Our Industry Today TRID AND BEYOND. RDH Education Services. Presented by RDH Education Services

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1 RDH Education Services Our Industry Today TRID AND BEYOND Presented by RDH Education Services RDH Education Services can be contacted at: 4361 Technology Dr, Unit A, Livermore, CA NMLS Approved Course Provider - ID number # Date of course content: 8/18/2015 Date of the course approval: 9/8/2015

2 Our Industry Today TRID and Beyond TABLE OF CONTENTS INTRODUCTION 7 SECTION ONE: FEDERAL LAW 9 INTRODUCTION AND BACKGROUND 9 THE INTEGRATED DISCLOSURES 10 COVERED TRANSACTIONS 10 RECORD RETENTION 11 THE LOAN ESTIMATE 11 GENERAL REQUIREMENTS 11 EARLY ESTIMATES 12 DISCLOSURE TIMING 13 INTENT TO PROCEED 14 DEFINITION OF BUSINESS DAY 15 ACCURACY REQUIREMENT 15 LIMITATION ON FEES AND TOLERANCES 16 CHANGED CIRCUMSTANCES 17 RESTRICTIONS ON ISSUING A REVISED LOAN ESTIMATE BEFORE CONSUMMATION 18 TILA-RESPA INTEGRATED DISCLOSURE MATRIX EFFECTIVE OCTOBER 3, A PAGE-BY-PAGE OVERVIEW 27 THE SPECIAL INFORMATION BOOKLET (KNOW BEFORE YOU OWE TOOLKIT) 32 THE CLOSING DISCLOSURE 33 A PAGE BY PAGE OVERVIEW 35 DEFINITION OF CONSUMMATION 40 SETTLEMENT AGENT 40 WAIVER OF THE THREE BUSINESS-DAY WAITING PERIOD 41 REVISIONS TO THE CLOSING DISCLOSURE AND TIMING 42 MORE INFORMATION ON THE TRID RULE 43 2 Copyright RDH Education Services All Rights Reserved

3 Our Industry Today TRID and Beyond RESPA SECTION 8 REVIEW AND UPDATES 44 RECENT ENFORCEMENT ACTIONS 45 3 Copyright RDH Education Services All Rights Reserved

4 Our Industry Today TRID and Beyond SECTION TWO: ETHICS 49 INTRODUCTION AND BACKGROUND 49 FAIR LENDING AND DISCRIMINATION 53 EXAMPLES AND RECENT ACTIONS BY HUD 54 DISPARATE IMPACT 57 YOUR HOME LOAN TOOLKIT : A STEP-BY-STEP GUIDE 59 MORTGAGE FRAUD 60 FRAUD SCHEMES AND RECENT ENFORCEMENT 61 SECTION THREE: NONTRADITIONAL MORTGAGES 64 INTRODUCTION 64 DODD FRANK AND ABILITY TO REPAY 67 ABILITY TO REPAY 67 QUALIFIED MORTGAGE YEAR FIXED MORTGAGE 70 IO MORTGAGES 71 IO MORTGAGE FEATURES 71 IO MORTGAGE PROS AND CONS 71 IO MORTGAGE POTENTIAL PITFALLS 73 5 YEAR IO 74 NEGATIVE AMORTIZATION MORTGAGE 75 DEFINITIONS 75 NEGATIVE AMORTIZATION MORTGAGE FEATURES 75 NEGAM MORTGAGE PROS AND CONS 76 NEGAM EXAMPLE 77 ADJUSTABLE RATE MORTGAGE (ARM) 79 ARM MORTGAGE FEATURES 80 ARM MORTGAGE REFINANCE 83 BENEFITS OF ARMS 84 4 Copyright RDH Education Services All Rights Reserved

5 Our Industry Today TRID and Beyond ARM MORTGAGE CONSIDERATIONS 85 BORROWER CONSIDERATIONS 86 ARM HIGH/LOW INTEREST RATE EXAMPLES 87 OPTION ADJUSTABLE RATE MORTGAGE 89 CROSS-COMPARISONS 90 ALTERNATIVE MORTGAGE LOAN SUMMARY 90 SECTION FOUR: CALIFORNIA PROFESSIONALS RULEBOOK 94 INTRODUCTION 94 LICENSE MAINTENANCE 97 DEFINITIONS 97 LICENSE RENEWAL 100 EDUCATIONAL REQUIREMENTS 100 RECORD KEEPING 102 SURETY BOND 103 SURRENDER, REVOCATION OR SUSPENSION OF LICENSE 103 POWERS OF THE COMMISSIONER AND THE ATTORNEY GENERAL/REQUIRED CONDUCT 105 DEFINITIONS 105 POWERS OF THE COMMISSIONER 106 POWERS OF THE ATTORNEY GENERAL 110 REQUIRED CONDUCT 110 THE HOMEOWNER S BILL OF RIGHTS 113 APPLICABILITY OF THE LAW 113 DEFINITIONS 113 ADDITIONAL GUIDELINES AND RULES 114 NO DUAL TRACKING DURING SHORT SALE 114 CANCELLING A PENDING TRUSTEE S SALE 114 SINGLE POINT OF CONTACT 115 NO DUAL TRACKING DURING LOAN MODIFICATION 115 NO LATE FEES OR APPLICATION FEES Copyright RDH Education Services All Rights Reserved

6 Our Industry Today TRID and Beyond ADDITIONAL LOAN MODIFICATION SAFEGUARDS 117 BINDING IF LOAN IS TRANSFERRED 117 REVIEW OF FORECLOSURE DOCUMENTS 117 EXTENDING INITIAL CONTACT REQUIREMENTS 118 NOTIFYING BORROWERS BEFORE NOTICE OF DEFAULT 119 NOTIFYING BORROWERS AFTER NOTICE OF DEFAULT 119 POSTPONING A TRUSTEE S SALE 119 LEGAL REMEDIES FOR BORROWERS 120 LENDERS STANDARD OF CARE TO INVESTORS Copyright RDH Education Services All Rights Reserved

7 RDH Education Services I N T R O D U C T I O N OUR INDUSTRY TODAY TRID AND BEYOND Introduction This class discusses the mortgage, lending and real estate markets in Since 2008 the industry has undergone tremendous change. The new rules put in place and the increased regulation has transformed everything about the way this industry does business. It is important for all Loan Originators to understand both what the rules and the law require of them as well as the intent of the law. In Federal Law, we will discuss the new integrated Truth in Lending/Real Estate Settlement Procedures Act Integrated Disclosures (TRID). We will review RESPA referrals and compliance with Section 8. Ethics will discuss Fair Lending Laws and disparate impact. In Consumer Protection we will discuss the companion to the TRID for consumers, the Your Home Loan Toolkit. Our housing markets are showing signs of increased activity and that means an increase in mortgage fraud, we will review the newest mortgage loan fraud information. In Non-Traditional Mortgages ARMS and IO s we will cover several different types of mortgages and discuss their construction, their pros and cons, risks and ethical impacts. The California Department of Business Oversight Division 9 sets standards for required behavior

8 Federal Law in California. This section focuses on License Maintenance, the Powers of the Commissioner and the Attorney General, Required Conduct as well as the Homeowner s Bill of Rights. 8 Copyright RDH Education Services All Rights Reserved

9 RDH Education Services S E C T I O N O N E Federal Law Section One: Federal Law Introduction and Background Since 1974 The Real Estate Settlement Procedures Act (Regulation X) has been an important consumer protection law. RESPA requires that borrowers receive disclosures at various times in a real estate transaction. The disclosures spell out the costs associated with their transaction, outline lender servicing practices and how escrow accounts are handled as well as inform consumers of business relationships between the various settlement service providers. We will discuss the newest disclosures in this section. RESPA also helps to prevent the increase in settlement services by prohibiting certain practices. We will look at Section 8 of RESPA and discuss referrals, Affiliate Business Arrangements and current enforcement actions.

10 Federal Law The Truth-in Lending Act (Regulation Z) promotes the informed use of consumer credit by requiring disclosures about its terms and costs. It gives consumers the right to cancel certain credit transactions and requires a maximum interest rate to be stated in variable-rate contracts secured by the consumer s dwelling. The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed in July 2010 and transferred rule making authority for both RESPA and TILA to the Consumer Financial Protection Bureau (CFPB) in July The Integrated Disclosures For over 30 years the Truth in Lending Act and The Real Estate Procedures Act have required two different and separate disclosures to be delivered to consumers at various times in the transaction, the Good Faith Estimate (RESPA) and the Truth in Lending Statement (TILA). Section 1032(f) of the Dodd Frank Act mandated the creation of model disclosures that integrate the RESPA and TILA disclosures. In November 2013 the CFPB issued the Final TILA-RESPA Integrated Disclosure Rule (TRID) which: Combines the early Good Faith Estimate and the early Truth in Lending Statement into the new Loan Estimate. Consolidates the HUD Settlement Statement and the final Truth in Lending Statement into the new Closing Disclosure. Covers more transaction than RESPA previously did. Revises the definition of Application. Sets new timing rules for disclosure. Establishes new limitations for certain cost tolerances. The effective date of the final rule is applications taken October 3, Lenders cannot use the new disclosures earlier than October 3, 2015 and may not use the old disclosures after that date. Covered Transactions The TRID final rule applies to most closed end transactions secured by real property, as defined by State Law, other than a Reverse Mortgage. Included transactions are: Home purchase, refinance and home equity Lot loans, loans secured by bare land 10 Copyright RDH Education Services All Rights Reserved

11 Federal Law Loan secured by more than 25 acres Construction only loans Temporary, closed end transactions Loans extended to family or estate trusts Exempt transactions are: Home Equity lines of credit Reverse Mortgages Mortgages secured by a mobile home or a dwelling that is not attached to land Loans made by a person not a creditor: Who makes five or fewer mortgages in a year Some no interest second mortgages such as down payment assistance, property rehabilitation, energy efficiency and foreclosure intervention loans. Record Retention According to TILA-RESPA Integrated Disclosure Rule Small entity compliance guide ( ) the creditor must retain copies of the Closing Disclosure (and all documents related to the Closing Disclosure) for five years after consummation. The creditor, or servicer if applicable, must retain the Post-Consummation Escrow Cancellation Notice (Escrow Closing Notice) and the Post-Consummation Partial Payment Policy disclosure for two years. For all other evidence of compliance with the Integrated Disclosure provisions of Regulation Z (including the Loan Estimate) creditors must maintain records for three years after consummation of the transaction. 1 The Loan Estimate General Requirements The TRID Rule combines four existing disclosures into two. The first is the Loan Estimate which replaces the GFE and TIL Statement and must be provided to the borrower no later than three business days after application. The second is the Closing Disclosure which replaces the HUD1 and HUD1A and must be delivered to the borrower at least three business days before consummation. For closed end transactions that are secured by real property (defined by State Law), the MLO, lender or creditor is required to provide a good faith estimate of the transaction terms and credit costs on the Loan Estimate Copyright RDH Education Services All Rights Reserved

