Higher Priced Mortgage Loans Higher Priced Covered Transactions Qualified Mortgages High Cost Mortgage Loans Total Points and Fees

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1 Seeded and Actual Questions from our Dodd Frank Act Mortgage Regulations Implementation Workshops Fort Walton Beach, Orlando, and Tampa September 2013 Ability to Repay Lending Questions 1. We are not sure if we should offer non Qualified Mortgage Loans. What is our liability if a non QM loan is challenged? A loan can be challenged as violating the Ability to Repay (ATR) rules as a direct action within 3 years after consummation, or as a defense to a foreclosure action at any time. The borrower has the initial burden of proving there was a violation of the general ATR rules. As an affirmative defense, the creditor can prove that the loan met one of the QM tests; once that burden is met, if the loan was not higher priced, the matter ends as the creditor is deemed to have complied with the ATR rules. If the loan is proved to be QM but is a higher priced loan, the consumer can overcome the presumption of the creditor s compliance with the ATR rules by proving that he/she had insufficient income to repay the loan due to obligations that the creditor was aware of at the time. For non QM loans (or, for loans that were intended to be QM but for which the creditor cannot prove met the QM test), the cost of the dispute will typically be higher as the matter would go through longer phases of litigation. If a violation is proven that the Bank cannot demonstrate was not material, statutory damages are the sum of all finance charges (including interest) and fees paid, along with regular TILA statutory damages including actual damages, court costs and attorney s fees. The legal uncertainty of having your loan underwriting questioned at any point in time is troublesome (although, the CFPB and other sources say that strong and documented underwriting processes will defend the Bank if challenged, and that small creditors will not face significant litigation risks from the ATR requirements); however, perhaps more troublesome than the legal liability from the borrower, is the potential for fair lending concerns if you treat applicants differently in originating non QM loans. As the CFPB points out in supplemental information, the likelihood and costs of defending an ATR dispute increase proportionally with the probability of delinquency or default (i.e., those with low debt to income ratios are less likely to need or want to bring a claim). So, be careful of policies that encourage non QM loans only for those with significant excess residual income. This is a matter we hope to get more guidance on as the market reacts to the ATR rules. 2. Can we still offer balloon loans? Congress generally favors adjustable rate mortgage (ARM) loans over balloon loans, as ARM loans are perceived to be better for consumers. That said, you can still offer balloons under the Ability to Repay (ATR) general rules. Also, if you are a small creditor, you can offer balloons under Qualified Mortgage (QM) exemptions #4 or #5. Note however that balloons are not allowed for high cost mortgage loans (defined in the next Question) unless it is a QM, a bridge loan, a term out of HELOC, or as required to accommodate the irregular income of the borrower. For calculating the residual or debt to income ratio (monthly payment) on a proposed balloon loan under the ATR general rules, you use the maximum payment during the 1 st 5 years after the 1 st periodic payment. So, be sure that your balloon payment is the 61 st payment and not the 60 th (yes, this is somewhat circumventing the rules). If the loan will be a higher priced covered transaction, (defined in the next Question) you must use the maximum payment (i.e. the balloon). Under QM #4 or #5, if all requirements are met, you do not need to include the balloon payment when considering residual or debt to income. Disclaimer: The answers are based on our review of the regulations and commentary as of 10/1/13 and all are believed to be accurate. However, there are no guarantees, and all are subject to change at any time with an inconsistent interpretation or regulatory revision. Specific facts and circumstances could also change the answers or outcome. Please contact your compliance officer, consultant or attorney for confirmation and fact specific advice, as 1

