Re-disclosing the Closing Disclosure

QUESTION

We are a lender and long-time subscriber. In fact, we meet each week as a group to discuss compliance, sales, and underwriting, and your weekly FAQs are part of our discussion. So, thank you for publishing these FAQs! A few weeks ago, you published the article New TRID FAQs. There were four new TRID updates from the CFPB. Although you did cut through the legalese and mumbo-jumbo, we still are a little confused by two of them. So, for the sake of clarity, please clarify these two new FAQs from the CFPB. 

(1) If there’s a change to disclosed terms after we provide the initial Closing Disclosure, are we required to ensure that the consumer receives a corrected CD at least three business days before consummation? 

(2) Are we required to make sure that a consumer receives a corrected CD at least three business days before consummation if the APR decreases?

ANSWER

Thank you for the kind words about our FAQs. Also, thank you for subscribing to the weekly FAQs. We offer them as a “labor of love,” because we feel strongly that knowledge should be shared! You do not have to be a client of ours as a precondition of receiving our articles, newsletters, FAQs, and website posts.

The article that you reference received a very high level of reader interest. There has been a flurry of activity regarding the new TRID clarifications issued by the Consumer Financial Protection Bureau’s posting of frequently asked questions. I am not surprised that you asked these two questions, as they often snag a lender in contortions of confusion. 

Let’s dig in!

(1) If there’s a change to disclosed terms after we provide the initial Closing Disclosure, are we required to ensure that the consumer receives a corrected CD at least three business days before consummation?

You do not need to provide a new disclosure and a new waiting period for most changes in terms. However, if the change results in one of the three situations listed below, then you must issue corrected disclosures and provide another waiting period:

• The change in terms results in the annual percentage rate (APR) becoming inaccurate;
• The loan product information required to be disclosed under the TRID Rule has become inaccurate; or
• A prepayment penalty previously undisclosed was added to the loan contract. 

(2) Are we required to make sure that a consumer receives a corrected CD at least three business days before consummation if the APR decreases?

If the overstated APR is accurate under Regulation Z, you must provide a corrected Closing Disclosure, but you are permitted to provide it at or before consummation without a new three-business-day waiting period. If the overstated APR is inaccurate under Regulation Z, you must ensure that a consumer receives a corrected Closing Disclosure at least three business days before the loan’s consummation.

For instance, the following is an example of an overstated APR in a real estate transaction that is still considered accurate:

If the APR and finance charge are overstated because the interest rate has decreased, the APR is considered accurate. So, you may provide the corrected Closing Disclosure to the consumer at consummation and you are not required to ensure that the consumer receives the corrected Closing Disclosure at least three business days before consummation.

In any event, I suggest you re-read the original FAQ we published to better understand the nuances (and there are nuances!) involved in such re-disclosure and also review the citations.

Jonathan Foxx

Managing Director

Lenders Compliance Group

Definition of a Military Person

QUESTION

We are a lender that originates mortgage loans primarily for active military service people, reservists and veterans. We would like to ensure that our lending extends to any person in the military. But we are not sure that the regulations offer enough guidance to us. What is a definition we can use to determine whether a person is in the military?

ANSWER

I think you’ll find that the Servicemembers Civil Relief Act (SCRA) will provide a good working definition. The SCRA defines the term “person in the military service” to include only members of the Army, Navy, the Marine Corps, the Air Force, the Coast Guard, the National Guard, and all commissioned officers of the Public Health Service or active in the National Oceanic and Atmospheric Administration. [50 USC 501 et seq.; 10 USC 101]

Actually, the SCRA’s definition of “servicemember” means a member of the uniformed services (which is defined in 10 USC 101). The Army National Guard generally is part of the U.S. Army and the Air National Guard is part of the U.S. Air Force, as implied by the SCRA’s definition of “military service” and the definition of “uniformed services.” It is worth noting that the Federal Reserve’s Division of Consumer and Community Affairs Letter 05-3, dated May 6, 2005, says “[t]he law protects, among others, active duty members of the Army, Navy, Air Force, Marine Corps, or Coast Guard, including members of the National Guard called to active service.”

The term “military service” means federal service on active duty, or in the case of a member of the National Guard, service under a call to active service authorized by the President or the Secretary of Defense for a period of more than 30 consecutive days for purposes of responding to a national emergency declared by the President and supported by federal funds. [32 USC § 502(f)]

“Active duty” includes any period during which a person in military service is absent from duty on account of sickness, wounds, leave, or other lawful cause. You may have come across the term “period of military service”. This term means the period beginning on the date a servicemember enters military service and ending on the date on which the servicemember is released from military service or dies while in military service.

