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Thursday, June 27, 2019

Obligation to accept Private Flood Insurance


QUESTION
We are a community bank financing the construction of a mixed use property consisting of retail/business use on the first floor and four residential units on the second floor. The property, which will be the collateral for the loan, is located in a flood zone. The loan amount is $550,000, with a replacement cost value of $980,000 (as is)/$1,110,000 (completed). The borrower is asking that we accept a private flood insurance policy that contains an 80% coinsurance clause which also has a 20% coinsurance deductible. Do we have any obligation to accept such a policy? And, if not, are we permitted to accept such a policy?  Lastly, given that this is a mixed use property, how do we determine the maximum amount of coverage available under the NFIP?

ANSWER
Let’s take the last question first. Nonresidential buildings include mixed use buildings with less than 75% residential square footage. If you are stating the first floor is commercial space and the second floor is residential space, I am assuming the square footage is 50-50, which would make it a nonresidential building for the purpose of flood insurance under the NFIP. The maximum coverage available for Other Non-Residential is $500,000. 

Now onto the private flood insurance policy issue! In light of the current regulations as well as those effective July 1, 2019, the bank is under no obligation to accept a private flood insurance policy containing a coinsurance clause. However, the bank may use its discretion and accept same, provided the policy meets certain criteria which include the provision of sufficient protection of the loan, consistent with general safety and soundness considerations.

Under current law, with respect to properties located in a flood zone, the bank must require flood insurance in an amount at least equal to the lesser of the outstanding principal balance of the loan or the maximum coverage available for the particular type of property under the Act.  [12 CFR §339.3 (effective 10/01/15)] Under the National Flood Insurance Program (NFIP) policy, insurance will cover up to whatever the stated amount is (less any deductible).  

The current regulation is silent as to whether the bank must accept private flood insurance in lieu of that provided under the NFIP.

Effective July 1, 2019 (although earlier adoption is permissible), the regulations have been revised such that the bank must accept private flood insurance in satisfaction of the requirement for flood insurance if the policy meets certain requirements. 

The bank is mandated to accept a private flood insurance policy that, among other items 
“provides flood insurance coverage that is at least as broad as the coverage provided under an SFIP for the same type of property, including when considering deductibles, exclusions, and conditions offered by the insurer. To be at least as broad as the coverage provided under an SFIP, the policy must, at a minimum: . . .  (ii)  Contain the coverage specified in an SFIP, including that relating to building property coverage; personal property coverage, if purchased by the insured mortgagor(s); other coverages; and increased cost of compliance coverage; (iii) Contain deductibles no higher than the specified maximum, and include similar non-applicability provisions, as under an SFIP, for any total policy coverage amount up to the maximum available under the NFIP at the time the policy is provided to the lender; . . . and (v)  Not contain conditions that narrow the coverage provided in an SFIP.”  [12 CFR §339.2 (effective 7/01/19)] 

A private flood insurance policy which contains a coinsurance clause does not equate to a policy issued under the NFIP. The coinsurance clause narrows the coverage otherwise provided under an SFIP, and effectively is a clause not applicable in an SFIP policy. Under an NFIP General Property – Standard Flood Insurance Policy, which is what issues with respect to Other Non-Residential Building such as the property you describe, the insurance covers up to whatever the stated amount is (in this case $500,000) less any deductible. However, the amount covered under a private policy with a coinsurance clause vastly differs.

Under a policy with a coinsurance clause, the insured must carry insurance equal to at least a certain percentage of the property’s actual cash value. This is done to ensure that the property is not underinsured when the replacement cost loss settlement option is purchased.

Your scenario is as follows: 
  • Loan amount: $550,000
  • RCV: $980,000 (as is)/$1,110,000 (as complete)
  • Insurance: $500,000
  • Coinsurance Clause: 80% 

Let’s assume the loss to the property is $600,000 and the actual cash value at time of loss is $980,000. 
  • Required coinsurance = $784,000 (ACV x .80 coinsurance)
  • 63.75% = $500,000 (amount of insurance carried) / $784,000 (amount of insurance should have carried)
  • 63.75% x $600,000 (amount of loss) = $382,500 (amount covered by insurance less any deductible) 

For the purpose of this analysis, I will assume that the deductible under both the NFIP and private policy is $0. So, at the end of the day, under the NFIP policy, $500,000 will be covered by insurance whereas under the private policy, only $382,000 will be covered by insurance. Thus, as the coverage provided under the private policy is not meeting the maximum coverage available under the Act, the bank is under no obligation to accept it. 

