuses to its loan originators that had positive balances in their individual employee expense accounts.  Regarding RPM, the CFPB claimed that RPM’s loan originators had open access to their individual expense accounts, and that they could use the funds to: (1) offset tolerance cures or other fee concessions to borrowers on future loans, and (2) provide periodic raises to themselves on future loans.          

2.         Civil Liability

            In the action against Franklin, the CFPB ordered Franklin to pay $730,000.00 in redress to borrowers for its alleged violation of the Rule.  Due to Franklin’s financial condition, the CFPB did not seek civil penalties against it. 

            With respect to RPM, the CFPB ordered RPM and its CEO to pay, jointly and severally, $18 million in civil damages; it also ordered RPM and its CEO to pay $1 million in civil penalties, respectively.

                                   

3.         Analysis

In both enforcement actions, the CFPB filed civil lawsuits against the defendants in federal courts in California.  The defendants in both cases chose to enter into a settlement agreement (Stipulated Final Judgment and Order) with the CFPB instead of trying the cases before the judge or a jury.  Therefore, concerned stakeholders in the mortgage industry will probably not know whether the CFPB’s allegations are facts or merely allegations.  While the results accomplished by the CFPB in these actions may demonstrate to the mortgage industry the enforcement power the CFPB wields, these cases lack the clarity and guidance that judicial decisions may otherwise provide.  Nonetheless, unless defendants in future enforcement actions are able to “fight” back, entering into settlement agreements and consent orders with the CFPB in enforcement actions will probably become the norm.   

     

            Assuming the CFPB’s allegations against Franklin and RPM were true, the “fatal” flaw in Franklin and RPM’s compensation plan was funding the employee expense accounts with revenue tied to the terms of loan transactions.  Terms under the Rule include fees, charges, interest rate, APR, collateral type, etc., related to covered mortgage loans.  By tying the employee expense accounts (e.g. source of additional compensation) to the revenue generated from each loan, Franklin and RPM’s compensation plans, arguably, incentivized loan originators to offer loan terms detrimental to consumers (higher rates and/or fees) in order to maximize the revenue on each loan so as to gain additional deposits into their expense accounts.  To be compliant, any compensation plan should not contain provisions that, directly or indirectly, purposefully or accidentally, link compensation to the terms of loan transactions.

            In zealously enforcing consumer finance protection laws, the CFPB has repeatedly demonstrated its willingness to hold mortgage company executives personally liable for civil penalties and damages.  Under the Consumer Financial Protection Act of 2010, a “related person” may be held jointly liable for a mortgage company’s violations, and the CFPB has actively relied on this legal tool to impose personal liability on executives for alleged violations that occurred on their watch.  Therefore, prudence dictates that mortgage company executives exercise due care and diligence in establishing and practicing a compliant lending culture that permeates all facets of a mortgage lender’s operations.    

4.         Conclusion

Creating a competitive and compliant loan origination compensation plan can be a challenging task.  On the one hand, the compensation plan must contain favorable terms to attract and maintain gifted loan originators in a highly competitive market place.  After all, the financial success of any mortgage lender largely depends on productive loan originators capable of originating high quality loans.  On the other hand, the Franklin and RPM enforcement actions serve as a stark reminder that a compensation plan incentivizing loan originators must comply with the Rule.  To accomplish these twin purposes in any compensation plan, mortgage lenders and their executives should carefully review their compensation plans for compliance with the Rule.  When necessary, they should engage legal counsel to see if their compensation plans contain any prohibited provisions.         

Homeownership Counseling Disclosure

Lenders of federally-related mortgage loans are now required to provide the Homeownership Counseling Disclosure.  This disclosure is in addition to the GFE required under RESPA.

Here are the basics:

1.  Effective Date:  for loans with an application date of 01/10/2014 or later.

2. Scope:  This new requirement covers all federally-related mortgage loans.  Essentially, if the GFE is required for a loan, you must also provide this Homeownership Counseling Disclosure.

3. When: within three business days after the receipt of an application, or information sufficient to constitute an application.  The timing is identical with that of the GFE.

4. What: this disclosure must contain a list of at least ten HUD-approved housing counseling agencies located closest to the borrower's current address (zip code).  At this moment, the easiest way to generate this list of counseling agencies is to go here, plug in the zip code of the borrower's current address, hit "Find A Counselor", and print or save search results.  Before you send the list to the borrower, be sure to include the following language on your disclosure document:

The counseling agencies on this list are approved by the U.S. Department of Housing and Urban Development (HUD), and they can offer independent advice about whether a particular set of mortgage loan terms is a good fit based on your objectives and circumstances, often at little or no cost to you. This list shows you several approved agencies in your area. You can find other approved counseling agencies at the Consumer Financial Protection Bureau’s (CFPB) website: consumerfinance.gov/mortgagehelp or by calling 1-855-411-CFPB (2372).  You can also access a list of nationwide HUD-approved counseling intermediaries at http://portal.hud.gov/hudportal/HUD?src=/ohc_nint.

