ATTORNEYS MICHAEL A. KUS MICHAEL J. RYAN MARSHA J. GRECO JEFFREY S. HOROWITZ ANTHONY E. VALENTINE DANA K. PEZNOWSKI OF COUNSEL JAMES C. ROSE THOMAS G. SCHLUENTZ This publication is for information purposes and does not contain, convey or constitute legal advice and may not be relied upon as such. The information contained in this publication should not be relied upon in regard to any particular circumstances or facts. You should consult an attorney about your own particular facts and/or circumstances. MARCH 2011 This Memorandum was prepared for a client in response to a request for guidance on the distinction between a residential mortgage loan prequalification versus a residential mortgage loan preapproval. MEMORANDUM MORTGAGE PREQUALIFICATION VS MORTGAGE PREAPPROVAL You have requested our firm provide you (the Bank ) with guidance on what information may be provided by or requested from a consumer who may be seeking a residential mortgage loan for purposes of prequalification versus preapproval for a residential mortgage loan. As you are aware various statutory and regulatory provisions relate to what is or is not an application. While there is some similarity between the various statutory and regulatory provisions, there are differences that must be considered as well. Real Estate Settlement Procedures Act & Regulation X Under the Federal Real Estate Settlement Procedures Act ( RESPA ) 12 U.S.C. 2602, and its implementing Regulation X, the term application is defined as: the submission of a borrower s financial information in anticipation of a credit decision relating to a federally related mortgage loan, which shall include the borrower s name, the borrower s monthly income, the borrower s social security number to obtain a credit report, the property address, an estimate of the value of the property, the mortgage loan amount sought, and any other information deemed necessary by the loan originator. An application may either be in writing or electronically submitted, including a written record of an oral application. 1 Thus, for RESPA purposes, an Application consists of: 1. Borrower s name 2. Borrower s monthly income 3. Borrower s social security number 4. Property address (used as security for the loan) 5. Estimate of the value of the property 6. Mortgage loan amount sought 7. Any other information that the loan originator deems necessary. 2851 High Meadow Circle, Suite 120 Auburn Hills, Michigan 48326 Phone: 248.364.3090 Copyright 2011 Kus,Ryan & Associates, PLLC Facsimile: 248.364.3097
Under RESPA and Regulation X, a loan originator must issue a Good Faith Estimate ( GFE ) no later than three (3) business days after the loan originator receives an application or information sufficient to complete an application. If the creditor has not received all of items 1 7 noted above, there has not been an application for RESPA and Regulation X purposes. Home Mortgage Disclosure Act & Regulation C 12 C.F.R Part 203 The Home Mortgage Disclosure Act ( HMDA ) 2 and its implementing Regulation C also define what constitutes an application. HMDA and Regulation C discuss the word application in relation to a written or oral request for a residential mortgage loan that is made according to the procedures used by a financial institution for the type of credit requested. 3 Regulation C specifically discusses preapproval programs, and notes that a request for a preapproval is an application if the request is: reviewed under a program in which the financial institution, after a comprehensive analysis of the creditworthiness of the applicant, issues a written commitment to the applicant valid for a designated period of time to extend a home purchase loan up to a specified amount. 4 (emphasis supplied). The term home purchase loan is defined in Regulation C as a loan secured by and made for the purpose of purchasing a dwelling. 5 Additionally, Supplement 1 to Part 203 Staff Commentary, 12 C.F.R. Pt. 203, Supp. I, Section 203.2(b) 1. states that under Regulation C the definition of an application does not include prequalification requests. Section 203.2(b) 2. Discusses prequalifications in some detail, as follows: A prequalification request is a request by a prospective loan applicant (other than a request for preapproval) for a preliminary determination on whether the prospective applicant would likely qualify for credit under an institution s standards, or for a determination on the amount of credit for which the prospective applicant would likely qualify. Some institutions evaluate prequalification requests through a procedure that is separate from the institution s normal loan application process; others use the same process. In either case, Regulation C does not require an institution to report prequalification requests on the HMDA/LAR, even though these requests may constitute applications under Regulation B for purposes of adverse action notices. (emphasis supplied). The HMDA/Regulation C discussion of prequalifications is all couched in tentative terms such as preliminary and likely and not in definitive terms of the application such as comprehensive. In addition, under HMDA and Regulation C, to be classified as a preapproval, the lender must issue a written commitment, valid for a designated period of time, to extend a home purchase loan up to a specified amount. It is our opinion that a reasonable interpretation of the Regulation C discussion of prequalifications verses preapprovals is that unless the loan originator has made a comprehensive analysis of the credit worthiness of the applicant and issued a written commitment that meets the requirements of the regulation, then there has not been a application for HMDA/Regulation C purposes. Equal Credit Opportunity Act & Regulation B 12 C.F.R. 202.3 The Equal Credit Opportunity Act ( ECOA ) and its implementing Regulation B, define application as: HELOC Appraisal Fees Regulation Z Requirements Page 2 of 5