12 The Loan Estimate must be delivered within three business days of receiving a completed application (we will discuss timing in a later section). Federal Law No fees for issuing any Loan Estimate, Closing Disclosure or any other required RESPA/TILA disclosure are allowed. According to the CFPB Small Entity Compliance Guide 2 : Loan Estimate must contain a good faith estimate of credit costs and transaction terms. If any information necessary for an accurate disclosure is unknown, the creditor must make the disclosure based on the best information reasonably available at the time the disclosure is provided to the consumer and use due diligence in obtaining the information. ( (e)(1)(i); Comment 19(e)(1)(i)-1) Loan Estimate must be in writing and contain the information prescribed in The creditor must disclose only the specific information set forth in (a) through (n), as shown in the Bureau s form in appendix H-24. ( (o)) Delivery must satisfy the timing and method of delivery requirements. The creditor is responsible for delivering the Loan Estimate or placing it in the mail no later than the third business day after receiving the application. ( (e)(1)(iii)) Creditors may only use revised or corrected Loan Estimates when specific requirements are met. Creditors generally may not issue revisions to Loan Estimates because they later discover technical errors, miscalculations, or underestimations of charges. Creditors are permitted to issue revised Loan Estimates only in certain situations such as when changed circumstances result in increased charges. ( (e)3)(iv)) In certain situations, mortgage brokers may provide a Loan Estimate. As discussed in more detail in section 6.3 below, if a mortgage broker receives a consumer s application, either the creditor or the mortgage broker may provide the Loan Estimate. ( (e)(1)(ii)) 3 Early Estimates You can provide the borrower an estimate of the transactions estimated terms, fees and costs prior to issuing a Loan Estimate. However, if a written estimate is provided before the Loan Estimate it must meet certain guidelines. It must clearly and conspicuously state at the top of the front of the first page, Your actual rate, What are the general requirements for the Loan Estimate disclosure? ( (e) and ) 12 Copyright RDH Education Services All Rights Reserved

13 Federal Law payment, and costs could be higher. Get an official Loan Estimate before choosing the loan. This statement must be in 12 point font size or larger; and there must be no headings, content, or format substantially similar to the Loan Estimate or the Closing Disclosure. Disclosure Timing As we discussed earlier, the Loan estimate must be delivered to the borrower no later than threebusiness-days of receiving a loan application. The first step in determining when to issue the early disclosures is to understand when we have an application. The definition of application has been revised for the Loan Estimate. The new definition is similar to RESPA (Regulation X), which removes the seventh catch all item, and any other information deemed necessary by the loan originator. The six pieces of information that create application are: An application means the submission of a consumer s financial information for purposes of obtaining an extension of credit. For transactions subject to (e), (f), or (g), an application consists of the submission of the following six pieces of information: The consumer s name; The consumer s income; The consumer s social security number to obtain a credit report; The property address; An estimate of the value of the property; and The mortgage loan amount sought. An application may be submitted in written or electronic format, and includes a written record of an oral application. (Comment 2(a)(3)-1) 4 To clarify, once the lender/creditor has all six pieces of information you have an application and a Loan Estimate must be delivered to the borrower within the three-business-day timing requirement. Even if more information is needed to process or make a decision on the loan, you must deliver the Loan Estimate to the borrower. A lender/creditor cannot stop a borrower from providing any of the six pieces of information just to avoid issuing a Loan Estimate What is an application that triggers an obligation to provide a Loan Estimate? ( (a)(3)) 13 Copyright RDH Education Services All Rights Reserved

14 Federal Law Think About It You have a borrower whom you have pre-approved for a purchase loan for their primary residence. You now have a credit approval, having sent in their income, assets and credit to the underwriter for review. The borrower is ready to make an offer on a home. Their real estate agent s you to ask for a pre-approval letter, which you have no problem providing. The real estate agent tells you the property address of the home and asks you to put it on the pre-approval letter to make it more personal. Can you do this? If so, will you now have to issue an LE? Why or why not? The rule requires either a mortgage broker or lender/creditor to provide the Loan Estimate form upon receipt of an application by a mortgage broker. However, even if the mortgage broker provides the Loan Estimate, the lender/creditor remains responsible for complying with all requirements concerning the provisions of the form. If a lender determines that the borrower s application cannot be approved or if the borrower withdraws their application within the three-business-day period then the lender does not have to provide the Loan Estimate. However if the lender/creditor then completes the transaction under the original terms, it will be in violation of TILA (Regulation Z). Consistent with current law a MLO or lender/creditor may not charge any fees, except a fee for the credit report, until the borrower acknowledges receipt of the Loan Estimate and indicates their intent to proceed with the transaction. The Loan Estimate must be delivered to the borrower or placed in the mail no later than seven (7) business days before consummation. The borrower has the right to waive the three-business-day requirement for delivery of the Loan Estimate, the seven-business-day waiting period for consummation and the three-business-day waiting period for delivery of the Closing Disclosure. We discuss this in detail in the CD section later in this chapter. Intent to Proceed The borrower must acknowledge their intent to proceed with the application. They can indicate their intent to proceed in any manner unless the lender/creditor requires a particular form of communication. In fact FNMA specifically states that a signature of intent to proceed is not required but suggests it as a practice. In keeping with the form requirements of CFPB, Fannie Mae will not require that the borrower and seller (if applicable) sign the CD or Loan Estimate. 14 Copyright RDH Education Services All Rights Reserved

15 Federal Law Though these signatures are not required, lenders may obtain borrower and seller signatures, which Fannie Mae supports as a best practice, especially on the C D. 5 Silence by the borrower is NOT an intent to proceed; they must take action. Definition of Business Day The definition of Business Day in context of delivering the Loan Estimate is: For purposes of providing the Loan Estimate, including a revised Loan Estimate, a business day is a day on which the creditor s offices are open to the public for carrying out substantially all of its business functions. (Comment 19(e)(1)(iii)-1, (a)(6)) 6 Note that the term business day is defined differently for other purposes, including counting days to ensure the consumer receives the Closing Disclosure on time. (See (a)(6), (f)(1)(ii)(A) (f)(1)(iii)). This definition also applies when issuing a revised Loan Estimate before consummation. For these other purposes, business day means all calendar days except Sundays and the legal public holidays specified in 5 U.S.C. 6103(a), such as New Year s Day, the Birthday of Martin Luther King, Jr., Washington s Birthday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans Day, Thanksgiving Day, and Christmas Day. (See (a)(6); Comment 2(a)(6)-2; Comment 19(f)(1)(ii)-1) 7 Accuracy Requirement You have to disclose initial fees accurately and in good faith. The lender/creditor is responsible for ensuring that the figures that are stated in the Loan Estimate are made in good faith and consistent with the best information available at the time they are disclosed. A Loan Estimate is considered to be made in good faith if you charge a fee that is less than the amount disclosed and not in good faith if the fee charged is higher than the amount originally 5 Selling Guide Announcement SEL June 30, What is considered a business day under the requirements for provision of the Loan Estimate? (Comment 19(e)(1)(iii)-1, (a)(6)) What is considered a business day under the requirements for provision of the Loan Estimate? (Comment 19(e)(1)(iii)-1, (a)(6)) 15 Copyright RDH Education Services All Rights Reserved

16 Federal Law disclosed, even if the lender/creditor later finds a technical error, miscalculation, or underestimation of a charge. 8 Limitation on Fees and Tolerances Generally, Mortgage Originators, Lenders and Creditors are not permitted to charge consumers more than the amount disclosed on the Loan Estimate under any circumstances, other than changed circumstances that permit a revised Loan Estimate. Zero tolerance charges include: Fees paid to the creditor, mortgage broker, or an affiliate of either; Fees paid to an unaffiliated third party if the creditor did not permit the consumer to shop for a third party service provider for a settlement service; or Transfer taxes. Note that some of the charges above are currently included in the 10% tolerance allowance. Think About It What are the third party fees that the borrower cannot shop for that are currently included in the 10% tolerance? Discuss these items and how they will affect your Loan Estimate now that they have 0% tolerance for increase after disclosure. An example is the appraisal fee. It now has 0% tolerance for increase (without a changed circumstance). How will you disclose accurately? Discuss some of the other fees now included and how you will disclose accurately. Generally, Mortgage Originators, Lenders and Creditors are allowed to charge the borrower more than the amount disclosed on the Loan Estimate for some fees, as long as the total sum of the charges added together does not exceed the sum of all such charges disclosed on the Loan Estimate by more than 10 percent for the following: 10% Tolerance charges include: Recording fees Fees paid to an unaffiliated third party, if the MLO, Lender, Creditor, permitted the borrower to shop for the service and the borrower selects a third party service provider on the creditor s written list of service providers. The charge is not paid to the MLO, lender, creditor or their affiliate What is the general accuracy requirement for the Loan Estimate disclosures? ( (e)(3)(iii)) 16 Copyright RDH Education Services All Rights Reserved

17 There are also some charges that are allowed to be higher than their estimates as long as the estimated charge was based on the best information reasonably available to the Mortgage Originator, Lender, Creditor, at the time the disclosure was made. Charges with no tolerance limit include: Federal Law Prepaid interest; Property insurance premiums; Amounts placed into an escrow, impound or reserve account; Charges paid to third-party service providers selected by the consumer that are not on the list provided by the creditor; and Charges paid to third-party service providers for services not required by the creditor. If the amounts paid by the borrower at closing exceed the amounts disclosed on the Loan Estimate beyond the tolerance threshold, the lender/creditor, creditor must refund the excess to the consumer no later than 60 calendar days after consummation. Changed Circumstances The definition of what creates a changed circumstance remains the same as with current RESPA (Regulation X) and allows a revised Loan Estimate to be issued under these circumstances: Expiration of Loan Estimate; Changed Circumstances Affecting Settlement Charges; Changed Circumstances Affecting Eligibility; Revisions Requested by the Consumer; Interest Rate Dependent Charges. The revised Loan Estimate must be delivered within three business days of receiving the information that establishes the changed circumstance. Think About It What is a real life example of an event that creates a changed circumstance for each of the items below? Name or list at least one event that you have experienced from the list below that created a changed circumstance. Expiration of Loan Estimate Changed Circumstances Affecting Settlement Charges Changed Circumstances Affecting Eligibility Revisions Requested by the Consumer Interest Rate Dependent Charges 17 Copyright RDH Education Services All Rights Reserved

18 Restrictions on issuing a revised Loan Estimate before consummation Federal Law The Lender/creditor may not issue a revised Loan Estimate on or after the date it provides the Closing Disclosure. The borrower must receive the revised Loan Estimate no later than four (4) business days prior to consummation, or, if mailed an additional three (3) business days after it is placed in the mail. Remember that in this case, the four-business-day period prior to consummation, the definition of business day is all days except Sunday and legal federal holidays. If there are less than four business days in between the time a the revised Loan Estimate would have been required to be provided to the consumer and consummation, creditors may provide consumers with a Closing Disclosure reflecting any revised charges resulting from the changed circumstance and rely on those figures (rather than the amounts disclosed on the Loan Estimate) for purposes of determining good faith and the applicable tolerance. (Comment 19(e)(4)(ii)-1) If the changed circumstance or other triggering event occurs between the fourth and third hbusiness days from consummation, the creditor may reflect the revised charges on the Closing Disclosure provided to the consumer three business days before consummation. If the event occurs after the first Closing Disclosure has been provided to the consumer (i.e., within the three-business-day waiting period before consummation), the creditor may use revised charges on the Closing Disclosure provided to the consumer at consummation, and compare those amounts to the amounts charged for purposes of determining good faith and tolerance. (Comment 19(e)(4)(ii)-1) 9 TILA-RESPA Integrated Disclosure Matrix effective October 3, 2015 Covered Transactions Exemptions New Rule Effective October 3, 2015 Closed-end consumer credit transactions secured by real property with or without a dwelling Reverse Mortgages HELOCs Chattel-dwelling loans Credit extended to non-natural Existing Rule Through Sept. 30, 2015 Closed-end consumer credit transactions secured by a residential real property with a 1-4 family structure Business Purpose Loans Lot loans Exceeds 25 acres Construction-only loans What if a changed circumstance occurs too close to consummation for the creditor to provide a revised Loan Estimate? (Comment 19(e)(4)(ii)-1) 18 Copyright RDH Education Services All Rights Reserved