2 3. We are confused with Higher Priced Mortgage Loans, Higher Priced Covered Transactions, Qualified Mortgages, High Cost Mortgage Loans and Total Points and Fees. Can you summarize the tests, requirements and exemptions? A. Higher priced mortgage loans (HPML) (slides 17 & 55) are covered at TILA Section They are closedend consumer purpose loans, secured by the consumer s principal dwelling, in which the APR* exceeds the average prime offer rate (APOR) for a comparable transaction at the time the rate is set, by 1.5% or more for a first lien, 2.5% or more for a Jumbo loan, or 3.5% or more for a subordinate lien loan. If the loan is a HPML: 1. If a first lien, you must escrow for taxes and insurance for at least 5 years, and can only cease the escrow account under certain requirements. a. This section does not apply to initial construction, temporary or bridge loans with term of 12 months or less, or reverse mortgages. Also, Small creditors who do not otherwise escrow, and who made more than half of their 1 st lien mortgage loans in a rural or underserved counties (in any of the prior 3 calendar years) are exempt for portfolio loans. 2. If the loan is secured by a principal dwelling (re: appraisals): a. You must provide an appraisal disclosure within 3 business days of discovering will be a HPML*(Note: one would already have been provided if 1 st lien, under the Reg B Appraisal rules); b. You must obtain an appraisal (regardless of loan amount or whether one is required under FIRREA) that meets specific requirements, including a full interior inspection; Appendix N provides a safe harbor if followed c. If a flip (property held 90 days and being sold for >10% price increase, or held 180 days and >20% price increase) you must obtain a second (independent) appraisal at the Bank s cost d. You must provide a copy of the appraisal at least 3 days prior to closing with no exceptions allowed. e. This section does not apply to Qualified Mortgages, or if collateral is mobile home/camper/trailer or new manufactured home (with some additional exemptions pending), the loan is a bridge loan of 12 months or less, the construction loan (or the construction phase of a Construction permanent loan) is to finance the initial construction of the dwelling, or for reverse mortgages. B. A higher priced covered transaction (HPCT) (slides 30 & 32) is a defined term under TILA s Ability to Repay Rules at (b)(4). It is a closed end consumer purpose loan (any lien position and 2 nd homes included) with an APR* that exceeds the average prime offer rate (APOR) for a comparable transaction, at the time the rate is set, by more than 1.5% for a first lien loan, or by more than 3.5% for a subordinate lien or small creditor/small rural creditor QM loan. 1. A Qualified Mortgage has different safe harbors depending on whether it is HPCT or not. 2. If the HPCT will be a balloon loan, you have to include the balloon in the general rule s calculation of the monthly loan payment. 3. Excluded from HPCT are timeshares; reverse mortgages; construction, temporary or bridge loans of 12 months or less; or the construction phase (regardless of length) of a loan to finance the initial construction of a dwelling. C. A Qualified Mortgage (slides 33 42) is an Exception to the Ability to Repay general requirements: 1. Agency Loans eligible to be purchased or insured by a GSE/Agency 2. Vanilla loans (no balloon) meet Total Points & Fees Test and debt to income 43% under Appendix Q 3. Vanilla loans (no balloon) meet Total Points & Fees Test and made and held by Small creditor who considers DTI or residual income and verifies debt 4. Fixed rate Balloon loans over 5 years made and held by Small, Rural/Underserved creditor Meets Total Points & Fees test 2

3 5. Until 1/11/16, Fixed rate Balloon loans over 5 years made and held by Small creditor Meets Total Points & Fees test 6. Exempt from the ATR requirements are HELOCs, timeshares, reverse mortgages, temporary or bridge loans of 12 months or less, the construction phase of a loan to finance the initial construction of the dwelling (any term), the construction phase of 12 months or less of a construction/perm loan. D. A high cost mortgage loan (HCML) (slides 21 25) is also called a HOEPA loan and is defined under TILA at It is an open or closed end loan secured by the consumer s principal dwelling in which there is (any of the following): 1. APR* (measured as of the date the interest rate is set) exceeds APOR for comparable transaction on that date by more than a. 6.5% for first lien; b. 8.5% for first lien on personal property (i.e., mobile homes or RVs) and loan < $50,000; c. Or 8.5% for subordinate lien loan; 2. Or, Total Points and Fees exceed (figures will be adjusted annually,): a. 5% of total loan amount if loan $20,000; or b. 8% of total loan amount or $1,000, whichever less, if loan <$20,000; 3. Or, a prepayment penalty that can be charged (HELOCs too) more than 36 months after consummation OR for >2% of the amount prepaid. 