an oral or written request for an extension of credit that is made in accordance with procedures used by a creditor for the type of credit requested. The term application does not include the use of an account or line of credit to obtain an amount of credit that is within a previously established credit limit. 6 The requirements under ECOA and Regulation B apply to a completed application, which is: an application in connection with which a creditor has received all the information that the creditor regularly obtains and considers in evaluating applications for the amount and type of credit requested (including, but not limited to, credit reports, any additional information requested from the applicant, and any approvals or reports by governmental agencies or other persons that are necessary to guarantee, insure, or provide security for the credit or collateral). 7 It is the Official Staff Interpretations of Regulation B that provide the most useful insight into when an inquiry becomes a completed application, thus triggering the ECOA and Regulation B requirements. The Official Staff Interpretations regarding the term application provide the following explanation and examples: 3. When an inquiry or prequalification request becomes an application. A creditor is encouraged to provide consumers with information about loan terms. However, if in giving information to the consumer the creditor also evaluates information about the consumer, decides to decline the request, and communicates this to the consumer, the creditor has treated the inquiry or prequalification request as an application and must then comply with the notification requirements under 202.9. Whether the inquiry or prequalification request becomes an application depends on how the creditor responds to the consumer, not on what the consumer says or asks. (emphasis supplied). 4. Examples of inquiries that are not applications. The following examples illustrate situations in which only an inquiry has taken place: i. A consumer calls to ask about loan terms and an employee explains the creditor s basic loan terms, such as interest rates, loan-to-value ratio, and debt-to-income ratio. ii. A consumer calls to ask about interest rates for car loans, and, in order to quote the appropriate rate, the loan officer asks for the make and sales price of the car and the amount of the down payment, then gives the consumer the rate. iii. A consumer asks about terms for a loan to purchase a home and tells the loan officer her income and intended down payment, but the loan officer only explains the creditor s loan-tovalue ratio policy and other basic lending policies, without telling the consumer whether she qualifies for the loan. iv. A consumer calls to ask about terms for a loan to purchase vacant land and states his income and the sales price of the property to be financed, and asks whether he qualifies for a loan; the employee responds by describing the general lending policies, explaining that he would need to look at all of the consumer s qualifications before making a decision, and offering to send an application form to the consumer. 5. Examples of an application. An application for credit includes the following situations: i. A person asks a financial institution to preapprove her for a loan (for example, to finance a house or a vehicle she plans to buy) and the institution reviews the request under a program in which the institution, after a comprehensive analysis of her creditworthiness, issues a written commitment valid for a designated period of time to extend a loan up to a specified amount.... But if the creditor s program does not provide for giving written commitments, requests for preapprovals are treated as prequalification requests for purposes of the regulation. 8 HELOC Appraisal Fees Regulation Z Requirements Page 3 of 5
