|Points of Interest - Winter 2009|
New Section 35 TILA Rules: A Minefield to Be Avoided?
As predicted, the Federal Reserve has adopted new regulations under the Home Owners Protection Act (HOEPA) which severely limit and control the manner in which credit secured by single family owner occupied residences may be granted. The main goal of the changed regulations is to prevent lenders making loans with little or no income documentation. The “no doc” “low doc” loans was viewed by the policy makers as the main progenitor of the subprime mortgage meltdown. Unsuspecting lower income home buyers and homeowners were hoodwinked to purchase homes or refinance their home based solely on the expected increase in value of their homes and with no regard to their ability to repay their loans. The subsequent decline in housing prices left these homeowners with no place to refinance the debt they could not afford driving them into foreclosure and the housing market into free fall.
The new HOEPA regulations create a new class of loans for which special rules apply, the so called Section 35 loans, named for the new section of the act. This section is an “add on” to the old HOEPA law which contains provisions for “high cost” loans commonly known as Section 32 loans. By adding this new group of loans to HOEPA, the Fed has provided, somewhat insidiously, increased penalties for those who dare enter the land minefield of loans that are not “conventional.
The new section of HOEPA defines a “higher priced” loan as any first mortgage loan whose annual percentage rate is 1.5 points (for more junior loans the differential is 3 percentage points) higher than a new standard to be created shortly by the Fed called the The Average Prime Mortgage Rate. This new TAPR will be based on the Freddie Mac survey of prime rates. While the current rate only provides rates for four types of loans, 15 year fixed, thirty year fixed, variable and variable, the Fed promises to provide rates for a broader selection of loans by interpolation.
Once a loan exceeds this rate the most important is the requirement that at the time of the loan consummation the lender must be reasonably assured that the borrower has the ability to make the payment called for under the terms of the loan. This is a major change from the old HOEPA Section 32 loans, which required a showing that a plaintiff prove a “pattern or practice” of the lender in making loans without ability to pay. The older standard is much more difficult for consumer lawyers to prove.
The original draft of the proposed amendments contained the old “pattern or practice” language and the Fed, in its final rule, changed the standard to a loan by loan requirement in response to the consumer lawyers’ argument that such a standard made enforcement by private right of action unrealistic and practically impossible
The most important point in the new regulation is the expansion of damages under Section 35 to be the same as the damages under Section 32. Under the new regulations, now if a borrower is able to prove a violation, the damages include a refund of all fees, charges and interest paid on the loan, PLUS attorneys fees, PLUS $4,000 per transaction violation. In a loan priced under the current market conditions, this would mean that if a borrower commenced an action three years after origination, damages would be equal to about one half of the principal of the loan. And as an added bonus, there is no holder in due course defense and any assignees would have to pay the damage.
When the original HOEPA section 32 law was passed, many experts predicted that very few lenders would be willing to take the risk of making loans over the HOEPA Section 32 triggers because the risk of penalty was far too great… and that was in a situation where the borrower or his attorney had to prove a “pattern or practice” of making loans that a borrower could not afford to repay. In addition the new law gives consumer lawyers more grist for Unfair Business Practice allegations under Business and Professions Code Section 17000 et. Seq.
After the passage of the original Section 32 some 12 years ago loans over the HOEPA trigger virtually ceased to exist. There were some players who for a while dabbled in the market and there are still some small lenders with little or no net worth who do make loans over the Section 32 limit, but for all practical purposes, the market for those loans ceased to exist.
So what are the prospects and options for brokers and lenders after the effective date of new Section 35, October of next year? Will all lending of loans over the Section 35 limit become so dangerous and compliance so difficult and expensive, that no lenders will dare to make such loans?Will the average California private money mortgage lender will be able to make any loans to consumers secured by their homes after October 1st, 2009?
Based on experience of the implementation of Section 32, the answer would seem to be no. If there was an unacceptable risk seen by the market place in making a loan over the Section 32 HOEPA limit where the test for violation was “pattern or practice” of making a loan to borrower without regard to ability to repay the loan with sources other than the equity in the real property, how can one assume that any loans will be made over the Section 35 limit, where the test is much more stringent, i.e. a case by case analysis of any single loan where the lender does not correctly assess the borrowers ability to repay the loan and the damages are the same?
Bank and larger finance companies, to the extent they choose to remain or reenter the consumer mortgage market, will not make any loan with a rate that will take them into Section 35 Higher Priced loan land. For the near term lenders will learn how to operate in the FHA or other conventional markets. Of course this will restrict the amount of credit available to borrowers with blighted credit or those where the condition of the home does not meet the stricter criteria for FHA or other conventional lenders.
The problem for lenders who are thinking about entering the Higher Cost mortgage market is how to devise a systematic approach to making these types of loans. Of particular concern will be weighing the cost of implementing systems designed to assure compliance with strict new rules on credit verification, income verification
Some will seek to find a magic number for debt to income ratio and then assume following such a test will provide protection. However a set debt to income or net cash spendable amount does no such thing. The law does not provide a guideline of maximum debt to income, or net spendable amount. To the contrary the law and commentary specifically say there is no such “magic” number and the lender/broker must find a method through its own practices.
In order to meet the challenge of the new Higher Cost Mortgages, brokers and lenders must evaluate today whether or not they can afford to enter this high risk area of lending or to leave the owner occupied market completely. At a minimum the broker/lender should extract debt in income ratios, net cash spendable indices from its recent loan production and check it against performance of the loan portfolio to see if a pattern can be discerned that will allow the creation of lending criteria that will meet the new standards. Also an analysis of the costs of compliance including legal review, computer programming changes, and servicing costs should be carefully studied and measured against the reward of remaining in what may become in the owner occupied market. In addition the question of disclosure to lenders of assignee liability must also be reviewed.
Every step of the transaction must be examined and documentation prepared that will provide a defense statement that establishes the lender/broker paid due regard to measuring the borrowers ability to repay and documenting the basis for the determining the borrower has enough documented income to afford the payments on the loan, the real estate related expenses, his other debts and enough left over to feed and clothe his family.
Such a review and analysis is expensive and may not result in tests that will sufficiently insulate the broker and the lender from liability. In short, cost of the mine detection equipment and armament against explosion may well exceed the benefit from entering the mine field of Section 35 loans.