19 Definition of application Initial disclosures Delivery Requirements 3-Business day definition-for Initial Disclosure 7-Business day definition persons (Ex: trusts, estates, business entities etc.) Some loans associated with housing assistance loan programs for low to moderate buyers Consumer s name Consumer s income Consumer s Social Security number Property address Estimated property value Loan amount sought Loan Estimate (LE) Unchanged Unchanged Unchanged Federal Law Bridge loans or temporary closed-end consumer credit Credit extended to non-natural persons such as an estate Reverse Mortgages HELOCs Consumer s name Consumer s income Consumer s Social Security number Property address Estimated property value Loan amount sought; and Any other information required by the creditor Good Faith Estimate (GFE) Early Truth in Lending Disclosure (TIL) Within 3 business days of application and at least 7 days prior to closing A day on which the creditor s offices are open to the public for substantially all business functions All calendar days except Sundays and legal public holidays Written list of service providers Fees restriction Unchanged List must be provided within 3 business days of application if creditor permits the borrower to shop for a service Unchanged Fees (except credit report) cannot be charged or collected until the LE is provided and borrower indicates intent to proceed 19 Copyright RDH Education Services All Rights Reserved

20 Pre-Application (LE/GFE) Disclosure- Fee Worksheet Permitted but must not look like the LE Must state in at least 12-point font on the top of 1 st page: your actual rate, payment, and costs could be higher. Get an official Loan estimate before choosing a loan Federal Law Permitted but must not look like the GFE Require verification of borrower documents Permitted cost increases from application disclosures (GFE&LE) to Consummation Disclosures (Settlement Statement & Closing Disclosure) Prohibited until LE is provided and borrower has indicated intent to proceed Costs that cannot increase from LE to Closing Disclosure (CD) Fees paid to creditor or broker Fees paid to an affiliate of creditor or broker Transfer taxes Fees paid to an unaffiliated third party if the creditor did not permit the consumer to shop for the third party Once the consumer s interest rate is locked The credit or charge for the interest rate chosen; and The adjusted origination charge Costs that can increase up to 10% in the aggregate: Government recording charges Services the consumer is permitted to shop for and selects the provider from the Prohibited until GFE is provided and borrower has indicated intent to proceed Costs that cannot increase from GFE to HUD 1: Origination charge Once the borrower s interest rate is locked, the credit or charge for the interest rate chosen and the adjusted origination charge Transfer taxes Costs that can increase in the aggregate up to 10%: Government recording charges Lender-required, lenderselected settlement providers Lender-required services, title services and required title insurance when the borrower uses a settlement service provider identified by the lender on the written list 20 Copyright RDH Education Services All Rights Reserved

21 Changed circumstances creditor s list but cannot be an affiliate Services the consumer is permitted to shop for and does not select a provider and the creditor selects a provider that is not an affiliate Services for which the creditor permits a consumer to shop, but fails to provide a written list of providers Costs that increase in any amount: Prepaid interest Property insurance premiums Amounts paid into escrow Charges paid to third-party service providers selected by the consumer that are not on the creditors written list Charges paid for third-party services not required by the creditor (may NOT be paid to affiliate of the creditor) No change, Same rules apply to the LE Federal Law Costs that increase in any amount: Prepaid interest Property insurance premiums Amounts paid into escrow Charges paid to third-party service providers selected by the consumer that are not on the creditor s written list Charges paid for third-party services not required by the creditor (may be paid to affiliate of the creditor) Categories of changed circumstances: Changed of circumstances affecting settlement costs Changed circumstances affecting the loan Borrower requested changes Expiration of the GFE (10 business days) with no intent to proceed Delayed settlement date on a construction-perm loan if notice is provided Interest rate dependent charges 21 Copyright RDH Education Services All Rights Reserved

22 Federal Law Trigger for revised application disclosures Timing of revised application disclosures Loan Estimate: Valid changed circumstance increasing a fee paid to the creditor, mortgage broker or affiliate of either, a fee for which the consumer is not permitted to shop or transfer taxes ( zero tolerance fees) by any amount Valid changed circumstance(s) increasing the sum of fees for changes the consumer is permitted to shop for or recording fees 10% tolerance fees) by more than 10% Locking in the loan s interest rate Expiration of LE with no intent to proceed Permanent financing of construction loan more than 60 calendar days after original LE with construction loan disclosure (if notice is provided to consumer on initial disclosure) Change in any material term of the loan APR becomes inaccurate by more than.125% Closing Disclosure: Sent within 3 business days of receiving information sufficient to establish that a changed circumstance trigger as described above occurred, except: Good Faith Estimate: Increase in costs resulting from valid changed circumstance Locking in the loan s interest rate Expiration of GFE with no intent to proceed Permanent financing of construction loan more than 60 calendar days after original GFE with construction loan disclosure Change in any material term of the loan etil APR becomes inaccurate by more than.125% Good Faith Estimate: Sent within 3 business days of receiving information sufficient to establish that a changed circumstance has occurred etil: 22 Copyright RDH Education Services All Rights Reserved

23 Federal Law Revised LE cannot be received by the borrower on the same day the borrower receives the CD thus, revised LE must be received at least 4 business days prior to closing Received by borrower at least 3 business days prior to closing If delivering the revised LE by means other than in person, (including electronic delivery) the disclosure is considered to be received 3 business days after placing it in the mail ( mailbox rule ) unless the creditor receives proof of receipt 23 Copyright RDH Education Services All Rights Reserved

24 Responsible party for accuracy of closing disclosure Definition of Business day for 3-Day to issue Redisclosure Title of closing disclosures Delivery of closing disclosures Subsequent changes to closing disclosures CD-Lender (Lender may contract settlement agent to provide the CD but lender remains responsible for disclosure) Unchanged Closing Disclosures (CD) Received by borrower no later than 3 business days prior to closing Cannot be received by borrower on the same day as a revised LE If delivering the CD by means other than in person, (including electronic delivery) the disclosure is considered to be received 3 business days after placing in the mail ( mailbox rule ) unless creditor receives proof of receipt Changes before closing that require a revised CD AND a new 3-business day period: APR increases by more than 1/8 of one percent for a fixedrate loan (1/4 of one percent for a variable-rate loan) Changes in loan product (e.g., fixed rate to variable rate Federal Law TIL: Lender HUD: Settlement agreement A day on which the lender s offices are open to the public for substantially all business functions HUD 1 Settlement statement (HUD) Truth in Lending disclosure (TIL) Available for inspection one business day prior to closing with items known to creditor At or before closing Changes Before Closing requiring a revised TIL and new 3-Day business day waiting period: The disclosed APR is found to be inaccurate by increasing more than.125% Any other changes required to the CD before closing need to 24 Copyright RDH Education Services All Rights Reserved

25 Federal Law Tolerance Violations (CURE) Addition of prepayment penalty Changes before closing requiring revised CD at or before closing but NO new waiting period: Any change other than those described above Revised CD must be available day before closing if requested by the consumer Changes following closing requiring a revised CD: Events that cause a change to the amount paid by the consumer within 30 days after closing. Revised CD is required within 20 calendar days of receipt of changed information Non-numeric Clerical errors Revised CD required within 60 calendar days of closing Not deemed a violation if: A revised CD is provided Amount is refunded to consumer within 60 calendar days after closing to be made and do not require a new wait period An inadvertent or technical error in completing the HUD-1 or HUD-1A Provide a revised HUD-1 or HUD-1A within 30 calendar days of settlement Not deemed a section 4 violation if: A revised HUD-1 or HUD-1A is provided Amount is refunded to the consumer within 30 calendar days after closing 25 Copyright RDH Education Services All Rights Reserved

26 Capture of Receipt if disclosures Rescissionable time period Initial LE and all subsequent LE Re-disclosures: Capture primary borrower on all disclosures Initial CD and all subsequent CD re-disclosures: All borrower with title interest in the property Unchanged Federal Law Initial GFE and all subsequent GFDE re-disclosures: Capture primary borrower on all disclosures Disclosure of final TIL All borrower with title interest in the property 3 business days, Saturday is considered a business day 26 Copyright RDH Education Services All Rights Reserved

27 Federal Law A Page-by-Page Overview Loan Estimate Page 1 Page 1 of the Loan Estimate includes general information, a Loan Terms table with descriptions of applicable information about the loan, a Projected Payments table, a Costs at Closing table, and a link for consumers to obtain more information about loans secured by real property at a website maintained by the Bureau. Page 1 of the Loan Estimate includes the title Loan Estimate and a statement of Save this Loan Estimate to compare with your Closing Disclosure. ( (a)(1), (2)). The top of page 1 also includes the name and address of the creditor. ( (a)(3)). A logo or slogan can be used along with the creditor s name and address, so long as the logo or slogan 27 Copyright RDH Education Services All Rights Reserved

28 Federal Law does not exceed the space provided for that information. ( (o)(5)(iii)) If there are multiple creditors, use only the name of the creditor completing the Loan Estimate. (Comment 37(a)(3)-1). If a mortgage broker is completing the Loan Estimate, use the name of the creditor if known. If not yet known, leave this space blank. (Comment 37(a)(3)- 2) Page 1: General information, loan terms, projected payments, and costs at closing 28 Copyright RDH Education Services All Rights Reserved

29 Federal Law Loan Estimate Page 2 Four main categories of charges are disclosed on page 2 of the Loan Estimate: A good-faith itemization of the Loan Costs and Other Costs associated with the loan. ( (f) and (g)) A Calculating Cash to Close table to show the consumer how the amount of cash needed at closing is calculated. ( (h)) For transactions with adjustable monthly payments, an Adjustable Payment (AP) Table with relevant information about how the monthly payments will change. ( (i)) For transactions with adjustable interest rates, an Adjustable Interest Rate (AIR) Table with relevant information about how the interest rate will change. ( (j)) 29 Copyright RDH Education Services All Rights Reserved

30 Federal Law The items associated with the mortgage are broken down into two general types, Loan Costs and Other Costs. Generally, Loan Costs are those costs paid by the consumer to the creditor and third-party providers of services the creditor requires to be obtained by the consumer during the origination of the loan. ( (f)). Other Costs include taxes, governmental recording fees, and certain other payments involved in the real estate closing process. ( (g)) These two tables are further broken down, as discussed below. Items that are a component of title insurance must include the introductory description of Title. ( (f)(2)(i) and (g)(4)(i)) If State law requires additional disclosures, those additional disclosures may be made on a document whose pages are separate from, and not presented as part of, the Loan Estimate. (Comments 37(f)(6)-1 and 37(g)(8)-1) 11 Think About It Review page 2 of the loan estimate. How do the fees and charges listed compare to the way they are listed on the GFE? What is better? What is not? Is there too little information, too much? Why or why not? Page 2: Closing cost details 30 Copyright RDH Education Services All Rights Reserved

31 Federal Law Loan Estimate Page 3 Page 3: Additional information about the loan. Page 3 of the Loan Estimate contains Contact information, a Comparisons table, an Other Considerations table, and, if desired, a Signature Statement for the consumer to sign to acknowledge receipt. (See (k), (l), (m), and (n)) In transactions involving new construction, this page may include a clear and conspicuous statement that the creditor may issue a revised disclosure any time prior to 60 days before consummation, pursuant to (e)(3)(iv)(F) if the creditor reasonably expects that settlement will occur more than 60 days after the provision of the initial Loan Estimate Page 3: Additional information about the loan 31 Copyright RDH Education Services All Rights Reserved

32 Federal Law Think About It The TIL Statement shows the total dollar amount a borrower will pay over the life of the loan. The TIP on the LE shows the amount of the interest paid over the life of the loan as a percentage of the loan amount. How does this information help the borrower understand the true cost of their financing? Is it better that than the total dollar amount calculation? Why or why not? The Special Information Booklet (Know Before You Owe Toolkit) The Mortgage Originator, lender or creditor must provide a copy of the special information booklet to borrowers who apply for a consumer credit transaction secured by real property, except: If the consumer is applying for a Home Equity Line of Credit (HELOC), the creditor can instead provide a copy of the brochure entitled, When Your Home is On the Line: Lines of Credit. The creditor need not provide the special information booklet if the consumer is applying for a real property secured consumer credit transaction that does not have the purpose of purchasing a one to four family residential property, such as a refinancing, a closed end loan secured by a subordinate lien, or a reverse mortgage. The Special Information Booklet, which is now called the Know Before you Owe Toolkit must be delivered or placed in the mail not later than three business days after the mortgage application is received. It can be delivered with the other early TRID disclosures. As with the other early disclosures if the loan is denied or withdrawn before the end of the third business day, the booklet does not have to be delivered. We will take a look at the new toolkit in the next chapter, Ethics. 32 Copyright RDH Education Services All Rights Reserved