Based on the examples given there are several factors to keep in mind. The first is that the definition of what is an application under ECOA and Regulation B is very much the same as for HMDA and Regulation C, namely the requiring of a comprehensive analysis of creditworthiness and a written commitment. The second factor to keep in mind is that even if, all other things being equal, the inquiry would be considered a prequalification, if the creditor tells the prospective applicant they would not qualify, then, for ECOA and Regulation B purposes, the inquiry is an application which would trigger the obligation of the creditor to provide an adverse action notice pursuant to section 202.9 of Regulation B. Paragraph five (5) of The Official Staff Interpretation for section 202.9 gives the following example: Section 202.9 Notifications * * * * * 5. Prequalification requests. Whether a creditor must provide a notice of action taken for a prequalification request depends on the creditor s response to the request, as discussed in comment 2(f)-3. For instance, a creditor may treat the request as an inquiry if the creditor evaluates specific information about the consumer and tells the consumer the loan amount, rate, and other terms of credit the consumer could qualify for under various loan programs, explaining the process the consumer must follow to submit a mortgage application and the information the creditor will analyze in reaching a credit decision. On the other hand, a creditor has treated a request as an application, and is subject to the adverse action notice requirements of 202.9 if, after evaluating information, the creditor decides that it will not approve the request and communicates that decision to the consumer. For example, if the creditor tells the consumer that it would not approve an application for a mortgage because of a bankruptcy in the consumer s record, the creditor has denied an application for credit. 9 (emphasis supplied). Truth in Lending & Regulation Z Disclosure obligations under the Federal Truth in Lending Act ( TILA ) and its implementing Regulation Z for federally related mortgage loans are triggered when a creditor receives a written application. The Official Staff Interpretations to Regulation Z gives the following explanation regarding what is a written application : Creditors may rely on RESPA and Regulation X (including any interpretations issued by HUD) in deciding whether a written application has been received. In general, Regulation X defines application to mean the submission of a borrower's financial information in anticipation of a credit decision relating to a federally related mortgage loan. See 24 CFR 3500.2(b). An application is received when it reaches the creditor in any of the ways applications are normally transmitted by mail, hand delivery, or through an intermediary agent or broker. 10 Thus, for TILA and Regulation Z purposes, the determination of whether a consumer submits an application thereby triggering the disclosure requirements is the same for RESPA/Regulation X and TILA/Regulation Z. Summary Prospective borrowers may provide certain information to the Bank in order for the Bank to prequalify the prospective borrower for particular loan products without having the inquiry become an application, thereby triggering the numerous required disclosures under the various statues and regulations discussed in this memorandum. HELOC Appraisal Fees Regulation Z Requirements Page 4 of 5
For RESPA/Regulation X and TILA/Regulation Z, if the prospective borrower provides each of the following pieces of information to the Bank, they have submitted an application : 1. Borrower s name 2. Borrower s monthly income 3. Borrower s social security number 4. Property address (used as security for the loan) 5. Estimate of the value of the property 6. Mortgage loan amount sought 7. Any other information that the loan originator deems necessary. For HMDA/Regulation C and ECOA/Regulation B purposes, if the Bank: A) completes a comprehensive analysis of the creditworthiness of the applicant; and B) issues a written commitment valid for a designated period of time to extend a home purchase loan up to a specified amount, then the inquiry becomes an application. The critical caveat for ECOA/Regulation B is that even if neither of the above conditions is met, if the Bank tells the prospective borrower they would not qualify for a loan product, then there has been an application for ECOA/Regulation B purposes and the Bank would have to provide the required adverse action notice. It is important for the Bank to develop a prequalification process and provide appropriate training to ensure that no prospective borrower who inquires about a prequalification is discouraged from making an actual mortgage loan application. This will not only avoid any potential transformation of the inquiry/prequalification into a preapproval/application but it will also avoid any potential for allegations of discriminatory lending practices. As with all interactions between the Bank and consumers, it is critical for the Bank to ensure that any prequalification process the Bank develops does not inadvertently result in potential fair lending violations. END NOTES 1 24 C.F.R. 3500.2(b). 2 12 U.S.C. 2801 et seq. 3 12 U.S.C. 2802(3) and 12 C.F.R. 203.2(b)(1), respectively. 4 12 C.F.R. 203.2(b)(2). 5 12 C.F.R. 203.2(h). 6 12 C.F.R. 202.2(f). 7 Id. 8 Supplement I to Part 202 Official Staff Interpretations, 12 C.F.R. Pt. 202, Supp. I, 2(f). 9 Supplement I to Part 202 Official Staff Interpretations, 12 C.F.R. Pt. 202, Supp. I, 9. 10 Supplement I to Part 226 Official Staff Interpretations, 12 C.F.R. Part 226 19(a)(1)(i) 3. HELOC Appraisal Fees Regulation Z Requirements Page 5 of 5