The benefits of the SCRA also extend to persons who serve with the forces of any nation with which the United States may be allied in the prosecution of any war in which the United States engages and who immediately prior to service were citizens of the United States, if the service is similar to military service as defined in the SCRA, unless they are dishonorably discharged or it appears that they do not intend to resume United States citizenship. The term of military service also includes the period from receipt of induction orders to actual induction.

There are statutes in many of the states, often referred to as “mini-SCRA” statutes, that specifically incorporate some or all of the provisions of the SCRA, and some specify that coverage extends to National Guard members who receive orders from the state’s governor. Two instances of such mini-SCRA statutes are Virginia [Virginia Code §§ 44–102.1] and Utah [Utah Code § 39-7-101 et seq.].

I probably don’t have to remind you that, in the event of a violation of the SCRA, an aggrieved servicemember might bring an action under both federal and state statutes. So, be sure to familiarize yourself with applicable state provisions in any state where you originate loans to military persons.

Jonathan Foxx, PhD, MBA

Managing Director

Lenders Compliance Group

Credit Scoring Systems

QUESTION

We want to develop our own credit scoring system as part of a new loan product roll-out. We could use some guidance on how to get started. Our question is, what do we need to consider in developing our own credit scoring system?

ANSWER

Let me premise my response by stating that developing a credit scoring system reaches many regulatory guidelines and interlocking regulatory frameworks and rules. Unless you have highly competent legal and regulatory compliance support, I urge you not to undertake such a formidable task. If you came to us for guidance, we would need to know quite a bit not only about the new loan product but also your company’s loan origination process as it relates to your other existing loan products. In other words, you should not review a proprietary credit scoring system as an isolated matter.

However, I will offer some pointers for an initial point of departure.

To begin, you might want to start with the Equal Credit Opportunity Act (ECOA). The ECOA sets forth two methods to evaluate applications (for ECOA purposes): (1) “empirically derived and other credit scoring systems,” and (2) “judgmental systems of evaluating applicants.” The former terminology is meant to refer to an objective method, while the latter is meant to refer to a subjective method. It is not a requirement to use either methodology, but, as a practical matter, creditors tend to use one of these methods or, in some cases, a combination of the two methods. If two methods are combined, regulators will treat the combined method as a judgmental system. I am not sure which method, or combination thereof, that you plan to develop. For the sake of an abbreviated answer here, I will call the first method “Empirical” and the second method “Judgmental.”

Essentially, an Empirical system contains two elements: (1) a credit scoring system, and (2) a means to derive data that is empirically derived as well as demonstrably and statistically sound. Determining what is and is not creditworthy, especially in a mechanical evaluation based on key attributes of the applicant and aspects of the transaction (which is the case in Empirical systems), is a deep dive undertaking. [See 12 CFR § 202.2(p)(1)] Be prepared to be challenged by a regulator, where you will need to show that your Empirical system provides at least the following four qualifications:

1. The system is based on data derived from an empirical comparison of sample groups or the population of creditworthy and non-creditworthy applicants who apply for credit in a reasonable preceding period of time;

2. Your company developed the system for a legitimate business purpose;

3. Acceptable statistical principles and methodology are used to develop the system; and,

4. There is a periodic, tracked sequence of revalidation of the statistical elements and methods, with adjustments (as needed) to maintain predictability.

I suggest that you review Regulation B and its Commentary – Regulation B is the implementing regulation of the ECOA – for additional guidance on the development, validation and revalidation of an Empirical system, whether yours or one obtained from another party. [12 CFR § 202.2(p)(2); 12 CFR Supplement I to Part 202, Official Staff Interpretations § 202.4(b)-1]

A Judgmental system is any system for evaluating the creditworthiness of an applicant other than an Empirical system. [12 CFR § 202.2(t)] That is, if the proposed Empirical system does not qualify as an Empirical system, the proposed system is a Judgmental system as far as the ECOA is concerned. In a Judgmental system, a “pertinent element” is applied, which is any information about applicants that a creditor obtains and considers that has a demonstrable relationship to a determination of creditworthiness. [12 CFR § 202.2(y)] 

For instance, in a Judgmental system a creditor may consider an applicant’s age (or whether an applicant’s income is derived from any public assistance program). Each of these is a factor affecting an applicant’s creditworthiness. But utilizing this kind of factor is exactly why I urge caution in trying to develop a credit scoring system without expert guidance. A factor can be a negative factor, too. In relation to the age of elderly applicants, a negative factor means the system utilizes a factor, value or weight in a less favorable way regarding elderly applicants than the creditor’s experience warrants or is less favorable than the factor, value or weight assigned to the class of applicants that are not classified as elderly and are most favored by a creditor on the basis of age. [12 CFR § 202.2(v)]

Jonathan Foxx, PhD, MBA

Managing Director

Lenders Compliance Group

NEW TRID FAQs

QUESTION

I hope this question is acceptable to ask, since it is probably going to require a long answer. But here goes! I am a compliance manager in a small mortgage lender in the Pacific Northwest. I just read that the CFPB issued a new FAQ about TRID. I downloaded and read it, but it is filled with legalese. Could you please assist me in understanding the CFPB’s new FAQs about TRID?