33 Federal Law The Closing Disclosure The Closing Disclosure integrates and replaces the current HUD1 and Final TIL disclosures. For any loan that requires a Loan Estimate the lender/creditor must issue the Closing Disclosure, which is a new form that reflects the actual charges and terms of the transaction. It is the lender/creditor responsibility to make sure the Closing Disclosure is issued and to ensure the borrower receives it no later than three (3) business days before consummation. To ensure the consumer receives the Closing Disclosure on time, the lender/creditor must arrange for delivery as follows: By providing it to the consumer in person. By mailing, or by other delivery methods, including . Creditors may use electronic delivery methods subject to compliance with the consumer consent and other applicable provisions of the Electronic Signatures in Global and National Commerce Act (15 U.S.C et seq.). ( (t)(3)(iii)) Creditors must ensure that the consumer receives the Closing Disclosure at least three business days prior to consummation. ( (f)(1)(ii)(A)) 13 According to the Compliance Guide: The Closing Disclosure generally must contain the actual terms and costs of the transaction. ( (f)(1)(i)). Creditors may estimate disclosures using the best information reasonably available when the actual term or cost is not reasonably available to the creditor at the time the disclosure is made. However, creditors must act in good faith and use due diligence in obtaining the information. The creditor normally may rely on the representations of other parties in obtaining the information, including, for example, the settlement agent. The creditor is required to provide corrected disclosures containing the actual terms of the transaction at or before consummation. (Comments 19(f)(1)(i)-2, -2.i, and -2.ii) The Closing Disclosure must be in writing and contain the information prescribed in The creditor must disclose only the specific information set forth in (a) through (s), as shown in the Bureau s form in appendix H-25. ( (t)) If the actual terms or costs of the transaction change prior to consummation, the creditor must provide a corrected disclosure that contains the actual terms of the transaction and How must the Closing Disclosure be delivered? ( (f)(1)(ii)) 33 Copyright RDH Education Services All Rights Reserved

34 Federal Law complies with the other requirements of (f), including the timing requirements, and requirements for providing corrected disclosures due to subsequent changes. (Comment 19(f)(1)(i)-1) New three-day waiting period. If the creditor provides a corrected disclosure, it may also be required to provide the consumer with an additional three-business-day waiting period prior to consummation. ( (f)(2)) 14 In rescindable transactions, the Closing Disclosure must be given separately to each consumer who has the right to rescind under TILA. In transactions that are not rescindable, the Closing Disclosure may be provided to any consumer with primary liability on the obligation What are the general requirements for the Closing Disclosure? ( (f) and ) 34 Copyright RDH Education Services All Rights Reserved

35 Federal Law A Page by Page Overview Closing Disclosure Page 1 Page 1: General information, loan terms, projected payments, and costs at closing. General information, the Loan Terms table, the Projected Payments table, and the Costs at Closing table are disclosed on the first page of the Closing Disclosure. ( (a), (b), (c), and (d)) Copyright RDH Education Services All Rights Reserved

36 Federal Law Closing Disclosure Page 2 Page 2: Loan costs and other costs. The Loan Costs and Other Costs tables are disclosed under the heading Closing Cost Details on page 2 of the Closing Disclosure. ( (f), (g), and (h)). The number of items in the Loan Costs and Other Costs tables can be expanded and deleted to accommodate the disclosure of additional line items and keep the Loan Costs and Other Costs tables on page 2 of the Closing Disclosure. ( (t)(5)(iv)(A); Comment 38(t)(5)(iv)-2) However, items that are required to be disclosed even if they are not charged to the consumer (such as Points in the Origination Charges subheading) cannot be deleted. (Comment 38(t)(5)(iv)-1) The Loan Costs and Other Costs tables can be disclosed on two separate pages of the Closing Disclosure, but only if the page cannot accommodate all of the costs required to be disclosed on one page. ( (t)(5)(iv)(B); Comment 38(t)(5)(iv)-2) When used, these pages are numbered page 2a and 2b. (Comment 38(t)(5)(iv)-2). For an example of this permissible change to the Closing Disclosure, see form H-25(H) of appendix H to Regulation Z Copyright RDH Education Services All Rights Reserved

37 Federal Law Closing Disclosure Page 3 Page 3: Calculating cash to close, summaries of transactions, and alternatives for transactions without a seller. On page 3 of the Closing Disclosure, the Calculating Cash to Close table and Summaries of Transactions tables are disclosed. ( (i), (j), and (k)). For transactions without a seller, a Payoffs and Payments table may be substituted for the Summaries of Transactions table and placed before the alternative Calculating Cash to Close table. ( (e) and (t)(5)(vii)(b)). For example, see page 3 of form H-25(J) of appendix H to Regulation Z Copyright RDH Education Services All Rights Reserved

38 Federal Law Closing Disclosure Page 4 Page 4: Additional information about this loan. On page 4 of the Closing Disclosure, Loan Disclosures, Adjustable Payment, and Adjustable Interest Rate (AIR) tables are shown with the heading Additional Information About This Loan. ( (l), (m), and (n)) Copyright RDH Education Services All Rights Reserved

39 Federal Law Closing Disclosure Page 5 Page 5: Loan calculations, other disclosures and contact information. Disclose Loan Calculations, Other Disclosures, Questions Notice, Contact Information, and, if desired by the creditor, Confirm Receipt tables on page 5 of the Closing Disclosure. ( (o), (p), (q), and (r)) For a description and instructions for calculations of amounts for the information and amounts required on the Closing Disclosure, please see the Closing Disclosure section of the TILARESPA Guide to Forms Copyright RDH Education Services All Rights Reserved

40 Federal Law Definition of Consummation Consummation occurs when the consumer becomes legally obligated to the creditor on a loan. A loan occurs when debt is incurred with the right to defer it. The point in time when a consumer becomes contractually obligated to the creditor on the loan depends on applicable State law. ( (a)(13) and Comment 2(a)(13)-1). 20 Think About It In California when is the borrower contractually obligated on the loan? Is it lender specific? Settlement Agent A settlement agent is allowed to provide the Closing Disclosure to the borrower, as long as the settlement agent complies with all necessary requirements as if it were the creditor. The lender/creditor and settlement agent must agree on a division of responsibilities regarding the delivery of the disclosures. The new rule is intended to allow for sufficient flexibility to arrive at the most efficient means of preparation and delivery of the Closing Disclosure to borrowers. The settlement agent is responsible for providing the Closing Disclosure to the Seller in a transaction. If the Closing Disclosure has buyer and seller information on it, the settlement agent can provide the same form to both. The settlement agent must provide the seller its copy of the Closing Disclosure no later than the day of consummation. If the seller s disclosure is provided in a separate document then the settlement agent has to give a copy of the disclosure that was provided to the seller to the lender/creditor for their records The rule requires creditors to provide the Closing Disclosure three business days before consummation. Is consummation the same thing as closing or settlement? ( (a)(13)) 40 Copyright RDH Education Services All Rights Reserved

41 Federal Law Waiver of the three business-day waiting period Can a borrower waive the three business-day waiting period? Yes, if the borrower can prove a bona fide personal financial emergency, the waiting period may be waived. They must submit a letter that describes the emergency, sign and date the letter, and provide to their lender/creditor. According to the Compliance Guide: Like the seven-business-day waiting period after receiving the Loan Estimate, consumers may waive or modify the three-business-day waiting period when: The extension of credit is needed to meet a bona fide personal financial emergency. ( (f)(1)(iv)); The consumer has received the Closing Disclosure; and The consumer gives the creditor a dated written statement that describes the emergency, specifically modifies or waives the waiting period, and bears the signature of all consumers who are primarily liable on the legal obligation. ( (f)(1)(iv)) 21 Note, however, the lender/creditor is prohibited from providing the borrower with a pre-printed waiver form. So what is a bona fide personal financial emergency? The example given in the text of TILA says For example, the imminent sale of the consumer s home at foreclosure, where the foreclosure sale will proceed unless loan proceeds are made available to the consumer during the waiting period, may be considered a bona fide personal financial emergency. (Comment 19(f)(1)(iv)-1). The comments go on to say that this example is not the only kind of personal financial emergency that may exist May a consumer waive the three business-day waiting period? ( (f)(1)(iv)) 41 Copyright RDH Education Services All Rights Reserved

42 Federal Law Think About It A consumer has the right to waive the waiting periods under TILA if they have a bona fide personal financial emergency. The text of TILA uses this example: For example, the imminent sale of the consumer s home at foreclosure, where the foreclosure sale will proceed unless loan proceeds are made available to the consumer during the waiting period, may be considered a bona fide personal financial emergency. (Comment 19(f)(1)(iv)-1) Discuss other personal financial emergencies that may allow a borrower to waive their waiting periods. Have you had a borrower successfully waive their waiting periods (since January 2010)? If so, what were the reasons? If not, why would a lender not allow a borrower to waive their waiting period if TILA clearly states they have that right? Revisions to the Closing Disclosure and Timing What happens if the Closing Disclosure needs to be revised? It is possible that changes will occur in the loan or the financing terms that trigger a requirement to issue a new Closing Disclosure. A revised Closing Disclosure must be issued if there are any changes that occur after the Closing Disclosure was first provided. There are three events that trigger the requirement to provide a corrected Closing Disclosure: Changes that occur before consummation that require a new three-business-day waiting period. ( (f)(2)(ii)) o Changes to the loan s APR; o Changes to the loan product; or o The addition of a prepayment penalty. Changes that occur before consummation and do not require a new three-business-day waiting period. ( (f)(2)(i)) o Which includes all other changes o For these changes, the creditor must ensure only that the consumer receives the revised Closing Disclosure at or before consummation. Changes that occur after consummation. ( (f)(2)(iii)) o Creditors must provide a corrected Closing Disclosure if an event in connection with the settlement occurs during the 30-calendar-day period after consummation that causes the Closing Disclosure to become inaccurate and results in a change to an amount paid by the consumer from what was previously disclosed. ( (f)(2)(iii); Comment 19(f)(2)(iii)-1) 42 Copyright RDH Education Services All Rights Reserved

43 Federal Law When a post-consummation event requires a corrected Closing Disclosure, the creditor must deliver or place in the mail a corrected Closing Disclosure not later than 30 calendar days after receiving information sufficient to establish that such an event has occurred. ( (f)(2)(iii); Comment 19(f)(2)(iii)-1) 22 If during the 30-day period after closing, an event in connection with the settlement of the mortgage occurs that causes the Closing Disclosure to become inaccurate, the lender/creditor must deliver or place in the mail corrected disclosures to the member not later than 30 days after receiving information sufficient to establish that the event has occurred. If there are clerical errors discovered, the lender/creditor must correct non-numeric clerical errors no later than 60 days after closing. If there is refund due the borrower after consummation, lender/creditor is required to refund settlement costs to the consumer due to a GFE discrepancy, the lender/creditor must deliver or place in the mail corrected disclosures that reflect the refund within the 60-day period. More information on the TRID Rule You will find the TILA-RESPA rule on the Bureau s website at In addition to a complete copy of the TILA-RESPA rule, that web page also contains: The preamble, which explains why the Bureau issued the rule, the legal authority and reasoning behind the rule, responses to comments, and analysis of the benefits, costs, and impacts of the rule; Official Interpretations of the rule; The TILA-RESPA Guide to Forms; and Other implementation support materials (including proposed rule amendments, if applicable). Useful resources related to mortgage rule implementation are also available at Are creditors required to provide corrected Closing Disclosures if terms or costs change after consummation? ( (f)(2)(iii)) Where can I find a copy of the TILA-RESPA rule and get more information about it? 43 Copyright RDH Education Services All Rights Reserved