4. There are restrictions on the terms that an HPML loan may have. For example (with exceptions) no: balloon payment, prepayment penalties, payoff statement fee, acceleration of debt clause, large late fees, charge for modification, financing of points and fees. They also have a mandatory pre closing counseling requirement. E. Total Points and Fees (slides 36 39) This is a figure used to determine whether the loan can be a Qualified Mortgage (e.g. must be 3% of total loan amount if loan is $100,000 or more), and also whether it is a High Cost Mortgage Loan (e.g. >5% of total loan amount if loan is $20,000 or more). The test is NOT the same as the finance charges under TILA. It includes finance charges (with some exceptions, like certain private mortgage insurance and bona fide 3 rd party charges) but it also includes loan originator compensation, charges paid to the creditor or affiliate, credit life insurance premiums, and prepayment penalties. *Note: How to calculate APR: For HPML and HPCT, use the APR disclosed by your disclosure system. For HCML/HOEPA, use the APR calculated by using the fully indexed interest rate or the introductory rate, whichever is greater. For all loans other than discount or premium rate ARMs, this will be the APR disclosed by your disclosure system. For discount or variable rate ARMs, this will be a different APR, as the APR calculated by your system, per TILA, uses a blend of the initial rate and the fully indexed rate, and takes rate caps into account. Note: How to calculate the spread to see if the % thresholds are met: Calculate the APR as above at every time the rate is set (i.e. at the time of the initial disclosure and at any subsequent rate change). Used the APOR tool provided at enter the APR and the term of the loan (or, the term of the initial fixed rate period if an ARM) to calculate the spread. If the spread is equal to or greater than the thresholds noted above, you have that loan type. 3

4 4. We want to offer adjustable rate mortgage (ARM) loans, can we under the new rules? Yes, and they can even qualify for Qualified Mortgage (QM) status (Standard QM Exception #2, or QM #3 for small creditors). When calculating the monthly payment (and the residual or debt to income ratio) on ARM loans under the ability to repay general rules, you use the fully indexed rate or the introductory rate, whichever is greater. But, when considering residual or debt toincome for QM Exemption #2 or #3, use the maximum rate that will apply during the 1 st 5 years after the 1 st regular payment (so, make sure that your 5 year ARM loans go at least 61 months before a rate change, and that your ARM loans of less than 5 years have periodic rate caps). 5. We are thinking about requiring prepayment penalties on closed and open end loans. What can we do? In the Dodd Frank Act rule changes, several areas discuss prepayment penalties. First, HOEPA prohibits prepayment penalties on high cost mortgage loans (defined in Question 3). In addition to the APR and Total Points and Fees test, HOEPA coverage is triggered if a penalty can be charged >36 months after closing or if it can exceed 2% of the amount prepaid. Second, under HOEPA and the Ability to Repay rules, prepayment penalties are included in the Total Points and Fees calculation. Third, under the Ability to Repay rules, prepayment penalties are only allowed for fixed rate, non higherpriced, qualified mortgages, and then they are limited to 3%, 2% or 1% of the amount prepaid during the 1 st, 2 nd and 3 rd years, respectively. Fourth, to pass the Qualified Mortgage test, Total Points and Fees are capped at 3% of the total loan amount, so, unless a creditor forgoes some or all other charges that would be included in Total Points and Fees, it will also limit the amount of prepayment penalties that can be charged. A Note on Bank paid fees: Prepayment penalty does not include any Bank paid third party charges that must be reimbursed if a consumer pays off a loan (in full) or terminates an open end credit plan sooner than 36 months after account opening. Commentary to (b)(6). But, any Bank fees included in those costs ARE prepayment penalties and would be subject to the above. 6. Can a HOEPA (high cost mortgage) loan be a qualified mortgage? Yes. Although the HOEPA total points and fees (TPF) threshold at 5% is higher than the Qualified Mortgage s TPF thresholds (e.g. 3%), a loan could be subject to HOEPA under its APR threshold while still meeting the criteria for a qualified mortgage. 7. Are creditor paid costs included in the Total Points and Fees test? Creditor paid compensation to a non employee Loan Originator is included. Other costs paid by the creditor (whether absorbed by the creditor or offset by a higher interest rate) are not included. 