Thursday, June 20, 2019

Scope of Revised Loan Estimate at Rate Lock

QUESTION
We have a mortgage loan in which the appraisal fees were not disclosed in the initial Loan Estimate pursuant to the requirements of the TILA/RESPA Integrated Disclosure Rule (“TRID”). We have now locked the loan. Is it acceptable to include the appraisal fees in the Revised Loan Estimate when we re-disclose for the rate lock? 

ANSWER
This question really has two parts: (1) should the appraisal fees be included in the Revised Loan Estimate and (2) if so, can the disclosure of appraisal fees in the Revised Loan Estimate (rather than the non-disclosure in the original Loan Estimate) be used as the basis for determining whether the disclosures were made in “good faith” under Regulation Z Section 1026.19(e)(1)?

The answer to the first part is “yes.” Under Section 1026.37(f)(2) the Loan Estimate is required to itemize “each amount, and a subtotal of all such amounts, [that] the consumer will pay for settlement services for which the consumer cannot shop…and that are provided by persons other than the creditor or mortgage broker.” Appraisal fees normally fall within this section. If they weren’t disclosed in the original Loan Estimate, they need to be disclosed in the Revised Loan Estimate.

The answer to the second part of the question is a little more complicated. Under TRID, mortgage lenders are held to a “good faith” standard in disclosing fees and charges on the Loan Estimate [12 CFR 1026.19(e)(1)].  The general rule is that “good faith” is measured by comparing what is disclosed in the original Loan Estimate with what the consumer actually pays at consummation. [12 CFR 1026.19(e)(3)(i)]

There are certain exceptions to this general rule, however, one of which is when a Revised Loan Estimate is authorized. 

Section 1026.19(e)(3)(iv) of TILA specifies six (6) circumstances under which Revised Loan Estimate may be issued, one of which is the so-called “rate lock” exception. Thus, Section 1026.19(e)(3)(iv)(D) provides: 
(D) Interest rate dependent charges. The points or lender credits change because the interest rate was not locked when the disclosures required under paragraph (e)(1)(i) of this section were provided. No later than three business days after the date the interest rate is locked, the creditor shall provide a revised version of the disclosures required under paragraph (e)(1)(i) of this section to the consumer with the revised interest rate, the points disclosed pursuant to §1026.37(f)(1), lender credits , and any other interest rate dependent charges and terms. (Emphasis added.)
(Note: The other five (5) circumstances under which a Revised Loan Estimate may be issued are: (1) “Changed circumstances” that cause an increase to settlement charges; (2) "Changed circumstances” that affect the consumer’s eligibility for the loan or affect the value of the property  securing the loan; (3) Consumer-requested changes; (4) Expiration of the original Loan Estimate; and (5) Construction loan settlement delays.)

At first blush, the underlined language of Section 1026.19(e)(3)(v)(D) would appear to be broad enough to allow revised disclosures of all of the charges listed in § 1026.19(e)(1). 

That section, in turn, is likewise broad and provides: 
“(e) Mortgage loans—early disclosures—(1) Provision of disclosures—(i) Creditor. In a closed-end consumer credit transaction secured by real property or a cooperative unit, other than a reverse mortgage subject to §1026.33, the creditor shall provide the consumer with good faith estimates of the disclosures in §1026.37.” (Emphasis added.)
This all seems to suggest that, once there is a valid “changed circumstance” or other triggering event authorizing a Revised Loan Estimate, the lender can revise anything that must be disclosed under §1026.37, including appraisal costs. 

However, the Official Commentary for § 1026.19(e)(3)(iv) indicates otherwise. It states that you can revise the original Loan Estimate disclosure “only to the extent that the reason for the revision… increased the particular charge.” 

Thus: 
“2. Actual increase. A creditor may determine good faith under § 1026.19(e)(3)(i) and (ii) based on the increased charges reflected on revised disclosures only to the extent that the reason for revision, as identified in § 1026.19(e)(3)(iv)(A) through (F), actually increased the particular charge. For example, if a consumer requests a rate lock extension, then the revised disclosures on which a creditor relies for purposes of determining good faith under § 1026.19(e)(3)(i) may reflect a new rate lock extension fee, but the fee may be no more than the rate lock extension fee charged by the creditor in its usual course of business, and the creditor may not rely on changes to other charges unrelated to the rate lock extension for purposes of determining good faith under § 1026.19(e)(3)(i) and (ii).” (Emphasis added.) 
Accordingly, while it is necessary to include the originally omitted appraisal fees in the Revised Loan Estimate issued in connection with a rate lock, those disclosures cannot be used to measure “good faith.” Instead, unless one of the other five grounds for a Revised Loan Estimate can be found to apply, the original Loan Estimate must be used. And, since the original Loan Estimate did not disclose any appraisal fees, those fees cannot be imposed on the consumer, or if they are, they will have to be refunded within 60 days of consummation pursuant to Section 1026.19(f)(v).