ANSWER

First and foremost, we welcome your question! Our commitment to offering weekly answers to readers’ questions is to contribute in our own way to the compliance needs of the mortgage community. So, please, keep asking questions and thank you for asking the question about this recent issuance.

I will provide brief answers that may give you some relief from legalese. The following is an outline, removing the questions, clarifying the answers – and without the legalese.

The Consumer Financial Protection Bureau (CFPB) posted a new compliance advisory on its website. It is dubbed TILA-RESPA Integrated Disclosure FAQs. These are the answers to frequently asked questions (FAQs) about the TILA-RESPA Integrated Disclosure Rule (“TRID Rule”). These FAQs were updated on January 25, 2019. The FAQs clarify a creditor’s obligation to provide a new three-day waiting period along with a corrected Closing Disclosure (CD) when a term previously disclosed has changed; how creditors may use model forms that do not reflect the CFPB’s 2017 amendments to the Rule; and, the impact of a recent TILA amendment to the requirement for corrected disclosures. Since the FAQs were posted without advance notice or comment, our view is that the CFPB may not initiate a long review for periodic clarifications but use the FAQs as a means to provide such clarifications from time to time.

1. Only Three Types of Changes to Previously Disclosed Terms Require a New Three-Day Waiting Period

TRID requires a creditor to provide a consumer with a CD at least three business days before consummation. The FAQ explains that if a disclosed term changes after the CD is provided, the creditor must provide a corrected CD. The FAQ states that only three circumstances require the creditor to provide the consumer with a corrected CD at least three business days before consummation: (i) if the previously disclosed APR becomes inaccurate under Regulation Z; (ii) if the loan product type changes; or (iii) if a prepayment penalty is added to the loan. For any other changes, the creditor must provide a corrected CD at or before consummation. [See 12 CFR § 1026.19(f)(1)(ii)(A); 12 CFR § 1026.19(f)(2)(i); 12 CFR § 1026.19(f)(2)(ii)]

2. A New Three-Day Waiting Period May Be Required If the APR Decreases

As I noted, TRID requires a corrected CD and a new three-day waiting period if the previously disclosed APR becomes inaccurate under Regulation Z. The FAQ states that an APR is accurate if the difference between the APR and the actual APR is within an applicable tolerance. [See 12 CFR § 1026.22(a)] The FAQ states that, for mortgage loans, Regulation Z provides that an APR that decreases (viz., “overstated”) is considered accurate if the overstatement results from an overstated finance charge. [12 CFR § 1026.22(a)(4)] If so, the creditor must provide a corrected CD at or before consummation. However, if the APR previously disclosed is overstated for a reason unrelated to the finance charge, and no other tolerance is available under 12 CFR § 1026.22(a), the creditor must provide a corrected CD at least three business days before consummation. [See also 12 CFR § 1026.19(f)(2)(i); 12 CFR § 1026.19(f)(2)(ii); CFR § 1026.22(a)(4)]

3. The Economic Growth, Regulatory Relief, and Consumer Protection Act Does Not Change the TRID Rule’s Timing Requirements for Corrected Disclosures

The FAQs also clarify that the “No Wait for a Lower Rates” provision – in Section 109(a) of the recent Economic Growth, Regulatory Relief and Consumer Protection Act – does not change TRID’s requirements for corrected disclosures. [Public Law 115–174, 132 Stat. 1296 (2018)] The CFPB points out that Section 109(a) amended TILA’s requirement for special disclosures for certain high-cost loans, and does not impact a creditor’s obligation to provide a corrected CD and a new three-day waiting period.

4. The TRID Rule’s Model Forms Provide a Safe Harbor Even If They Do Not Reflect the CFPB’s 2017 Amendments to the TRID Rule

In 2017 the CFPB made several amendments to the TRID Rule, but it did not make corresponding changes to certain model forms. The FAQ guidance states that if a creditor properly completes the appropriate model form with accurate content, the creditor satisfies the safe harbor standard even if the model form does not reflect the TRID Rule’s text and staff commentary as amended in 2017. For example, the 2017 amendments direct creditors to drop any trailing zeros to the right of the decimal point when disclosing the rate for prepaid interest. Model form H-24(C), however, shows the rate for prepaid interest with trailing zeros. The CFPB clarifies that a creditor satisfies the safe harbor by either including the trailing zeros or by dropping them. [See 82 Federal Register 37,761-62; 15 U.S.C. § 1604(b); 12 CFR § 1026.37(g)(2)(iii) and (o)(4)(ii)]

Jonathan Foxx

Managing Director

Lenders Compliance Group