Consumer Incentive Campaigns

QUESTION

As a lender, we would like to run a promotion whereby we offer to reimburse the borrower the cost of the appraisal at closing. We would like to know if this is permissible and if there are any parameters that should be considered with respect to such a promotion. If the program is permissible, is it possible to deduct the cost of the appraisal from the individual loan officer’s compensation?

ANSWER

With respect to your first question, neither the Real Estate Settlement Procedures Act and its implementing regulation, Regulation X, nor any other regulation prohibits a lender from “incenting” a consumer to do business with the lender, so long as the “thing of value” (in the case the lender credit for the appraisal charge) is not in exchange for referrals. [12 CFR § 1024.14(g)(1)] 

As to who pays for it (company vs. loan officer), with respect to a forward mortgage or a fixed rate reverse loan, the lender must pay for it as otherwise it would be a reduction in the compensation due to the loan officer which is not permissible. [12 CFR § 1026.36(d)(1)] As the Truth-In-Lending Act’s loan originator compensation rule does not apply to reverses structured as open-end credit, in those instances, it is permissible for the loan officer to reduce his compensation to cover the credit. [12 CFR § 1026.36(b)]

In discussing the parameters of promoting such a program, consideration should be given to whether the program will be offered to all potential applicants or whether it is limited to a certain group of applicants.  If the latter and the program results in a disproportionate number of applicants in non-protected classes receiving the credit as opposed to those in protected classes, the lender may be facing a fair lending issue.

Listed below are additional items to consider in setting forth the parameters of such a promotion:

• Ensure it is clear that the offer is for a closing credit only. If the loan does not close and fund, there is no credit or refund to the applicant for the appraisal fee. 
• Is the amount of the credit limited in any manner? For example, credit for appraisal fee not to exceed $500, with the borrower being responsible for any amount in excess of $500.  Also, ensure that it is clear the credit is only for the actual cost of the appraisal; if the appraisal charge is less than $500, the borrower does not receive the difference between $500 and the appraisal charge.
• Set forth the term of the promotion, including whether the consumer must apply by a certain date or close the loan by a certain date. 
• If there is a certificate that must be physically presented in order to obtain the credit, that requirement should be stated.
• Consider the loan programs to which the offer applies. Does it only apply to purchase money mortgages? Refinances?
• Set forth limitations as to the availability of the program to only new customers, if applicable.
• Consider whether the offer can be used in conjunction with any other loan offer.
• Be clear that the offer is not redeemable for cash. 

Of course, in advertising the promotion a lender needs to include the lender’s NMLS # and state licensing information, and give consideration to the following “typical” general disclosures:

• Programs, rates, terms, and conditions are subject to change without notice.
• Certain restrictions may apply.
• All approvals subject to underwriting guidelines.
• Not all applicants will qualify. 

And, if the advertisement discloses the amount or percentage of down payment for a credit sales transaction, the number of payments, the period of repayment, the amount of any payment or amount of any finance charge, then the lender must also disclose the following [12 CFR § 1026.24(d)]:

• The total down payment as a dollar amount of percentage.
• Terms of repayment.
• The “annual percentage rate” using that term.
• If a variable rate loan, a statement that the rate may change. 

As in all advertising, in promoting a lender closing credit offer, the lender must also ensure that the advertisement meets not only federal regulatory requirements but any additional state laws and regulations. 

Joyce Wilkins Pollison

Director/Legal & Regulatory Compliance

Lenders Compliance Group

Builder Incentives

QUESTION

We have an Affiliated Business Arrangement (AfBA) with a homebuilder. The builder currently discounts the purchase price of its homes if the buyer uses our company to finance the purchase. If the buyer chooses to use another mortgage company, there is still a discount, but it is lower. The builder, who is the majority owner of our company, now wants to offer discounts only to those buyers who use our company to finance the purchase. Is this a compliance problem? 

ANSWER

The issue of builder incentives and preferred and/or affiliate lenders continues to be a controversial one. There are two sides (at least) to the argument. On the pro-builder side is the assertion that a preferred lender or affiliated lender allows for better coordination between lender and builder, and thus a smoother, more predictable financing process, thereby improving the overall experience for the consumer. 

The counter to this argument is that, even if there is no express “requirement” for the buyer to use the builder’s lender affiliate, as a practical matter the buyer is being “required” to do so, in violation of the AfBA exception to RESPA Section 8 (12 U.S.C. §1024.15), one of the conditions of which is that, with limited exceptions:  “No person making a referral has required (as defined in 12 U.S.C. § 1024.2) any person to use any particular provider of settlement services or business incident thereto…” (Emphasis added.) (12 U.S.C. §1024.15(B)(2)). Critics also argue that the builder is “steering” the consumer to the builder’s preferred or affiliate lender, thus preventing the consumer from shopping in violation of anti-steering provisions.