Lenders should pay special attention to this requirement for a number of reasons.  First, many loan originators may be aware that housing counseling is required for reverse mortgages and Section 32 high cost mortgage loans; therefore, they may mistakenly ignore this disclosure when sending out the early disclosures on federally-related loans.  Second, most, if not all, secondary market investors will be looking for this disclosure when auditing loans.  A few have expressly stated in their bulletins that they would not purchase a loan absent this disclosure.

  

QM Points and Fees: What to Do about Bona Fide Discount Points?

Lenders and clients of our firm continue to ask for clarifications regarding bona fide discount points in calculating QM points and fees.  Many articles have been written, many webinars have been had, and many clarifications have been given, yet folks are still not sure about what to do about bona fide discount points.  So, it is, I think, not redundant to go over the basics one more time.

Discount points are finance charges, and are therefore included in the QM points and fees.  However, the QM Rule dos allow the following exclusions:

• up to two bona discount points paid by the consumer in connection with the loan if the loan's interest rate, without any discount, does not exceed the APOR by more than 1%;
• Upon to one bona fide discount if the loan's interest, without any discount, does not exceed  the APOR by more than 2%.

The math above seems easy enough, but the real problem lies in the definition of "bona fide" in the QM Rule. According to Section 1026.32(b)(3)(i), bona fide discount point means:

an amount equal to 1 percent of the loan amount paid by the consumer that reduces the interest rate or time-price differential applicable to the transaction based on a calculation that is consistent with established industry practices for determining the amount of reduction in the interest rate or time-price differential appropriate for the amount of discount points paid by the consumer.  [emphasis added]

 In simpler terms, a discount is considered "bona fide" if the discount fee paid by the borrower corresponds to a reduction in interest rate, but the ratio (rate reduction vs. discount fee) must conform to "well established industry practices".

What is "well established industry practices"?  CFPB explains as follows:

To satisfy this standard, a creditor may show that the reduction is reasonably consistent with established industry norms and practices for secondary mortgage market transactions. For example, a creditor may rely on pricing in the to-be-announced (TBA) market for mortgage-backed securities (MBS) to establish that the interest rate reduction is consistent with the compensation that the creditor could reasonably expect to receive in the secondary market. The creditor may also establish that its interest rate reduction is consistent with established industry practices by showing that its calculation complies with requirements prescribed in Fannie Mae or Freddie Mac guidelines for interest rate reductions from bona fide discount points. For example, assume that the Fannie Mae Single-Family Selling Guide or the Freddie Mac Single Family Seller/Servicer Guide imposes a cap on points and fees but excludes from the cap discount points that result in a bona fide reduction in the interest rate. Assume the guidelines require that, for a discount point to be bona fide so that it would not count against the cap, a discount point must result in at least a 25 basis point reduction in the interest rate. Accordingly, if the creditor offers a 25 basis point interest rate reduction for a discount point and the requirements of § 1026.32(b)(1)(i)(E) or (F) are satisfied, the discount point is bona fide and is excluded from the calculation of points and fees. [Emphasis added]

CFPB's staff commentary specifically refers to FNMA's definition or method of determining whether discount points are bona fide.  However, FNMA has since removed its definition from its guidelines.

Without the benefit of the only readily available and familiar standard, the mortgage lending industry is in dire need of clarity.  Secondary market investors have varying ways of determining "bona fide"; however, I do see a common requirement for documentation showing the connection between points paid and a corresponding rate reduction, which documents may include, without limitation:

• Rate sheet;
• Screen print from LOS and/or Pricing Engine;
• Rate lock agreement/confirmation with the borrower; and
• Final HUD-1.  

 In order to successfully exclude certain number of discount points from QM points and fees, a lender will have to present sufficient documentation to establish that the discounts paid by the borrower were indeed bona fide.

Qualified Mortgages: Are Seller-Paid Items Included in Points and Fees?