8. Do closing costs paid through an employer paid relocation expense program count as Total Points and Fees? Yes, if they are paid by a third party on behalf of the consumer for items that would be counted as points or fees. If you are not sure what fees will be paid the with the third party s funds, you can get a written statement from the borrower or other third party, including the seller or employer, as to the purpose of the payment. 9. Do the new requirements apply to renewals of existing loans? No, so long as the existing obligation is modified or extended without satisfying and replacing the existing obligation (generally, this means no new Note unless it states within that the original Note remains intact). 10. Do all fees paid to an affiliate title company be counted toward the Total Points and Fees test, including the portion for title insurance? All fees paid are included. 11. Where income from employment is considered as the basis for repayment, are we required to obtain a verification of employment or will a current W 2 suffice? It is not clear. The general Ability to Repay requirements authorize using payroll statements to verify income, but is silent on the type of records that will verify current employment status other than a verification of employment from an employer. The supplementary information opines that the burden of 4

5 performing a verification of employment shouldn t be too great, as an oral verification suffices so long as it is documented. On the other hand, using a payroll statement for verifying employment is mentioned in the supplemental discussion on using a Leave and Earnings Statement for verifying military employment (which was added as a means of verifying military employment). Appendix Q provides some guidance of what to do if you cannot obtain the verification. It states: creditors may assume that the consumer's salary or wage income can be reasonably expected to continue if the consumer's employer verifies current employment and income and does not indicate that employment has been, or is set to be terminated. Where no such appropriate verification is provided, the creditor must analyze the consumer's income and determine whether the consumer's income level can be reasonably expected to continue. In such cases, the Bureau believes that further analysis should be required of creditors, and that, as revised, section I.B provides creditors with an effective regulatory framework for carrying out that analysis (note that section I.B. does require verification for certain types of income to be included). Appraisals on dwellings 12. Do we have to provide internal valuations if an appraisal is also ordered and obtained? Yes, unless the valuation is comprised solely of publically available information (such as published sales prices or mortgage amounts, tax assessments, and retail price ranges), or simply restates the value in an appraisal being provided to the applicant. 13. Do we have to provide the appraisal review to the consumer? Only if it provides an opinion of value that does not merely restate the value of the dwelling contained in the appraisal or valuation being provided to the applicant. 14. Do we have to provide appraisals obtained for loan renewals or for calculating our ALLL? If an appraisal is developed in connection with a renewal (or a modification for that matter) of an existing extension of credit requested by an applicant, then yes. If, however, the renewal is unilateral action by the creditor to determine whether to renew a line of credit, then possibly no; it would depend on whether the action constituted an Application under ECOA (see 12 CFR (e), (f), (j) and (q)). With regard to impaired loans or the ALLL calculation, the commentary does not specifically address; however, since it would clearly not be an application under ECOA we would interpret the requirement as not applying. 15. Do we have to comply with E SIGN in sending appraisals (and the appraisal disclosure) on business loans? Yes, the E SIGN requirements (disclosure and demonstrative consent) apply to these disclosures. However, the appraisal disclosure can be made on application forms that are provided electronically without regard to E SIGN. Mortgage banking/secondary Market 16. We buy loans from mortgage brokers and correspondent lenders. What should we be thinking of? Among other things, you should consider whether you will only buy qualified mortgages (and then, only non higher priced QMs?). Also, the Total Points and Fees test double counts compensation paid to the originator by you in the wholesale environment, but not in a correspondent/secondary market environment (up front charges paid by the consumer to you as creditor are included as part of the finance charge, and fees paid by you as creditor to the LO/LO Organization are included as part of LO compensation). You should review your wholesale lending compensation agreements if they provide for consumer to creditor and creditor to loan originator compensation. Loan Originator (LO) Compensation/Qualifications 17. Would explaining how to complete an application be considered a Loan Originator (LO)? No, so long as the person does not actually fill out the application or assist the consumer in filling it out. 5