44 Federal Law RESPA Section 8 Review and Updates When RESPA was passed in 1974 it was a paradigm shift in the way real estate transactions were completed. In an effort to protect consumers from inflated transaction fees and costs RESPA aims to create transparency and give consumers all of the information about the costs of their transaction by requiring MLOs to provide accurate disclosures at various stages of the transaction process. Examples of disclosures include spelling out all of the costs associated with the settlement, outlining lender, broker, and mortgage loan originators servicing practices, outlining escrow account practices or describing business relationships between settlement service providers RESPA is a consumer disclosure and anti-kickback act. On the consumer disclosure side, the act requires lenders to provide buyers and sellers with full disclosure of the costs of the transaction. RESPA is also an anti-kickback act. The idea here is to prevent the payment of kickbacks and other fees, which drive up the costs of the product to consumers. Section 8(a) of RESPA prohibits any person from giving or receiving a thing of value for the referral of settlement services in connection with federally related mortgage loans. We will review again this year the text of RESPA as it defines a thing of value: Thing of value. This term is broadly defined in section 3(2) of RESPA (12 U.S.C. 2602(2)). It includes, without limitation, monies, things, discounts, salaries, commissions, fees, duplicate payments of a charge, stock, dividends, distributions of partnership profits, franchise royalties, credits representing monies that may be paid at a future date, the opportunity to participate in a money-making program, retained or increased earnings, increased equity in a parent or subsidiary entity, special bank deposits or accounts, special or unusual banking terms, services of all types at special or free rates, sales or rentals at special prices or rates, lease or rental payments based in whole or in part on the amount of business referred, trips and payment of another person's expenses, or reduction in credit against an existing obligation. The term payment is used throughout and as synonymous with the giving or receiving of any thing of value and does not require transfer of money. 24 One should be mindful of a potential violation in the law in any referrals or any fee splitting arrangements. Even if compensable loan origination services have been actually performed by an agent, that fact does not, by itself, make the contemplated payment legal. Even if the payment is 24 PART 1024 REAL ESTATE SETTLEMENT PROCEDURES ACT (REGULATION X) Prohibition against kickbacks and unearned fees (d) Thing of value 44 Copyright RDH Education Services All Rights Reserved

45 relative to the market value of similar services provided, there still may be a violation. Federal Law Many of the themes of RESPA may conflict with the instincts of real estate brokers who are used to receiving referral fees for referring their clients to other brokers (specifically permitted under a RESPA exception). RESPA did clarify that it is legitimate for attorneys, title insurance agents, servicers, real estate agents to get paid for their service. If different services are provided for by affiliated business arrangements, then charges are legitimate if there is a proper disclosure to the borrowers. Violations of the RESPA prohibition against kickbacks and unearned fees anti-kickback, referral fees and unearned fees provisions of RESPA are subject to criminal and civil penalties. In a criminal case a person who violates Section 8 may be fined up to $10,000 and imprisoned up to one year. In addition, failure to comply with RESPA may be grounds for administrative action by HUD. In a private lawsuit a person who violates Section 8 may be liable to the person charged for the settlement service up to three times the amount of the charge paid for the service. Recent Enforcement Actions Let s take a look at some recent enforcement actions that have shown how serious the CFPB believes violations of RESPA Section 8 are and how harmful it is to consumers. Here is a list of some of the violations since June of 2014: January CFPB Takes Action Against ***** ***** and ******** ***** for Illegal Mortgage Kickbacks Banks to Pay $35.7 Million After Loan Officers Illegally Traded Referrals for Cash and Marketing Services WASHINGTON, D.C. Today, the Consumer Financial Protection Bureau (CFPB) and the Maryland Attorney General took action against ***** ***** and ******** ***** for an illegal marketing-services-kickback scheme they participated in with XYZ Title, a now-defunct title company. The Bureau and Maryland also took action against former ***** ***** employee MLO A and his wife, MLO B, for their involvement. XYZ Title gave the banks loan officers cash, marketing materials, and consumer information in exchange for business referrals. The proposed consent orders, filed in federal court, would require $24 million in civil penalties from ***** *****, $600,000 in civil penalties from ******** *****, and $11.1 million in redress to consumers whose loans were involved in this scheme. MLOs A and B also will pay a $30,000 penalty. 45 Copyright RDH Education Services All Rights Reserved

46 Federal Law Today we took action against two of the nation s largest banks, ***** ***** ******** *****, for illegal mortgage kickbacks, said CFPB Director Richard Cordray. These banks allowed their loan officers to focus on their own illegal financial gain rather than on treating consumers fairly. Our action today to address these practices should serve as a warning for all those in the mortgage market. 25 April CFPB and State of Maryland Take Action Against Pay-To-Play Mortgage Kickback Scheme Loan Officers and Former Title Company Executives Who Traded Cash and Marketing Services for Illegal Referrals Will Be Banned, Pay Redress and Penalties WASHINGTON, D.C. Today the Consumer Financial Protection Bureau (CFPB) and the Maryland Attorney General took action against the participants in a mortgage-kickback scheme. In a complaint filed in federal court, the CFPB and Maryland allege that the Maryland-based title company s executives and the named loan officers traded cash and marketing services in exchange for mortgage referrals. Under proposed consent orders filed today, if entered by the court, five of the six individual defendants would be banned from the mortgage industry and required to pay a total of $662,500 in redress and penalties. The action will proceed against the remaining defendant. The announcement follows enforcement actions in January against Wells Fargo and JPMorgan Chase for their role in the scheme. Paying kickbacks for mortgage referrals is illegal, and it has been illegal for decades, said CFPB Director Richard Cordray. Secret and unlawful payments keep consumers in the dark and put honest businesses at a disadvantage, and the Consumer Bureau will continue to take action against them. CFPB Takes Action Against ABC Day Financial for Deceptive Mortgage Advertising and Kickbacks Lender to Pay $2 Million Civil Penalty for Illegal Conduct WASHINGTON, D.C. Today, the Consumer Financial Protection Bureau (CFPB) took action against ABC Day Financial, LLC for deceptive mortgage advertising and kickbacks. ABC Day deceived consumers about a veterans organization s endorsement of ABC Day products and participated in a scheme to pay kickbacks for customer referrals. ABC Day will pay a $2 million civil money penalty for its actions Copyright RDH Education Services All Rights Reserved

47 Federal Law ABC Day profited from the trust that veterans place in their veteran service organization, said CFPB Director Richard Cordray. Veterans, and any consumers getting a mortgage, deserve honest information about lender endorsements. June CFPB Takes Action Against Illegal Mortgage Referrals Bureau Orders New Jersey Title Company to Pay $30,000 for Illegal Kickback Scheme WASHINGTON, D.C. Today, the Consumer Financial Protection Bureau ordered a New Jersey company, ABC Title Services Inc., to pay $30,000 for paying illegal kickbacks for referrals. Kickbacks drive up the costs of getting a mortgage and put law-abiding companies at a disadvantage, said CFPB Director Richard Cordray. The Consumer Bureau will continue to take action against companies that seek to attract consumers through illegal schemes. The Bureau charged that ABC Title paid commissions to more than twenty independent salespeople who referred title insurance business to ABC. ABC solicited people to provide it with referrals of title insurance business, offering to pay commissions of up to 40% of the title insurance premiums Stonebridge itself received. These practices violated Section 8 of the Real Estate Settlement Procedures Act (RESPA), which prohibits kickbacks and payment of unearned fees in the context of residential real estate transactions. 26 September CFPB Takes Action Against Mortgage Kickback Agreements Bureau Orders Michigan Title Insurance Agency to Pay $200,000 WASHINGTON, D.C. Today, the Consumer Financial Protection Bureau (CFPB) ordered XYZ Title, a Michigan title insurance agency, to pay $200,000 for illegal quid pro quo referral agreements. Today s action sends a clear and simple message, that quid pro quo agreements for real estate referrals are illegal, said CFPB Director Richard Cordray. The Consumer Bureau will continue to take action to ensure that the mortgage market is a level playing field where everyone plays by the rules Copyright RDH Education Services All Rights Reserved

48 Federal Law The Bureau found that XYZ Title violated the Real Estate Settlement Procedures Act (RESPA), which prohibits, among other things, providing something of value to any person with an agreement or understanding that the person will refer real estate settlement services. 27 Think About It Discuss each of the enforcement actions above. Talk about what made the action an illegal referral. Could the action have been taken in a way that was not illegal? Why or why not? Is renting desk space in a real estate office at market rate a violation of Section 8? Is providing food for an open house a violation of Section 8? Why or why not? Copyright RDH Education Services All Rights Reserved

49 RDH Education Services S E C T I O N T W O Ethics Section Two: Ethics Introduction and Background Ethics is a combination of three different areas: ethics, morals, and values. It is the study of standards of behavior that promote human welfare and the good. It is a set of standards of right and wrong established by a particular group and imposed on members of that group as a means of regulating and setting limits on their behavior. Think of the importance of ethics for attorneys, doctors, medical professionals, clergy, scientists and other professionals. Ethics of course applies to the mortgage industry, investment advisors, and other financial professionals. Ethics can be defined as a system of moral principles or rules pertaining to conduct that govern a class of human actions, a particular group, or culture. Morals can be defined as the distinction between right and wrong as agreed upon by a particular group, class, or culture. Values are concepts that describe the beliefs of a person, group, or culture. A collection of values is known as a value system. When ethics, morals, values, and a value system are adopted by an individual, group, and/or culture, that adoption is simply defined as ethics. A code of ethics is commonly described as the

50 topic, idea, study, analysis, and discussion of the criteria for assessing the appropriateness of behaviors, decisions, actions, and/or positions. Ethics We can all (hopefully) agree that murder is both illegal and immoral. Can we also agree that a bank employee who reaches into the till and takes a thousand dollars is doing something both illegal and unethical? You can present a hundred different scenarios to people about what is illegal, immoral, and unethical and when the actions are egregious, people can generally agree on whether something is illegal, immoral, or unethical. But at some point, when you ask about things that are less egregious people start to disagree based on their ethical system. There are grades of illegal behavior, e.g., first degree murder, second degree murder and so forth, but we all agree that murder is illegal and immoral. Grand theft, petty theft, shoplifting or taking a grape at the grocery store constitute different grades of theft. All are illegal but we each may have a different opinion based on the severity of our ethical belief system. Is it different if you are hungry and take a grape or if you are well fed? That is the basis of ethics and a value system. Just as there are shades of illegal behavior, there are also shades of ethical behavior. You may not be willing to take $1,000 from the cash register, but are you okay with taking a pen or paper from your employer? Business ethics is the study of business behavior that promotes human welfare and positive outcomes for all participants. Ethics is how we structure our business society and therefore the laws that affect our business and our systems. Ethics is how we act as individual practitioners and how we structure our policies. In almost every organization there is a code of ethics, policies and procedures that employees and associates are expected to comply with. Ethics means not only knowing the laws and regulations of an industry; it is also combining that knowledge with one s personal ethics, values and morals to make the right decisions. What about business ethics? Let s examine the shades of illegal and unethical behaviors in the mortgage industry. Is refusing to take an application from a qualified borrower because of their race or religion both illegal and unethical? What about using whiteout on a W2? Can we agree that this is both illegal and unethical? How about not telling the lender that a borrower will be renting out the home instead of living in it? Can we agree that is illegal and unethical, or are some starting to say, Wait, I don t see a problem with that? The loan program guidelines say that someone must live in the house within 60 days of close and for at least 12 months. Now can we agree that this is inappropriate? But is it illegal, unethical, or immoral? How about giving a real estate agent cash for a referral when the transaction closes? We saw that this is illegal under RESPA section 8. But some MLOs are doing just this very thing. The point of understanding and being comfortable with your ethics and your company s ethics is to help guide you in your mortgage practice and maintain your reputation in the industry. Think About It 50 Copyright RDH Education Services All Rights Reserved