It's well established in the industry that seller's points are excluded from the APR calculation.  Likewise, a seller's credit/contribution to pay certain pre-paid finance charges, such as mortgage insurance premiums, may convert such fees into non-APR fees.  Lenders should feel fairly comfortable in such a practice with respect to a seller's credit/contributions because of the following Official Staff Interpretations:

Paragraph [1026.]4(c)(5)

1. Seller's points. The seller's points mentioned in §1026.4(c)(5) include any charges imposed by the creditor upon the noncreditor seller of property for providing credit to the buyer or for providing credit on certain terms. These charges are excluded from the finance charge even if they are passed on to the buyer, for example, in the form of a higher sales price. Seller's points are frequently involved in real estate transactions guaranteed or insured by governmental agencies. A commitment fee paid by a noncreditor seller (such as a real estate developer) to the creditor should be treated as seller's points. Buyer's points (that is, points charged to the buyer by the creditor), however, are finance charges.

 2. Other seller-paid amounts. Mortgage insurance premiums and other finance charges are sometimes paid at or before consummation or settlement on the borrower's behalf by a noncreditor seller. The creditor should treat the payment made by the seller as seller's points and exclude it from the finance charge if, based on the seller's payment, the consumer is not legally bound to the creditor for the charge. A creditor who gives disclosures before the payment has been made should base them on the best information reasonably available. [Emphasis added]

The question is whether a lender/creditor may approach seller credits in the same way when calculating the QM points and fees.  More specifically, if the seller pays a particular charge or fee included in QM points and fees, will this payment by the seller cause the fee to be excluded from QM points and fees?  A convoluted answer lies in the CFPB's Official Staff Interpretations:

2. Charges paid by parties other than the consumer. Under § 1026.32(b)(1), points and fees may include charges paid by third parties in addition to charges paid by the consumer. Specifically, charges paid by third parties that fall within the definition of points and fees set forth in § 1026.32(b)(1)(i) through (vi) are included in points and fees. In calculating points and fees in connection with a transaction, creditors may rely on written statements from the consumer or third party paying for a charge, including the seller, to determine the source and purpose of any third-party payment for a charge.

According to the above, the general rule is that even if a third party (including the seller) pays items included QM points and points, such items will still be counted in QM points and fees.  The CFPB gives the following examples:

i. Examples—included in points and fees. A creditor's origination charge paid by a consumer's employer on the consumer's behalf that is included in the finance charge as defined in § 1026.4(a) or (b), must be included in points and fees under § 1026.32(b)(1)(i), unless other exclusions under § 1026.4 or § 1026.32(b)(1)(i)(A) through (F) apply. [Comment: no exclusion applies to a lender's origination charge; therefore, this charge should still be included in QM points and fees no matter who pays it.]  In addition, consistent with comment 32(b)(1)(i)-1, a third-party payment of an item excluded from the finance charge under a provision of § 1026.4, while not included in the total points and fees under § 1026.32(b)(1)(i), may be included under § 1026.32(b)(1)(ii) through (vi). For example, a payment by a third party of a creditor-imposed fee for an appraisal performed by an employee of the creditor is included in points and fees under § 1026.32(b)(1)(iii). See comment 32(b)(1)(i)-1. 

However, some exceptions, as shown in the example below, apply.  

ii. Examples—not included in points and fees. A charge paid by a third party is not included in points and fees under § 1026.32(b)(1)(i) if the exclusions to points and fees in § 1026.32(b)(1)(i)(A) through (F) apply. For example, certain bona fide third-party charges not retained by the creditor, loan originator, or an affiliate of either are excluded from points and fees under § 1026.32(b)(1)(i)(D), regardless of whether those charges are paid by a third party or the consumer.

In other words, in order to utilize seller's credits to offset QM points and fees, such points and fees must fall into one of the following categories: 

• interest (1026.32(b)(1)(i)(A)) ;
• insurance premiums in Federal or State agency loan programs (1026.32(b)(1)(i)(B)) ;
• upfront and annual mortgage insurance premiums, guaranty fees, funding fees, etc. in government-insured loans (VA, FHA, USDA, etc.) (1026.32(b)(1)(i)(C));
• bona fide third-party charges in connection with the loan, not retained by the creditor/broker, or an affiliate of either (1026.32(b)(1)(i)(D)) ; and
• bona fide discount points  (1026.32(b)(1)(i)(E) - (F))

But, practically speaking, because the above items would have already been statutorily excluded from the QM points and fees, it would not make logical sense for a creditor to apply seller credits to offset them in the event that the lender has exceeded the 3% limit.  It appears that the Rule was designed to prevent the circumvention of QM points and fees by artful application of seller credits to pay charges.  

According to the CFBP's official comments, seller's points are, apparently, treated differently than seller's credits:

iii. Seller's points. Seller's points, as described in § 1026.4(c)(5) and commentary, are excluded from the finance charge and thus are not included in points and fees under § 1026.32(b)(1)(i). However, charges paid by the seller for items listed in § 1026.32(b)(1)(ii) through (vi) are included in points and fees. 

