Why the New Appraisal Disclosure (Reg B) is Tricky?

Effective on 1/18/2014, creditors must comply with new rules under Reg B governing appraisals ("Appraisal Rule") in connection with first lien loans secured by a dwelling with an application date of 1/18/2014 or later.

In a nutshell, a creditor must provide the borrowers a disclosure, within three business days after the receipt of a loan application, advising them of their right to receive a copy of all appraisals and other written valuations developed in connection with the loan.  Appendix C, Form 9 provides the following recommended language for the disclosure:

We may order an appraisal to determine the property's value and charge you for this appraisal. We will promptly give you a copy of any appraisal, even if your loan does not close. 

 You can pay for an additional appraisal for your own use at your own cost.

In addition, the creditor must provide a copy of the appraisal/valuation reports to the borrowers promptly upon completion or three business days before closing.

These requirements seem simple and straightforward enough.  What is so tricky about the new Reg B?

1.  Scope of Application
Unlike other federal regulations, for example, Reg Z (TILA), Reg X (RESPA), Reg V (Fair Credit Reporting Act), or the new fearsome QM Rules, the new Appraisal Rule applies broadly to both consumer credit transaction and business-purpose credit transactions.

Notably, the Official Staff Interpretations provides:

14(a)(1) In general.
1. Coverage. Section 1002.14 covers applications for credit to be secured by a first lien on a dwelling, as that term is defined in § 1002.14(b)(2), whether the credit is for a business purpose (for example, a loan to start a business) or a consumer purpose (for example, a loan to purchase a home). [Emphasis added]

In other words, if the borrowers apply for a first-lien loan secured by a dwelling (i.e., 1-4 family residence, including, mobile home, condo, and coop), the requirements under the new Appraisal Rule will be triggered.  Therefore, even if the loan is for a business purpose, for example, to acquire a non-owner occupied, 1-4 family rental/investment property, the Appraisal Rule applies.  Similarly, it applies to a business purpose loan even if the borrower is a business entity, such as a limited liability company.

In terms of scope and applicability, the Appraisal Rule departs from other federal regulations.  Creditors, who lend to business entities or rental property investors, must comply with the Appraisal Rule by providing the early disclosure. (I do note that the broad application of this disclosure requirement is an existing requirement under Reg B.)  

2. Written Valuations
While the industry is familiar with appraisal reports developed by appraisers, less is known, however, about "written valuations".  In Reg B, "valuations" is defined as follows:

any estimate of the value of a dwelling developed in connection with an application for credit.

According to this definition, valuations should cover (refer to this):

• An appraisal report (by an appraisal whether or not licensed or certified) including the appraiser's estimate or opinion of the property’s value;
• A document prepared by the creditor or its agent/contractor that assigns a specific monetary value to the property;
•  A report approved by a GSE for describing  the estimate of the property’s value developed pursuant to the proprietary methodology or mechanism of the GSE;
•  A report generated through an automated valuation model (AVM) to estimate the property’s value;
• A broker price opinion (BPO) prepared by a real estate broker, agent, or sales person to estimate the property’s value.

In some instances, a creditor may compile valuation data, post closing, regarding a property solely for quality control purposes.  Will those valuation data be subject to this rule?  Given the overarching goal of Reg B for preventing discrimination by promoting transparency during the loan origination process, written documentation developed by a creditor after closing for quality control purposes should fall outside the scope of the Appraisal Rule.

Texas Supreme Court Further Clarifies Home Equity Lending

Summary:

In a Supplemental Opinion On Motion for Rehearing dated January 24, 2014, the Supreme Court of Texas ruled that: (1) per diem interest and legitimate discount points are not included in the constitutional 3% fee cap in connection with Texas home equity loans secured by homestead; and (2) a power of attorney can only be used in closing a home equity loan if that power of attorney was properly executed in the office of a title company, an attorney, or of the lender.

Impact:

With this additional ruling from the high court, lenders can now exclude prepaid per diem interest from the 3% fee cap.  "Legitimate" discount points can also be excluded, but the Court did not define what constitutes "legitimate".  The intent of the Court was, probably, to state "bona fide" discount point, which is a concept familiar to the mortgage lending industry.  Like with the exclusion of bona fide discount points in calculating the QM 3%, lenders will likely be required to demonstrate the discounts were in fact bona fide.  It's possible the Court may issue additional clarification on "legitimate discount points", and I will continue to monitor for developments on this.  For lenders that only originate QM loans, they will need to comply with both the Texas 3% fee cap and QM 3% when the Texas home equity loan amount is equal to or greater than $100K. 

In addition, borrowers, who must sign closing documents with the help of a power of attorney, will have to execute a Power of Attorney in the office of an attorney, the lender, or title company.  As a practical matter, title companies that close Texas home equity loans may require evidence, proof, or certification that a Power of Attorney was indeed executed in one of the permitted locations.  To be safe, a lender should not allow an agent/attorney-in-fact to execute Texas home equity loan closing documents unless it is certain that the power of attorney giving authority to the agent was properly executed in the office of a title company, an attorney, or of the lender.      

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] 

Investment Property: Does the Qualified Mortgage Rule Apply?

To continue yesterday's discussion on my first impressions of the QM Rule, let's focus on the applicability of the QM Rule.  In particular, does it apply to investment properties?

Section 1026.43(a) details the scope of the QM Rule, and it identifies a list of transactions exempt from this Section, which is the crux of the QM Rule.  However, Section 1026.3(a)(1), which formulates "Subpart A" of Regulation Z that encompasses the QM Rule, provides specifically that an extension of credit primarily for commercial or business purposes is exempt from Regulation Z.  The Official Staff Interpretations regarding Section 1026.3(a)(1) clarify that credit extended to purchase, improve, or maintain non-owner occupied rental property is "deemed" to be for business purpose.  This means that residential mortgage loans to be secured by non-owner occupied investment property are exempt from Regulation Z, and thus Section 43 of Regulation Z.  However, if a borrower were to occupy the property for at least 14 days in one year (second home), a loan to be secured by such a property would not be deemed to be for business purpose, and thus, rendering it subject to the QM Rule.

Despite the express, statutory exemption for business-purpose loan transactions secured by investment properties, some investors have decided that such loans must comply with the QM Rule in order for them to be eligible for purchase.  For example,  Stonegate Mortgage Company, Cole Taylor Mortgage, and Freedom Mortgage all wrote in their QM bulletins or guidelines that they want, for the time being, the QM Rule to apply to investment properties.

These investors' interpretations are not necessarily wrong.  The investors just chose to approach the QM Rule more conservatively for legitimate business reasons, which is perfectly justifiable in the post-QM business environment.  They may, for good business reasons, change their interpretations a few months later when the jitters and uncertainties about these complex new rules settle down. For lenders and loan originators, in order to originate loans salable to investors that may appear to be a little conservative at this stage of the QM Rule, it is absolutely essential to know how the investors interpret the QM Rule.

In sum, knowing the QM Rule is important; knowing your investors' interpretations of the QM Rule is probably more important.