51 Ethics Discuss the ethical rules pertaining to conduct that your company sets as a standard of practice. Are the ethical behaviors, moral and value systems written? Implied? Passed down orally? How does that relate to your personal ethics, values and morals? Why bother refreshing our understanding of ethics? In order to fully recognize mortgage bankers and brokers as professionals, the industry is charged with clearly and distinctly defining the ethical commitments that each of us has to the public, to the profession, to clients, and to our competitors. We are faced with situations every day in the mortgage lending industry that force us to acknowledge that there is a definite distinction between professionals and non-professionals as a result of the degree of ethical responsibility demonstrated by each individual. Professionals act with a fiduciary duty to each of their borrowers, companies, and lenders and provide an important value-added service. A nonprofessional will put their personal needs ahead of their borrower, company, and others. Think About It The Tombstone Exercise Contemplating your own demise may seem like an overly dramatic way of getting in touch with your core values and central goals, but it can be remarkably effective. The following exercise was designed to give you that ultimate perspective. Think about and answer the following question: When I m gone, what would I like my tombstone to say about me? (Assume you have a very large tombstone.) Include in your tombstone description the five things that are answers to the following, more specific questions: How would I like people to remember me? What would I like to have accomplished in life? This exercise should help you step back and look at the bigger picture. It forces you to consider what exactly you value as worthwhile and important. It helps guide you to make the right decision when you are faced with acting in a way that others may ask of you that may be legal, but maybe not ethical. Or when you see others doing something and you may wonder if you should do it too. This can provide a bar to hold you on the right course of actions for your business and your life. Be honest and specific. We are going to take a deeper look at two areas where ethics and ethical behavior separate the professional from the non-professionals. 51 Copyright RDH Education Services All Rights Reserved

52 52 Copyright RDH Education Services All Rights Reserved Ethics

53 Ethics Fair Lending and Discrimination Now, I say to you today my friends, even though we face the difficulties of today and tomorrow, I still have a dream. It is a dream deeply rooted in the American dream. I have a dream that one day this nation will rise up and live out the true meaning of its creed: We hold these truths to be self-evident, that all men are created equal. Dr. Martin Luther King, Jr., March on Washington, DC, August 28, Discrimination is the unjust or prejudicial treatment of different categories of people or things, especially on the grounds of race, age, gender, or sexual identity. The effects of discrimination in housing are widespread. The Fair Housing Act sets clear standards for the legal treatment of consumers in real estate related transactions, including mortgage lending. Treating people equally and fairly is the cornerstone of a good mortgage business. Fair Housing Laws and Fair Lending Laws combine to create strong protections in our financial markets. The Fair Housing Act (FHA) protects borrowers against discrimination when they apply for a mortgage loan. The Equal Credit Opportunity Act prohibits discrimination in all credit transactions, and the Fair Housing Act prohibits discrimination in all residential real estate transactions. Let s review the prohibitions in Fair Housing Laws as they relate to mortgage lending (Fair Lending). Section (a) states that any person engaged in residential real estate-related transactions may not discriminate against any person in making available loans or other financial assistance for a dwelling, or which is or is to be secured by a dwelling because they are in a protected class. 1 Prohibitions include but are not limited to: Refusing to make a mortgage loan; Refusing to provide information regarding loans; Imposing different terms or conditions on a loan, such as different interest rates, points, or fees; Discriminating when appraising property; Refusing to purchase a loan; or Setting different terms or conditions for purchasing a loan. 1 PART 100 DISCRIMINATORY CONDUCT UNDER THE FAIR HOUSING ACT Discrimination in the making of loans and in the provision of other financial assistance. 53 Copyright RDH Education Services All Rights Reserved

54 Ethics Think About It For each of the prohibited practices under Fair Lending Laws, think of a specific act or statement that might occur or would describe the discriminatory action. For example under imposing different terms or conditions on a loan, such as different interest rates, points, or fees: charging a higher interest rate or more expensive loan fees to a borrower because they are a minority race or religion. What are some other examples of prohibited practices under Fair Lending? To use the fact that someone is in a protected class to impose different policies, practices, or procedures in evaluating or in determining creditworthiness of any person regarding a loan or financial assistance for a dwelling is also a prohibited practice. The underwriting guidelines established by the agency and the lender must be analyzed to fairly determine loan approval or denial. To ensure that a loan application gets fair consideration, an MLO must examine and provide all of the information that supports the application, including providing sufficient documentation to support the application and loan decision. HUD s FHA Office of Fair Housing and Equal Opportunity in the U.S. Department of Housing and Urban Development (HUD) enforces Fair Housing Act violations. An individual has up to one year to file a complaint with HUD. HUD notifies the alleged violator of a complaint and permits the loan officer and/or broker to respond. HUD then investigates the complaint and determines whether or not there is a reasonable cause to believe the Fair Housing Act has been violated. This process can take 90 days or more. Examples and Recent Actions by HUD In 2014 there were at least four cases that HUD either settled or conciliated involving lenders treatment of maternity leave benefits when underwriting residential mortgage loans. According to HUD, the mortgage lenders violated the Fair Housing Act s prohibition on discrimination on the basis of sex and familial status by declining to close loans to applicants relying on maternity leave income until after they returned to work. The largest, a $5 million settlement against a bank, resolved allegations that the lender discriminated against women who were pregnant, or had recently given birth and were on maternity leave. The bank required the women to return to work before allowing their income to qualify. According to the HUD announcement, No : Under its authority to enforce the Fair Housing Act, HUD has conducted an intensive campaign to end maternity leave-related lending discrimination. Since 2010, Copyright RDH Education Services All Rights Reserved

55 maternity leave discrimination complaints have been filed with HUD, resulting in more than 40 settlements for a total of nearly $1.5 million, prior to today s settlement. 2 Ethics The other three 2014 maternity leave settlements involved smaller lenders, fewer loan borrowers and lower settlements, which did not exceed $50,000, but three of the settlements required the lenders to revise their policies for underwriting loans involving parental leave. The fourth lender ceased its mortgage operations. According to the Fannie Mae Selling Guide B regarding temporary income: Temporary leave from work is generally short in duration and for reasons of maternity or parental leave, short-term medical disability, or other temporary leave types that are acceptable by law or the borrower s employer. Borrowers on temporary leave may or may not be paid during their absence from work. If a lender is made aware that a borrower will be on temporary leave at the time of closing of the mortgage loan and that borrower s income is needed to qualify for the loan, the lender must determine allowable income and confirm employment. Requirements for Calculating Income Used for Qualifying If the borrower will return to work as of the first mortgage payment date, the lender can consider the borrower's regular employment income in qualifying. If the borrower will not return to work as of the first mortgage payment date, the lender must use the lesser of the borrower's temporary leave income (if any) or regular employment income. 3 There were at least two HUD settlements involving disability income. The cases were based on the lenders attempts to document continuity of income, as required by investors and insurers in transactions where the applicant planned to use disability income to repay the loan, but the disability benefits award letter did not indicate how long the income would continue. In an effort to approve these applications, but avoid repurchase or indemnification demands for failing to properly document income, the lenders requested that the applicants doctors provide assurances that the underlying disabilities were likely to continue for at least three years. HUD claimed this was a violation of the Fair Housing Act s prohibition on discrimination on the basis of handicap and the ECOA s prohibition on discrimination on the basis of receipt of public assistance. The CFPB issued a bulletin on November 18, 2014, which states that some mortgage lenders have asked applicants relying on public assistance income, which also includes Social Security 2 HUD No Copyright RDH Education Services All Rights Reserved

56 Ethics income, for information about their disabilities and require statements from physicians about the likely duration of their disabilities. The bulletin clearly states that this kind of underwriting system violates ECOA, which prohibits lenders from discriminating against an applicant because all or part of the applicant s income derives from a public assistance program. To verify income for Qualified Mortgage debt-to-income ratios under the Ability-to-Repay rule, lenders are required to look at whether the Social Security Administration benefit verification letter or equivalent document includes a defined expiration date for payments. Unless the Social Security Administration letter specifically states that benefits will expire within three years of loan origination, lenders should treat the benefits as likely to continue. The bulletin goes on to say: ECOA and Regulation B may also be violated if an income verification standard has a disproportionately negative impact on a prohibited basis, even though the creditor has no intent to discriminate and the practice appears neutral on its face, unless the creditor practice meets a legitimate business need that cannot reasonably be achieved as well by means that are less disparate in their impact. 4 According to the Fannie Mae Selling Guide B here is the way to compute social security income if the loan is eligible for sale to FNMA. It gives us a good idea of what is legal, ethical and non-discriminatory when we use social security income to qualify. Verification of Social Security Income: Social Security income for retirement or longterm disability that the borrower is drawing from his or her own account/work record will not have a defined expiration date and must be expected to continue. However, if Social Security benefits are being paid as a benefit for a family member of the benefit owner, that income may be used in qualifying if the lender obtains documentation that confirms the remaining term is at least three years from the date of the mortgage application. Document regular receipt of payments, as verified by the following, depending on the type of benefit and the relationship of the beneficiary (self or other) as shown in the table on the next page: 4 CFPB Bulletin Date: November 18, 2014 Subject: Social Security Disability Income Verification. 56 Copyright RDH Education Services All Rights Reserved

57 Ethics Type of Social Security benefit Retirement Disability Survivor Benefits Supplement Security Income (SSI) Borrower is drawing Social Security benefits from own account/work record Social Security Administrator s (SSA) Award letter, OR Proof of current receipt NA SSA Award letter, AND Proof of current receipt Borrower is drawing Social Security benefits from another person s account/work record SSA Award letter, Proof of current receipt, AND Three-year continuance (e.g., verification of beneficiary s age) NA Disparate Impact The Consumer Financial Protection Bureau, HUD and other federal agencies take discrimination seriously. Discrimination is treating some people less fairly than others because of their race, color, national origin, religion, sex, familial status, religion, marital status, or age. One specific type of discrimination is known as disparate impact. Disparate impact focuses not on discriminatory intent, but instead on discriminatory consequences. A disparate impact occurs when a lender applies a facially neutral pattern of practice equally to all credit applicants but the policy or practice disproportionately excludes or burdens certain persons on a prohibited basis. Without nondiscriminatory access to credit, consumers face obstacles in obtaining equal access to housing. Remember a policy or practice can be facially neutral and non-discriminatory in its intention but, nonetheless, disproportionately affects individuals in a Fair Housing protected class. The National Fair Housing Alliance Disparate Impact Media Articles define disparate impact as: Disparate Impact is a legal doctrine under the Fair Housing Act which states that a policy may be considered discriminatory if it has a disproportionate adverse impact against any group based on race, national origin, color, religion, sex, familial status, or disability when there is no legitimate, non-discriminatory business need for the policy. In a disparate impact case, a person can challenge practices that have a disproportionately 57 Copyright RDH Education Services All Rights Reserved