Much depends on the definition of “required use,” which is found in 12 U.S.C. §1024.2 is as follows:

“Required use means a situation in which a person must use a particular provider of a settlement service in order to have access to some distinct service or property, and the person will pay for the settlement service of the particular provider or will pay a charge attributable, in whole or in part, to the settlement service. However, the offering of a package (or combination of settlement services) or the offering of discounts or rebates to consumers for the purchase of multiple settlement services does not constitute a required use. Any package or discount must be optional to the purchaser. The discount must be a true discount below the prices that are otherwise generally available, and must not be made up by higher costs elsewhere in the settlement process.” (Emphasis added.)

Some builders try to address this issue by having a list of preferred lenders. To one degree or another, however, that may still thwart the consumer from shopping outside that list. By excluding other mortgage companies from the builder incentive, the risk of a RESPA violation increases because it could be argued that such exclusivity of the incentive is a de facto “requirement.” 

Threatening Legal Action to Collect a Debt

QUESTION

We were recently collecting a debt from a consumer on behalf of a creditor. We threatened the consumer with legal action if the debt wasn’t paid. Our client, the creditor, told us to stop doing this immediately. But all we did was to threaten legal action if the consumer did not pay the debt. Are there restrictions on threatening legal action when we are trying to collect a debt?

ANSWER

In the Fair Debt Collection Practices Act (FDCPA), there is a section entitled “false or misleading representations.” [15 U.S. Code § 1692e] Under this section, asserting that actions will be taken that are not legally permitted or not intended are barred from communications with consumers to collect a debt. [15 U.S. Code § 1692e(5)]

This prohibition actually overlaps somewhat with another prohibition in this same section, which states:

"The representation or implication that nonpayment of any debt will result in the arrest or imprisonment of any person or the seizure, garnishment, attachment, or sale of any property or wages of any person unless such action is lawful and the debt collector or creditor intends to take such action." [15 U.S. Code § 1692e(4)]

Threats of legal action are prohibited by the FDCPA in collecting a debt. Even the mere implication of legal action can be a violation. This prohibition includes any such threats that are (1) beyond the debt collector’s legal or contractual authority; (2) not intended by the debt collector when the statement is made; (3) not imminent as stated by the debt collector; or (4) not likely based on particular circumstances known to the debt collector. [FTC Staff Commentary on FDCPA § 807(5)]

From the statutory point of view, examples of actions that are beyond the debt collector’s legal or contractual authority include threatening a suit that is time-barred or threatening a suit that may only be brought by the creditor or other third party. [Idem, et sequi]

It should be noted that the prohibition also applies to threats or implications of legal action by a third party, such as the creditor. A threat or implication that a creditor will take action would violate the FDCPA unless the debt collector has reason to believe, at the time the statement is made, that such action will be taken.

Do not assume that the threat is just meant to instigate the payment with no consequences to the creditor for such statements. The FDCPA is interpreted under the “least sophisticated consumer” standard, which means that the consumer is expected to interpret the threat as implying the legal action is intended, imminent, or being pursued. The debt collector should not state or imply remarks such as (1) garnishment of wages is available upon obtaining judgement, (2) the debt collector has the right to sue, or (3) further legal action has been recommended. These types of statements can lead to violations of the FDCPA’s prohibition against false and misleading representations.

So, as a general proposition, the action stated in a communication to the consumer must be legal and there must be a reasonable likelihood, at the time the statement is made, that such action will be taken. Determining what is a “reasonable likelihood” can be a challenge. A generic proposition would be that an action may be reasonably likely if such action is frequently taken by the debt collector or creditor in similar circumstances – but, if the debt collector is aware of circumstances that would make such action unlikely in the particular case, a threatening statement would violate FDCPA.

As to determining intent or the lack thereof in threats made to a consumer where collecting a debt is taking place, this is a tough area of the law to prove to the satisfaction of a court; however, lack of intent may be established in the following ways:

1. if the debt collector or creditor has a history of not pursuing the action under the particular circumstances;
2. if the debt collector made the threat before any required processes for determining whether a lawsuit is appropriate; or
3. if certain circumstances exist that would make the action unlikely, such as a small amount of debt. 

Over the years, we have encountered certain instances that demonstrate violations derivative of the foregoing communications, such as those caused by falsely threatening to initiate a lawsuit, threatening to report a debt to a credit bureau if the debt collector does not intend to (or is not otherwise permitted to do so), or threatening to assess a collection fee for nonpayment, if such a fee is unlawful.

Jonathan Foxx

Managing Director 

Lenders Compliance Group

Managing Risk of Non-QM Mortgages to Self-Employed Borrowers

QUESTION

How do I offer Non-QM mortgages to Self-Employed Borrowers in my local market and still manage the risks?

ANSWER

There are two main risks to address. First is the legal/regulatory risk. I am forced to defer into the future the discussion of how to manage this risk. There are no clear answers due to the lack of any state and federal regulatory enforcement actions or case law and judicial precedents with Non-QM loan products designed for the Self-Employed. The issue arises from the subset of Self-Employed Borrowers who are unable or unwilling to submit 2 years of 1040s and sign a 4506T for lenders to verify their income using the traditional methods as outlined in QM Ability to Repay (ATR) regulations.