Director/Legal & Regulatory Compliance
Lenders Compliance Group

Thursday, June 13, 2019

TRID Disclosures for Mortgage Assumptions

QUESTION
We are a mortgage lender and servicer with a large servicing portfolio. Recently, the CFPB published a Fact Sheet about the circumstances involving the disclosures of the LE and the CD for certain transactions. Our interest is in the assumption transactions. What disclosures are required for these types of transactions? What is the disclosure process?

ANSWER
The Consumer Financial Protection Bureau (CFPB) issued a Fact Sheet titled “Are Loan Estimates and Closing Disclosures Required for Assumptions?” (“Fact Sheet”). The purpose of the Fact Sheet was to discuss the circumstances under which a Loan Estimate (LE) and Closing Disclosure (CD) are required under the Truth-in-Lending Act/Real Estate Settlement Procedures Act (TILA-RESPA) Integrated Disclosure Rule (TRID Rule) for a specific group of transactions.

The Fact Sheet may be found on the CFPB’s TILA-RESPA Disclosures webpage.

If you need guidance in how best to implement the disclosure process, we have an entire group devoted to mortgage servicing compliance. Contact us for servicing compliance support.

The Fact Sheet contains a flowchart to help you decide whether the disclosures are necessary. You may wish to compare this flowchart to your mortgage documents to ensure that the proper documentation is being prepared, depending on the type of application received.

The flowchart is a quick reference that highlights the major questions to be answered when determining if a LE and CD are required for the assumption transactions described in the narrative portion of the Fact Sheet.

In providing an answer to your question, I am going to address the narrative information offered in the Fact Sheet.

Briefly, a mortgage assumption is the conveyance of the terms and balance of an existing mortgage to the purchaser of a financed property, commonly requiring that the assuming party is qualified under lender or guarantor guidelines. Your institution may have specific policies and procedures for assumptions as part of an overall credit policy, and your state may also have certain regulations regarding assumable mortgages. In terms of the contract, the mortgage note generally governs the legality of assumptions. However, in terms of the TRID rule, Regulation Z is the guidepost for disclosures for assumptions. The Fact Sheet addresses disclosures for specific types of transactions, regardless of what each institution might call the transaction.

The Fact Sheet pertains to transactions:
  • In which a new consumer is being added or substituted as an obligor on an existing consumer credit transaction;
  • That are closed-end consumer credit transactions secured by real property or a cooperative unit; and,
  • That are not reverse mortgages subject to 12 CFR 1026.33.

To answer your question about the required disclosures, determine if you have a loan application that is subject to the TRID Rule, that is, a transaction that is a closed-end consumer credit transaction secured by real property or a cooperative unit and that is not a reverse mortgage subject to 12 CFR 1026.33. Then, determine if the transaction is an assumption as that term is specifically defined in Regulation Z, 12 CFR 1026.20(b).

Drilling down further, an assumption under 12 CFR 1026.20(b) occurs when a creditor expressly agrees in writing to accept a new consumer as a primary obligor on an existing residential mortgage transaction. Generally, to satisfy this particular definition of assumption, a transaction must meet the following three elements:
  1. Include the creditor’s express acceptance of the new consumer as a primary obligor. However, take note, the mere addition of a guarantor to an obligation for which the original consumer remains primarily liable does not give rise to an assumption under 12 CFR 1026.20(b).
  2. Include the creditor’s express acceptance in a written agreement. For a transaction to be an assumption under 12 CFR 1026.20(b), it must include a written agreement, and that written agreement must include the creditor’s express acceptance of the new consumer.
  3. Be a residential mortgage transaction as to the new consumer. A residential mortgage transaction is a transaction in which a security interest is created or retained in the new consumer’s principal dwelling and which finances the acquisition or initial construction of the new consumer’s principal dwelling. [See 12 CFR 1026.2(a)(24)]

If the transaction is an assumption under 12 CFR 1026.20(b), the creditor must provide a LE and CD, unless the transaction is otherwise exempt from these requirements.