58 Ethics adverse effect on those protected by the Fair Housing Act and are otherwise unjustified by a legitimate rationale. 5 Think About It What are some mortgage industry policies or practices that might have a disproportionate adverse impact based on race, national origin, color, religion, sex, familial status, or disability? Even a legal business practice may have an adverse impact, so think about a practice where there is no legitimate, non-discriminatory business need for the policy. On June 26, 2015 the Supreme Court ruled to uphold the definition of disparate impact. The Court stated that remedial orders in disparate impact cases should concentrate on the elimination of the offending practice, and courts should strive to design race-neutral remedies. Remedial orders that impose racial targets or quotas might raise difficult constitutional questions. To further understand the Supreme Court decision and impact on the housing and mortgage industry, let s look at the opinion of Cory Andrews. According to his SCOTUS blog: In 2012 and 2013, when civil rights leaders persuaded St. Paul, Minnesota (Magner v. Gallagher) and then Mount Holly, New Jersey (Mount Holly v. Mt. Holly Gardens Citizens in Action) to abruptly dismiss legal challenges to Fair Housing Act (FHA) disparate-impact liability on the steps of the U.S. Supreme Court, the conventional wisdom was that at least five justices on the high court were prepared to rule that the FHA prohibits only intentional discrimination not statistical disparities. With today s ruling in Texas Department of Housing and Community Affairs v. The Inclusive Communities Project, Inc., a majority of the Supreme Court proved that conventional wisdom wrong. In a surprising decision authored by Justice Kennedy, the Court clarified that the FHA reaches otherwise lawful activities which, while free of discriminatory intent, are nonetheless found to have a disparate impact on minority groups. In so holding, the Court agreed with decades of unanimous federal appeals-court precedents that arrived at the same conclusion. At the same time, the high court cabined disparate impact liability to those policies that pose artificial, arbitrary, and unnecessary barriers. That important qualifier may ultimately determine the outcome of this case on remand. And the Court further reminded the government and lower federal courts that important constitutional considerations limit the remedies available for disparate impact liability under the FHA. Most importantly, the full majority cautions that disparate impact liability poses special dangers that must be limited to avoid serious constitutional questions that might arise under the FHA if, for example, such liability were imposed based solely on a showing of a statistical disparity. This requires giving housing authorities and private developers Copyright RDH Education Services All Rights Reserved

59 Ethics adequate leeway to explain the valid interests their policies serve, an analysis that is analogous to Title VII s business necessity defense. The Court emphasizes that policies are not contrary to the disparate impact requirement unless they are artificial, arbitrary, and unnecessary barriers. And the Court confirms that a disparate impact claim relying on a statistical disparity must fail if the plaintiff cannot point to a defendant s policy causing that disparity. The Court views this crucial causality requirement as necessary to ensure that defendants (and courts) do not resort to the use of racial quotas. To summarize, discrimination can be either overt or covert, and it is imperative that mortgage loan originators always strive to comply with the guidelines, legal and ethical requirements that their brokers, lenders, and creditors set. If you do, your internal ethical code, your professional ethical code and that of your company, lenders and industry will be in alignment. Your Home Loan Toolkit : A Step-by-Step Guide The third form in the TRID Rule is the Your Home Loan Toolkit, which is an interactive kit designed to help borrowers navigate the process of buying a home. The form is designed to help borrowers make better choices along their path to homeownership. When a borrower has completed the toolkit they will have information about: The most important steps they need to take to get the best mortgage for their situation The kit starts with helping borrowers define what their situation is and how to shop around for financing. o Define what affordable means to you o Understand your credit o Pick the mortgage type that works for you o Choose the right down payment for you o Understand the tradeoff between points and interest rate o Shop with several lenders o Choose your mortgage o Avoid pitfalls and handle problems The next step is how to better understand closing costs and what it takes to buy a home. o Shop for mortgage closing services o Review your revised Loan Estimate o Understand and use your Closing Disclosure A few ways to be a successful homeowner o Act fast if you get behind on your payments o Keep up with ongoing costs o Determine if you need flood insurance o Understand Home Equity Lines of Credit (HELOCs) and refinancing 59 Copyright RDH Education Services All Rights Reserved

60 The interactive portion of this toolkit allows borrowers to understand the home buying process, orient themselves to where they are in the process, highlight tips to research further information and identify areas in the process to start conversations with others in their transactions to gather more facts. This new form is designed to empower consumers to take more control of their economic lives. 6 Ethics Mortgage Fraud Mortgage fraud is a material misstatement, misrepresentation, or omission relied upon by an underwriter or lender to fund, purchase, or insure a loan, or make a larger loan than would have been obtained had the lender or borrower known the truth. Mortgage loan fraud is divided into two categories: fraud for property and fraud for profit. Fraud for property/housing entails misrepresentations by the applicant for the purpose of purchasing a property. This scheme usually involves a single loan and represents illegal actions perpetrated by the borrower. The simple motive behind this fraud is to acquire and maintain ownership of a house under false pretenses. This type of fraud is typified by a borrower who makes misrepresentations on their application regarding their income or employment history to qualify for a mortgage loan. However, this type of fraud also often involves some participation from industry insiders, even if only to look the other way. Fraud for profit, however, often involves industry participants and includes multiple loans and elaborate schemes perpetrated to gain illicit proceeds from property sales. Mortgage fraud perpetrators include licensed/registered and non-licensed/registered mortgage brokers, lenders, appraisers, underwriters, accountants, real estate agents, settlement attorneys, land developers, investors, builders, bank account representatives, and trust account representatives. Numerous regulatory, industry, and law enforcement agencies collaborate to share information used to assess the current fraud climate. According to the LexisNexis Risk Solutions th Annual Mortgage Fraud report, its annual analysis of mortgage fraud in the U.S. reveals that despite improving economic conditions, mortgage fraud is still a national problem. In fact, mortgage application fraud and misrepresentation has grown during the three years 2010 to Seventy-four percent of loans reported in 2013 involved some kind of fraud or misrepresentation on the loan application compared to 69 percent in 2012 and 61 percent in The annual mortgage fraud report provides a full analysis of mortgage fraud activity nationwide. Findings show that application fraud and misrepresentation continues to pose an increased threat 6 Your Home Loan Toolkit: A Step-by-Step Guide Copyright RDH Education Services All Rights Reserved

61 while appraisal and property valuation fraud has hit a new five year low. For more information see the LexisNexis report for The application form is comprehensive in collecting borrower personal identity, employment, asset, and liability information (all of which present verification challenges). Application fraud and misrepresentation includes, but is not limited to, the following categories on the loan application: incorrect name(s) used for the borrower(s); occupancy, income, employment, debt and asset misrepresentation; different signature(s) for the same name(s); invalid Social Security number(s); misrepresented citizen/alien status; incorrect address(es) or address history; and incorrect transaction type. Other trends include: Ethics The most notable increase for loans investigated in 2013 was for fraud and misrepresentation on credit documentation. This type of fraud, involving misrepresentation on the credit report or with credit history or references, increased to 17 percent in 2013 from five percent in Reported fraud on the appraisal and property valuation was at a five-year low in Only 15 percent of loans reported in 2013 included these issues, compared to 26 percent in 2012, 31 percent in 2011, 33 percent in 2010, and 31 percent in Twelve percent of loans reported in 2013 included tax return or financial statement fraud. Verification of deposit and verification of employment fraud and misrepresentation decreased to 15 percent each in Of the seven fraud categories measured, four of them saw increases over last year and three of them reached five-year high levels. 9 Fraud Schemes and Recent Enforcement Former Real Estate Agent Sentenced for Mortgage Fraud Scheme On May 18, 2015, in Fresno, California, Arlene Jeanette Mojardin, of Bakersfield, was sentenced to 30 months in prison for conspiring to commit bank fraud, mail fraud, and wire fraud. According to court documents, from 2007 to 2010, Mojardin, a licensed real estate agent, conspired with others to use straw buyers to purchase residential properties in Bakersfield, California. They paid straw buyers to purchase properties developed by Jara Brothers Investments (JBI) and Pershing Partners LLC and funded the purchases using loans they obtained based on false and fraudulent loan applications. The loan applications contained false statements concerning the straw buyers employment status, income, assets, intent to occupy the Types of Fraud Reported. 61 Copyright RDH Education Services All Rights Reserved

62 Ethics properties as their personal residences, and the source for the down payments for the purchase of the properties. The conspirators concealed from the lenders that the property developers funded some down payments. They submitted false supporting documentation to lenders such as false and altered bank account statements purporting to show that the straw buyers had high bank account balances, false verifications of the straw buyers bank account funds, false verifications of rent purporting to be from the straw buyers landlords, false pay stubs, and false verifications of employment. Mojardin was also employed at relevant times at JBI, was a property buyer from Pershing Partners on at least two of the real estate transactions in the conspiracy, and obtained loans based on false and fraudulent information. She received proceeds from the conspiracy including payments for purchasing property as a nominee buyer and payments for acting as the real estate agent on many of the other transactions in the conspiracy. Mojardin admitted she caused lenders approximately $3,713,600 in losses due to her role in the conspiracy. 10 California Man Sentenced for Leading Massive Foreclosure Rescue Scam On March 5, 2015, Sacramento, California, Alan David Tikal, formerly of Brentwood, Calif., was sentenced to 288 months in prison. Tikal was convicted following a bench trial on Sept. 15, 2014 on eleven counts of mail fraud and one count of mail fraud relating to a foreclosure rescue scam. According to evidence presented at trial, between Jan. 7, 2010, and Aug. 20, 2013, Tikal was the principal behind a business known as KATN, which targeted distressed homeowners experiencing difficulties making their existing monthly mortgage payments. Tikal promised to reduce their outstanding mortgage debt by 75%, falsely claiming he was a registered private banker with access to an enormous line of credit and the ability to pay off homeowners mortgage debts in full. Tikal told homeowners that in return for various fees and payments, their existing loan obligations would be extinguished, and the homeowners would then owe new loans to Tikal in an amount equaling 25% of their original obligation. In reliance upon misrepresentations made by Tikal, many of these homeowners stopped making payments on their existing mortgage loans and lost their homes to foreclosure. In fact, Tikal never made any payments to financial institutions on behalf of homeowners in satisfaction of their pre-existing mortgage debt obligations; the purported loan payments paid to Tikal were simply spent by himself, his family and his associates for personal use. There was not a single instance in which a homeowner s debt was paid, forgiven or otherwise extinguished as a result of the mortgage relief program. In all, Tikal and his associates convinced more than 1,000 homeowners in California and other states to participate in the program. Those homeowners paid more than $5,800,000 in fees and monthly payments into the program. Of that, more than at least $2,500,000 was paid into Copyright RDH Education Services All Rights Reserved

63 accounts controlled by Tikal and/or his family. Co-defendant Ray Kornfeld was sentenced on Feb. 19, 2015, to 60 months in prison. On July 16, 2015, Tikal s wife, Tamara Tikal was sentenced to 45 months in prison and ordered to pay $3,671,000 in restitution. 11 Ethics Real Estate Agent Sentenced for Fraudulent Short Sale Scheme On Feb. 17, 2015, in Fresno, California, Minerva Sanchez, of Fremont, was sentenced to 21 months in prison and ordered to pay $421,372 in restitution to financial institutions for conspiring to commit bank fraud. According to court documents, Sanchez was a licensed real estate agent who, beginning in or around March 2010, represented the seller of a home in Patterson, California. Sanchez recommended that the seller undertake a short sale of his home using Sanchez s son as the straw buyer. The seller, Agustin Simon, acting on Sanchez s advice, submitted to a bank and Freddie Mac false and fraudulent short sale applications, and caused these financial institutions to approve the charge-off of funds for the short sale of the seller s home. With Sanchez s knowledge, Simon provided the straw buyer with the full purchase price of the home. Sanchez provided Simon with a hardship letter for him to use in connection with the short-sale application, which misrepresented Simon s inability to make his monthly mortgage payments. In fact, Sanchez knew that Simon could make his monthly mortgage payments with proceeds from a pending sale of other real property he owned. Sanchez, along with Simon and a straw buyer, made other misrepresentations to the financial institutions in connection with the short sale. Sanchez s criminal conduct caused the financial institutions to lose more than $316,000. Simon was sentenced on March 2, 2015, to 15 months in prison, ordered to pay $421,372 in restitution to financial institutions and forfeit a home for conspiring to commit bank fraud Copyright RDH Education Services All Rights Reserved