6 18. Would helping a blind applicant, or providing translation services for an applicant, be considered a LO? Yes, it would be considered assisting in making the application. We recommend affected applicants be referred to a designated LO for this assistance. 19. Would a CSR who referred a new deposit customer to the mortgage department of the Bank be considered a LO? No, so long as no information was used in making the referral. If the CSR asked questions and referred the consumer to a particular LO based on those questions, the CSR would be a LO even if the Bank does not pay referral fees (The reg does not require compensation to be tied to the particular transaction; salary from their job at the Bank is enough. As a LO, the CSR s compensation could not be based on a term of the loan. That said, typical referral incentive programs are flat fees and would not run afoul of the compensation requirements.) 20. Is a processor who gathers or verifies application information a LO? No, so long as the information is being collected on behalf of a LO, and not on behalf of the consumer to provide to an LO or creditor. 21. Are we required to perform credit and criminal background checks on our existing employees who may become Loan Originators under these rules? The reg does not require a loan originator organization to review the covered information and make the required determinations for an individual whom the loan originator organization hired as a loan originator on or before January 1, 2014, and screened under applicable statutory or regulatory background standards in effect at the time of hire or used to screen the individual thereafter. The underlined terms are not defined under the reg or commentary, although commentators noted that FDIC has pre employment screening guidelines. For mortgage loan originators, you would have screened under the SAFE Act s requirements. For either, if you become aware that the individual may not meet the standards, based on reliable information, you are required to review and determine again. 22. If we become aware that a LO has credit problems during their application for a loan that is made to one of our employees, does that trigger a requirement to review and determine? That would depend on whether the individual employee s knowledge would be attributed to the Organization. Many banks require employee loan applications be reviewed through specific channels (i.e. a senior loan officer or the human resource department). In an abundance of caution, you can consider that the application would trigger a review of the LOs credit report for financial responsibility. You can use the regulation s safe harbor provision and implement procedures for this review. See Comments 36(f)((3)(ii)(B) 1 and Is a commercial lender who takes an application for referral to a mortgage loan officer considered a LO under the rules (and therefore will his/her bonus be regulated?) Yes because he took the application (assumes more than just receiving the form) he/she would be considered a LO and his/her bonus would be regulated as with any LO. The bonus would be appropriate if it was: (a) not determined with reference to mortgage related business; (b) determined solely by the mortgage loans he/she originated, but not by any term of those transactions (see commentary for factors that are not terms of the transaction); (c) contributions to a defined contribution plan that is a designated tax advantaged plan, and for which the contributions are not based on the terms of his/her mortgage transactions; or (d) determined with reference to pooled mortgage profits (and not directly or indirectly based on the terms of his/her mortgage transactions), but where he/she was a LO for 10 transactions in the prior 12 rolling months or where aggregated the bonus 10% of his/her total compensation for the period in which the bonus is being paid. 24. Is a discretionary budgeted bank wide bonus (profit based, so mortgage profits are included) to all employees including LOs, subject to the 10% bonus rule? The commentary s exclusion to the 10% bonus limit for budgeted items is for retention or performance bonuses that are set aside in advance. By stating they do not violate the prohibition on payment of compensation based on the terms of transactions of multiple loan originators it implies 6