Here’s an example, using the preceding guidelines. Certain housing assistance loans are otherwise exempt from the requirements to provide a LE and CD. The creditor must make the disclosures in the LE and CD based on the remaining obligation. For instance, the amount financed is the remaining principal balance plus any arrearages or other accrued charges from the original consumer credit transaction.

Similarly, in determining the amount of the finance charge and the annual percentage rate to be disclosed, the creditor should disregard any prepaid finance charges paid by the original obligor but must include in the finance charge any prepaid finance charge imposed in connection with the assumption transaction. If the creditor requires the new consumer to pay any charges as a condition of the assumption, those sums are prepaid finance charges as to that consumer, unless exempt from the finance charge under 12 CFR 1026.4.

According to Regulation Z commentary, if a creditor adds a new consumer to an existing consumer credit transaction (regardless of whether that event triggers the requirement to provide a LE and CD), the extension of credit remains a consumer credit transaction under Regulation Z. Thus, the creditor, assignee, or servicer must comply with any ongoing obligations pertaining to the consumer credit transaction, such as servicing-related requirements. Furthermore, even if the event does not trigger the requirement to provide a LE and CD, it may trigger other disclosure requirements under TILA or RESPA.

Jonathan Foxx, Ph.D., MBA
Managing Director
Lenders Compliance Group

Thursday, June 6, 2019

Finance Charge Controversies

QUESTION
In our weekly sales meeting, there was a big debate about how to explain APR and the Finance Charge to borrowers. The problem is that (1) our loan officers do not seem to know how to explain them, (2) those who can explain them can’t do the calculations, and (3) everybody says most borrowers are confused by the explanations and the calculations. 

Then the controversy went to figuring out what charges are finance charges, depending on whether the finance charges are charged to all approved borrowers.

Anyway, we got to the point where the explanations were meshing and even the calculating was under control, but we did not get much of an understanding of how to resolve the controversy about the finance charges. So, we got together as a group and decided to write this question to you, as everyone is willing to rely on your explanation. Here’s our question: if we want to apply a finance charge only to approved applicants, would this be permissible and what are the risks?

ANSWER
Regulation Z, the implementing regulation of the Truth In Lending Act (TILA), includes very detailed instructions on how to calculate a loan’s “finance charge,” critical to determining a loan’s annual percentage rate (APR). Sometimes it must seem like you need to be a math wiz to understand APR.

Loan officers are embarrassed and may even lose deals when they cannot explain APR to applicants. I know some top-notch attorneys who can’t figure it out, let alone explain it to loan officers or borrowers. That said, it is not so inscrutable. However, your question is not about explanation or calculation. It is about the finance charge itself. I will explain how a finance charge applied only to approved applicants may cause considerable mischief for a financial institution – and I’ll give you some caveats, too!

I think I know where you’re going with this question. 

A recent case offers a good place to start with an explanation.

A federal district court in Pennsylvania recently reviewed TILA in connection with a specific loan program. In Payne v. Marriott Employees Federal Credit Union [2019 U.S. Dist. (E.D. Pa. Jan. 9, 2019)], the case turned on the following allegations:
  • Marriott Employees Federal Credit Union had obtained loans that provided quick access to $500, repayable in five monthly payments of $90 and a final payment of $79.23. We’ll call these type of loans the “teeny-tiny loans.”
  • Members had to pay a $35 “application fee” when they applied for teeny-tiny loans.
  • Members who had obtained teeny-tiny loans sued the credit union, alleging that its loan disclosures understated the finance charge and APR in violation of TILA because the credit union had not included the application fee in determining the finance charge. 
The court ultimately dismissed the claim because the members failed to sufficiently allege actual damages, but the court denied a motion to dismiss the finance charge claim. And that is where I want to go with my response to your question!

The allegations in the complaint gave rise to a reasonable inference that the credit union had not charged the $35 application fee to all applicants and that the fee was not related to costs associated with processing applications. The members asserted that the credit union only charged the application fee when their teeny-tiny loans were approved.

Also, they alleged that the fee was not being used “to recover the costs associated with processing applications for credit” because the credit union had never performed any credit checks or investigations into their applications or conducted any review of their property.

Why are those allegations important? Because Regulation Z states that application fees are not finance charges if they are application fees charged to all applicants for credit whether or not credit is actually extended. Thus, if charged only to approved applicants, Regulation Z’s exclusion of application fees would not apply and the $35 fee imposed on borrowers would be considered a finance charge.