Therefore, unless seller's credits can be treated as sellers' points, the seller's credits will, in effect, not be permitted to offset QM points and fees.        

For the purpose of calculating QM points and fees, can a lender/creditor LEGALLY treat seller credits (toward paying finance charges) as seller's points?

To date, there seems to be two schools of thought and interpretation.

On the one hand, some believe the answer is "Yes" because of the Official Staff Interpretations on §1026.4(c)(5), which section is part of the general provisions (Subpart A) in Regulation Z and the definitions therein should apply to the rest of the regulatory provisions, including QM.  According to the CFPB,

[...] The creditor should treat the payment made by the seller as seller's points and exclude it from the finance charge if, based on the seller's payment, the consumer is not legally bound to the creditor for the charge. [...]  

It seems plausible to argue that CFPB would want "seller's points" to have a consistent meaning in the context of both APR fees and QM points and fees; therefore, a seller's payment of finance charges at or before closing should be treated as seller's points so long as the consumer is no longer legally responsible for paying such charges.

On the other hand, some approach this more conservatively, believing that seller's credits are treated differently than seller's points, and that seller's credits can be applied toward pre-paid finance charges only if exclusions to points and fees in § 1026.32(b)(1)(i)(A) through (F) apply.

Absent further clarification from the CFPB, lenders/creditors should follow their investor's particular guidelines on these complex issues so as to originate salable loans on the secondary market.  If a lender does not sell its loans on the secondary market, it is probably more prudent to refrain from applying seller's credits toward pre-paid finance charges with the intent to reduce the amount of QM points and fees.  

Qualified Mortgages: Are Lender-Paid Items Included in Points and Fees?

With the exception of LO/broker compensation, lender-paid items are excluded from QM points and fees.

As supported by the official guidance below, if a loan exceeds the QM 3% in points and fees, the lender can always issue a lender credit to bring the loan into compliance before closing:

iv. Creditor-paid charges. Charges that are paid by the creditor, other than loan originator compensation paid by the creditor that is required to be included in points and fees under § 1026.32(b)(1)(ii), are excluded from points and fees. [Official Interpretations] 

Qualified Mortgage Rules: Will the Sky Fall?

The CFPB's regulations on qualified mortgages ("QM") have been in effective since 1/10/2014, but most covered transactions have yet to make through the origination/underwriting process.  In the next few weeks, more loans will proceed to closing in the post-QM, mortgage lending environment.  Before lenders and loan originators begin the last minute preparation to close their loans, I would like to share some of my first impressions on QM.

First, secondary market investors have very different interpretations on QM.  Based on my perusal of a large number of bulletins, guidelines, and updates issued by a handful of investors, it appears that investors interpret many aspects of QM very differently.  For example, while Regulation Z clearly states that non-owner occupied investment property is exempt from the QM requirements, some investors still require loans secured by investment properties to comply with QM rules.  Although most investors are poised to purchase QMs, some may only purchase certain loan products that fall under the safe harbor QMs.

Second, confusion seems abundant in a number of areas.  Some folks may still find it difficult to grasp the nuanced distinction between pre-paid finance charges (APR fees) and QM points and fees.  What is typically an APR fee, for example, contract processing fee, may not necessarily be included in the QM points and fees if the contract processor receiving the fee is not an affiliate of the lender/broker.  On the other hand, what is counted in the QM points and fees, for example, certain real estate-related charges (appraisal fee, credit report fee, title policy premiums) paid to an affiliate of the lender, are generally not APR fees.  It's essential for lenders and originators to identify the differences and connection between APR fees and QM points and fees.  In addition, the 3% threshold applies when the loan amount (note amount) equals to or is greater than $100,000.  In such cases, the total points and fees cannot exceed 3% of the total loan amount.  For the purpose of calculating the QM points and fees limit, the total loan amount, in most cases, is the amount financed as shown on the final TIL disclosure, not the note amount.

Third, lenders and investors alike seem to still struggle with how to apply seller credits.  Before QM, the same issue surfaced when lenders tried to comply with Fannie Mae's 5% points and fees limit.  Fannie Mae did clarify in its Announcement 09-24 that "points or fees are counted against the limitation regardless of the party paying the fee".  With respect to QM points and fees limit, the CFPB's guidance document and staff interpretation seem to indicate that seller credits/contributions can be used to offset pre-paid finance charges in 1026.32(b)(1) that are included in the QM points and fees.  However, if charges paid by the seller were for broker compensation, real estate-related fees (payable to the lender's affiliate), or credit insurance premiums, such charges should still be included in QM points and fees.

In the next few days, I will provide addition details on each of the above three topics.  Please check back for more.