7 they are not profit based. The Proposed Rule stated: The proposed comment also notes that a bonus that is made without reference to profitability (emphasis mine), such a retention payment budgeted for in advance, does not violate the prohibition on payment of compensation based on transaction terms. and A bonus that is paid to an individual loan originator without reference to the profitability of the person or business unit, as applicable, such as a retention payment budgeted for in advance, does not violate the prohibition on payment of compensation based on transaction terms 25. If a LO originates 10 or less covered mortgage loans, does the 10% bonus rule apply? No, so long as the bonus is not based on terms of that LO s mortgage transactions (rules prohibit compensation based on the terms of multiple transactions by an individual loan originator). 26. Do we include 401(k) Bank contribution (not related to the profits of the Bank) and stock option values in the total compensation against which the 10% bonus limit is calculated? Contributions to designated tax advantaged plans that are defined benefit plans can be included, at the option of the payer. Other compensation is included if reportable in a W 2 or 1099 MISC (i.e., salary, wages, commissions, the calculated bonus.). 27. Can LO be paid higher percentage for lower loan amounts (i.e. to encourage CRA loans)? Although compensation can be based on a percentage of a loan amount, the percentage itself cannot vary on the amount extended for any particular transaction. However, the creditor can provide a floor (i.e., $1,000 minimum for each loan) or ceiling on a per transaction basis. 28. In an effort to increase ongoing income through portfolio lending (ARM or balloon loans), can we pay LOs a higher percentage (based solely on loan amount) for portfolio loans than secondary market loans? No, if the portfolio/secondary placement varies with a loan term (ARM vs. fixed, balloon vs. fully amortizing) over a significant number of transactions, and the LO has the ability to change the factor (encourage/offer an ARM or balloon loan). 29. Can we pay portfolio mortgage lenders a higher percentage basis than secondary market mortgage lenders? The rule does not apply to differences in compensation between different individual loan originators. 30. Can we pay higher percentages for higher loan volumes (e.g. 1% for first $1million, 1.25% for $1million 3million, and so on)? This practice was common under the TILA compensation rules effective June 2011, and the LO comp rules were not supposed to substantively change this; however, informal CFPB opinion is that flat percentages are required (noting, however, that compensation can be adjusted periodically and increases based on volume at those adjustments are allowed). 31. Can we pay incentive based compensation on loan terms for HELOCs? Yes. HELOCs are not subject to the LO compensation rules. 32. How do we pay compensation for applications that are in process on the effective date? The rule is effective for loans consummated and payments made on or after 1/1/14, regardless of when the application was taken. 33. Is bonus compensation included in the TPF test? Not typically, unless it can be attributed to that transaction at the time the interest rate is set is included (for example, a set amount based on volume of originations at that time). Servicing 34. We want to get out of this ARM portfolio business. Refinancing an ARM loan into a standard loan is exempt from the ATR QM rules (as are neg am or interest only loan refinances). A standard loan requires a fixed payment for at least 7

8 5 years and NO balloon. The monthly payment must be materially lower, the application to refinance must be received within 2 months of the recast, and the borrower cannot have been recently past due (none within prior 6 months, and only 1x within prior 12 months). 35. Can we net out escrow amounts from the loan payoff quote? The commentary specifically states that it does not prohibit a servicer from netting any remaining funds in an escrow against the outstanding balance of the borrower s mortgage loan; the supplemental information recognizes that community banks commented they often do this. 36. Can a servicer still report a loan as delinquent after receipt of error if the alleged error had nothing to do with the posting of payment? Yes, the rule prohibits reporting regarding any payment that is the subject of the notice of error. 37. Do small servicers have an obligation to notify consumers of their error resolution or right to information rights? No, unless you want to require that a notice or request be received at an exclusive address (then, you need to post that address on any mortgage servicing website that lists your contact address AND in any communication provided to the borrower with contact information for assistance). 8

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