So that leaves us with the second risk, the one risk we can manage today: the credit risk. Let's begin by defining in our credit policies the benchmark mortgage risk, using the average rate of foreclosure to compare and adjust the risk of foreclosure to keep this product within acceptable risk levels. Your benchmark product is a 30-year fixed rate loan to finance the purchase or rate & term refinance of a single family, detached property with a max 80% LTV/CLTV, a FICO Floor of 700, a max DTI of 43% (or less), full documentation as defined by Ability to Repay (ATR) regulations, and 3 months of cash reserves. This loan will have an average foreclosure rate of 1.3%. [Moody's Analytics, March 11, 2011]

And, speaking of "pricing," use your Fannie/Freddie 30-year fixed rate pricing.

The challenge is how do you manage the risk of loss in foreclosure when you waive the requirement for 2 years 1040s and a signed 4506T? The answer is you manage it by managing the layering of risk for this loan product. This is done by adjusting your credit policy for this product to arrive at an expected foreclosure rate at or below your benchmark loan policy. This Alt Doc product could be called a "24-month Bank Statement Loan" or a "Collateral Loan". When you move to Alt Docs, the incremental foreclosure risk increases 3 times or 300% to 3.9%; a level that is unacceptable. You want to lower this risk to below 1.3%, your benchmark average foreclosure rate.

At 70% LTV/CLTV, the average foreclosure rate is 0.2%. [Moody's Analytics, March 11, 2011] With Alt Docs, the average foreclosure rate increases 3 times that average, to 0.6%, well below the benchmark product risk profile defined in your credit policy above. An average foreclosure rate of 0.6% vs 1.3% for the benchmark leaves you a good margin for error.

Three additions to this Alt Doc credit policy are: 1) a max 36% DTI, to allow for greater borrower discretionary income to support a higher standard of living, as many of these loans will be Jumbo's, 2) a 6 months cash reserves, and 3) a max 65% LTV/CLTV (viz., I have heard this number cited many times over in my mortgage banking career as "the LTV breakeven at foreclosure").

So, let's recap this new credit policy for your "self-employed alt doc loans": owner-occupied, single family, purchase or rate & term refinance, max 65% LTV/CLTV, 700 FICO Floor, max 36% DTI, and 6 months reserves. You may also want to ask the borrower to sign a well worded "Affidavit of Borrower's Ability to Repay" as part of a future legal defense, if needed.

Market this product to your self-employed customers and in your local lending market(s). It is best to price this product to your benchmark full doc product above. Why? We have managed the risk with credit policy, not pricing. And, hold these loans in your portfolio. Or, as I like to say, "eat your own cooking".

If you do not have a loan portfolio (mortgage banker or broker), you will need to price this loan at 100-200 BP higher interest rate, based on your investor's pricing, and follow that investor's product guidelines (max LTV of 50-60%?). You will need balance sheet $$$ Capital for your 5% "risk retention," as these loans will sooner or later be sold into the Wall Street capital markets in a Private MBS.

Make sure your warehouse bank is on board, unless the loan is approved, closed, and funded by the investor (including the LE & CD). Set up a loan loss reserve (min. 20 BP of the UPB?). Lastly, negotiate the R&W in the Purchase and Sale Agreement limiting your fraud/misrepresentation liability to only the documents you verify. Otherwise you are making a 30-year R&W and will be liable for legal costs and any foreclosure losses (as we have seen, property values can rise and fall over time, changing your risk profile). This product will be a huge challenge for non-depositories.

Remember, you still have a yet-to-be-quantified regulatory and legal risk. Happy lending!

Ben Niles

Director/Client Relations

Lenders Compliance Group

Home Equity Plans – Credit Limits

QUESTION

We offer home equity plans in our loan product selection. In some instances, we want to prohibit the consumer from increasing credit. We may also want to reduce the credit limit. When are we allowed to prohibit a consumer from increasing the credit limit under a home equity plan? When can we reduce the credit limit? Can we specify the default requirement to prohibit credit extensions?

ANSWER

This question has some complicated factors that impact a comprehensive answer. 

However, it is possible to outline six bases where a creditor may prohibit the consumer from increasing the credit limit or the creditor may reduce the credit limit in any given period where:

1. The value of the dwelling securing the plan declines significantly below the dwelling’s appraised value for purposes of the plan;
2. The creditor reasonably believes the consumer will be unable to fulfill the repayment obligations of the plan due to a material change in the consumer’s financial situation;
3. The consumer is in default of any material obligation under the agreement;
4. The creditor is precluded by government action from imposing the APR provided for in the agreement;
5. The priority of the creditor’s security interest is adversely affected by government action so that the value of the security interest is less than 120% of the credit line; or
6. The creditor is notified by its regulatory agency that continued advances constitute an unsafe and unsound practice. [12 CFR § 226.5b(f)(3)(vi)]

With respect to a default, a creditor may specify events that would qualify as a default of a material obligation for purposes of the ability to prohibit additional extensions of credit or reduce the credit limit applicable to an agreement for a home equity plan. [12 CFR Supplement I to 226, Official Staff Commentary § 226.5b(f)(3)(vi)-8]

Jonathan Foxx

Managing Director

Lenders Compliance Group