Safe Harbor Protection to Avoid Steering Violations

QUESTION 

I am the CEO of a Midwest mortgage lender. We are being sued in a class action alleging that we violated the steering prohibitions. They're claiming that we can’t use the safe harbor protection. Our General Counsel and outside counsel are fighting back. 

However, I would like your review, and I especially want other companies to know about their potential vulnerability. Since your newsletter is hugely followed, I hope you will provide the safe harbor elements to your readers. 

What are the elements of the safe harbor to avoid steering violations? 

ANSWER 

Although originators know the anti-steering disclosure and anti-steering requirements, many do not realize that there is a legal safe harbor. A transaction does not violate the steering prohibition if the consumer is presented with loan options that meet the conditions regarding the presentation of loan options. This applies to each type of transaction in which the consumer expressed an interest. 

Let’s clarify what I mean by “each type of transaction” for purposes of the safe harbor. 

These three criteria relate to the meaning of each type of transaction:[i] 

1. A loan has an annual percentage rate that cannot increase after consummation; 

2. A loan has an annual percentage rate that may increase after consummation; or 

3. A loan is a reverse mortgage transaction. 

Now, concerning the presentation of loan options, there are three dispositive factors. 

I will outline the factors because they can be a bit complex. 

The transaction satisfies the safe harbor only if the loan originator presents loan options for each type of transaction in which the consumer expressed an interest and all of the following conditions are met:

 

1. The loan originator must obtain loan options from a significant number of creditors with which the originator regularly does business and, for each type of transaction in which the consumer expressed an interest, must present the consumer with the loan options that include:

 

a. The loan with the lowest interest rate;

 

b. The loan with the lowest interest rate without

                                           i. negative amortization,

                                          ii. a prepayment penalty,

                                         iii. interest-only payments,

                                         iv. a balloon payment in the first seven years of the life of the loan,

                                          v. a demand feature,

                                         vi. shared equity, or

                                        vii. shared appreciation; or

                                       viii. in the case of a reverse mortgage transaction,

A. a loan without a prepayment penalty, or

B. shared equity, or

C. shared appreciation; and

                                        ix. The loan with the lowest total dollar amount for origination points or fees and discounts points;

 

2. The loan originator must have a good faith belief that the options presented to the consumer are loans for which the consumer likely qualifies; and

 

3. For each type of transaction, if the originator presents more than three loans to the consumer, the originator must highlight the loans that satisfy the criteria specified in item 1 above.[ii]

 

Note: The loan originator can present fewer than three loans and satisfy the safe harbor conditions if the loan(s) presented to the consumer satisfy the criteria of the options set forth above in item 1 and the conditions in items 1 to 3 are otherwise met.[iii]

Jonathan Foxx, Ph.D., MBA 

Chairman & Managing Director
Lenders Compliance Group

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[i] 75 FR 58,509, 58,534, codified in 12 CFR § 226.36(e)(2)

[ii] 75 FR 58,509, 58534, codified in 12 CFR § 226.36(e)(3)

[iii] 75 FR 58,509, 58534, codified in 12 CFR § 226.36(e)(4)

Payment Shock Notices

QUESTION

During a banking examination, the examiner said we should consider issuing a payment shock notice. We do not believe there is a requirement to issue such a notice. Although it was only a suggestion, we are a concerned that our regulator will frown on our not providing this notice. What is a payment shock notice? And, is a payment shock notice a regulatory requirement?

ANSWER

A payment shock notice is a voluntary notice that a lender or servicer may provide to a borrower to alert the borrower to the potential for a substantial increase in property taxes for a home. A typical example involves a newly constructed home, where the property taxes for the first year may be based on the unimproved value or only partially on the improved value. This situation can result in a substantial increase in the property taxes once the taxes are fully based on the improved value.

Consider this notice a Best Practice!

HUD actually took a position on this subject twenty years ago. In deciding to adopt a Best Practice approach to allow a payment shock notice – but not mandate the notice – HUD stated:

“The Department intends this final rule to encourage more originators and servicers to adopt practices that will ensure that consumers are informed of the payment shock problem and given the opportunity to avoid it. These practices include:

• Notifying borrowers in advance and providing an opportunity to make voluntary payments ahead of the schedule to avoid payment shock. The Department encourages servicers to use the recommended format published today to notify borrowers of this potential problem when the originator or servicer, in applying sound business judgment, believes that payment shock is like to occur. 

• Offering consumers extended repayment plans, even beyond those required under RESPA, to make up substantial shortages associated with payment shock." [63 FR 3214, 3233, 3237-3238 (1998)]

So, this is in line with a Best Practice procedure, which is good for the lender, servicer, and consumer in the long run. I believe that it is appropriate to provide a payment shock notice when a lender or servicer anticipates a substantial increase in the bills paid out of the escrow or impound account after the first year. By the way, the payment shock notice can be delivered with or separate from an initial escrow account statement. [63 FR 3214, 3237-3238 (1998)]

Think of this notice as a Best Practice that is common and customary, which I would guess is why the examiner recommended it to you. By issuing the payment shock notice, you are advising the borrower of the potential for a substantial increase in bills paid out of the escrow or impound account because of property taxes (or another applicable item) after the first year. This procedure then gives the borrower a chance to voluntarily make higher payments into the account during the first year to offset the payment shock.

Jonathan Foxx

Managing Director

Lenders Compliance Group

Payment Shock Notices

QUESTION 

As a servicer, we issue a payment shock notice. I have always thought that this notice was a requirement. But I am being told that issuing a payment shock notice is optional and not a requirement. Are we required to issue a payment shock notice?

ANSWER
The payment shock notice is optional. Issuing the payment shock notice is not a regulatory requirement. As such, it has been viewed by HUD as a “best practices” action. The payment shock notice is usually issued when there is an adjustment in escrow that causes a higher monthly payment, such higher payment usually attributable to an increase in property taxes.

HUD outlined its reasoning for not requiring the Payment Shock Notice back in 1998, when it amended Regulation X’s section on Escrow Account Procedures in a Final Rule. [63 Federal Register, Volume 63:13, 3214, 3233, 3237-3238, 1998, Rules and Regulations]

As HUD stated in the Final Rule:

“With regard to the ‘payment shock’ problem, the Department determined…that extensive additional regulatory changes are not required and could prove detrimental to consumers. Instead, the Department determined that this problem would be better resolved by identifying and sharing best practices of servicers.” (Emphasis added.)

In part, HUD stated there was a problem involving “…disbursements for items such as property taxes [that] will increase substantially in the second year of the escrow account and where ‘payment shock’ -- the consumer's experiencing of a substantial rise in escrow payments -- will result. The Department has chosen to address this matter by recommending (but not mandating) a best practice for servicers: a voluntary agreement to accept overpayments.” (Emphasis added.)

Thus, HUD had identified a problem with respect to applying an escrow account procedure under Regulation X, and sought to remedy it in the Final Rule. 

Jonathan Foxx
President & Managing Director
Lenders Compliance Group