64 RDH Education Services S E C T I O N T H R E E NONTRADITIONAL MORTGAGES Section Three: Nontraditional Mortgages Introduction Welcome to this session about alternative mortgage types. We will cover several different types of mortgages and discuss their construction, their pros and cons, risks and ethical impacts. The mortgage types we will talk about include: Adjustable rate mortgages (ARMs) Interest Only mortgages (IOs) Negative Amortization mortgages (NegAm s)

65 Nontraditional Mortgages The SAFE Act defines a Nontraditional Mortgage Product as a mortgage loan that differs from a 30-year fixed-rate mortgage, what we will call an FRM. Generally, the differentiating factor will be either (a) interest rate, (b) monthly or periodic payments, and/or (c) the terms of repayment. Please note: Under the SAFE ACT, the nontraditional definition would also include 40, 25, 20, 15, and or 10/year fixed rate mortgage products. Some of these types of loans became popular in the early 1980s, when high interest rates put buying a home beyond the reach of many first-time homeowners. In response, banks and savings institutions quickly introduced a variety of alternative mortgages, all designed to reduce the homebuyer's mortgage payment or to allow the buyer to finance a larger home. These new mortgage types included Adjustable rate mortgages (ARMs), Interest Only mortgages (IOs) and Negative Amortization mortgages. These mortgages tend to carry additional risk compared to regular 30-year FRMs, including interest rate risk, market risk (of home value) and refinance risk. Under the right economic environment, lending these mortgages to borrowers who can afford to take additional financial risks can lead to real savings for homebuyers. This is true considering the mortgages that allow borrowers to pay only the interest for the first few years or have a more flexible payment options that tend to be lower than a 30-year fixed mortgage. It is important to consider that with this flexibility and these lower payment options, there is also the increased risk in the later years of the mortgage. These include, the risk of interest rate uncertainty when the rate is not fixed, the value of the home declining or even remaining stable though the principal balance is increasing with each mortgage billing cycle, and the risk of not being able to refinance as needed due to credit eligibility for these stated reasons. For the rest of the lesson, it would be useful to remember the concept of Higher Risk, Higher Possible Return. Although some of these alternative mortgage types can potentially generate higher return, homebuyers must be made aware that they are also riskier than a standard FRM. Now, if we fast forward 20 years into the current era, where interest rates are much lower, than in the early 80s, many of these same loans were still available and even more risky. When mortgage interest rates in the years 2001 to 2005 declined to the lowest rates (5-6% in the end of 2002 and rates stayed below 7% until 2005) in forty years, home sales (and home values) soared to record levels. Financial institutions responded to soaring home values with an even greater supply of alternative mortgage loans. Many of these loans were made to borrowers who could either not afford to take the risk, or were not aware of the risk. For example, when an ARM interest rate went up, some homeowners found they couldn t pay the newly adjusted monthly payment. Combined with a slowdown in housing prices, borrowers found that they could not sell or refinance their house, and many

66 Nontraditional Mortgages suffered a significant loss in equity value and defaults began. When borrowers defaulted, foreclosures ensued, leading to lower housing prices, which then lead to even more foreclosures. The result was a downward spiral.

67 Nontraditional Mortgages Dodd Frank and Ability to Repay Following the financial crisis of 2008, studies and researched showed that too many mortgages were made to consumers without regard to the consumer s ability to repay the loans. Some lenders had underwriting practices that did not take into account whether or not a borrower could actually replay the loan being made. This inability to consider the borrower s ability to repay included such practices as failing to verify the consumer s income or debts and qualifying consumers for mortgages based on teaser interest rates that would cause monthly payments to jump to unaffordable levels after the first few years, making loans to borrowers based solely on the equity in their property rather than their income and liabilities, and even failing to document and/or verify whether or not the borrower actually earned the income that was being used to qualify for them for the mortgage. These practices, along with others, contributed to a mortgage crisis that led to the nation s most serious recession since the Great Depression. In response to this crisis, in 2008 the Federal Reserve Board adopted a rule under the Truth in Lending Act, which prohibits creditors from making higher-price mortgage loans without assessing consumers ability to repay the loans. Later, Dodd Frank implements the rule of a qualified mortgage, whereby if the loan meets certain, specific criteria, then the lender is presumed to have met the ability to replay requirements. Throughout this module, we will explore a variety of different loan types. When reviewing them, it is important to keep the concepts of ability to repay in mind. Ability to Repay A mortgage loan originator has the moral, ethical and legal responsibility to help borrowers understand what type of and how large of a mortgage they can afford and to determine that a borrower has a reasonable ability to repay the loan. To this end the Consumer Financial Protection Bureau enacted rules to ensure creditors and lenders obtain and verify information that will help them determine if the borrower can repay the mortgage loan as well as other mortgage related obligations. These rules amended both Regulation Z, which implements the Truth in Lending Act (TILA) and also sections 1411 and 1412 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) 40. Both laws generally require creditors to make a reasonable, good faith determination of a consumer s ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage, or temporary loan) (e)(2)(v)(B)

68 Nontraditional Mortgages Under the Ability-to-Repay Rule, there are certain requirements lenders must follow to determine whether a borrower has the ability-to-repay principal and interest of the mortgage over the long term. The rule does not set particular underwriting models but requires an underwriter, mortgage originator, creditor or lender to review and verify financial documents and records. At a minimum, a lender must consider these eight underwriting standards: Current income or assets Current employment status Credit history The monthly payment for the mortgage The monthly payments on any other loans associated with the property The monthly payment for other mortgage related obligations (such as property taxes) Other debt obligations, including Alimony and Child Support The monthly debt-to-income ratio (DTI) or residual income the borrower would be taking on with the mortgage. (Debt-to-income ratio is a consumer s total monthly debt divided by their total monthly gross income). An underwriter will look at current or reasonably expected income and assets to support the income that is used on the application using documents such as paystubs, W2 s, 1099 s and award letters. The underwriter may also need an additional verification of employment immediately before the transaction closes. Verifying and documenting the assets used to qualify for the mortgage may be required just before closing as well. They will take into consideration the payment for this mortgage and other loans against the property using the highest payment that will apply in the first five years of the loan(s). The underwriter will also consider property taxes, homeowners insurance, homeowners association dues and any other mortgage related obligations. Other obligations that may not show up on a credit report such as alimony or child support will be considered. Lenders must generally use reasonably reliable third party records to verify the information they use to evaluate the eight categories above, such as a credit report, bank statement, award letter or other official document. Qualified Mortgage In order for a lender or creditor to prove that they have taken the consumer s situation into consideration while qualifying them for a loan, TILA offers a safe harbor 41 or rebuttable presumption of compliance with the Ability-to-Repay rule by creating loans called Qualified Mortgages. If a creditor or lender issues a Qualified Mortgage they will have certain protections from legal action in the future if a consumer defaults on their loan CFR (e)

69 Nontraditional Mortgages Specifically, the statutory definition of qualified mortgage requires the creditor to: (1) Verify and document the income and financial resources relied upon to qualify the obligors on the loan; and (2) Underwrite the loan based on a fully amortizing payment schedule and the maximum interest rate during the first five years, taking into account all applicable taxes, insurance, and assessments. Qualified Mortgages may be prime loans or higher-priced loans and they must meet certain requirements which prohibit or limit the risky features of a loan. These features include: No interest only loans. No loans where the principle can increase such as negative amortization loans. No loan terms over 30 years. No balloon payment loans except by smaller creditors in rural or underserved areas. No excess upfront points and fees. Fees paid by the creditor or consumer may not exceed three percent (3%) of the total loan amount, although certain bona fide discount points are excluded for prime loans. Debt-to-income ratios must be 43% or less with one exception. For a temporary transitional period loans meeting government affordability or other standards such as being eligible for purchase by the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (Freddie Mac) will be considered Qualified Mortgages. Section (e)(1)(i) provides a safe harbor for qualified mortgages that are not higher-priced covered transactions. These are lower-priced loans that are typically made to borrowers who pose fewer risks. If the loan goes south, the lender will be considered to have legally satisfied the ability-to-repay requirements. For qualified mortgages that are higher-priced loans, (e)(1)(ii)(A) provides a rebuttable presumption of compliance with the repayment ability requirements. These higher-priced loans are typically made to consumers with insufficient or weak credit history. If the loan goes into default, the consumer can rebut the presumption that the creditor properly took into account their ability to repay the loan.

70 $ Monthly Payment Nontraditional Mortgages 30 YEAR FIXED MORTGAGE Total Interest Owed $ 0 Total Interest Payment $ 90,515 Beginning Payment Period Ending Payment Period Monthly Interest Payment* Monthly Principal Payment* Monthly Mortgage Payment 1-Feb-10 1-Jan-40 From $406 to $2 From $123 to $527 $529 Fixed *Payments (and payment allocation) are rounded throughout the course materials for easy comparison Components of Monthly Mortgage Payments 30 Yr Fixed Interest Payment 30 Yr Fixed Principal Payment Years Since Closing

71 Nontraditional Mortgages IO Mortgages IO Mortgage Features IO loans are mortgage loans that allow the borrower to pay only interest on the mortgage for a certain initial term, called the IO Period. At the end of the IO Period, typically 5-7 years, (though it can range from 3 to 10 years), the mortgage payment begins to include both interest and principal. The payment of principal and interest is called a fully-amortized payment, meaning that the payment will cover all outstanding interest and allocate the remaining payment to reduce the principal balance. Some IO loans offer teaser rates in an initial introductory period which can last up to 5 years (Note that most IO mortgages also have adjustable interest rates. See the section on ARMs for more information). IO mortgages have what is called a Payment Shock. This means that at the end of the IO Period, a borrower s mortgage payment can become significantly higher than the initial payments for two reasons: 1. Interest is calculated based on a high loan outstanding amount. For example, if the loan principal is $300,000 and the borrower has only paid interest in the first 5 years, the principal remains $300,000. Even if the new, adjusted interest rate is the same as an equivalent FRM, the borrower will be paying out a higher dollar amount of interest. 2. The principal needs to be repaid in fewer years than in an FRM. For example, if the IO period of a 30 year loan is 5 years, then the principal amount of $300,000 has to be paid back over 25 years. Whereas, in a 30 year FRM, the principal amount has to be paid back over 30 years, so that the principal amount to be repaid each year is lower in the case of an FRM. IO Mortgage Pros and Cons Target Borrowers Employees with Lumpy Compensation. Historically, IO loans were offered for affluent borrowers. The most typical scenario is a person whose main source of income is paid once or twice a year. This can apply to bonus-compensated employees such as a sales manager, a senior executive or other affluent borrowers with fluctuating income. Small Business Owners. Small business owners with unpredictable income can use their IO loan part of their business working capital management solution during the months when the business needs working capital, the owner can choose to pay the lower mortgage interest.

72 Nontraditional Mortgages Savvy Investors. Some people, instead of paying off their IO loan principal, invest in alternative investments, such as business ventures, stock markets, their own business and so forth. This strategy makes sense for those who are savvy about investments and are in high tax brackets because their tax-effected mortgage interest rate is lower than that of an average borrower. For example, when interest rates were 4%, homeowners may have invested the savings in the stock market if they believed that the stock market return is above 4%. Fast Track Employees. Some companies might provide IO loans to borrowers whom they believe are on a career fast track also if these borrowers are eager to take advantage of a housing market dislocation. These borrowers intend to buy a small house and then trade up in later years, but this strategy entails higher transaction cost. They might opt to take the risk and buy a bigger house from the get go. Homeowner s Investment. In some cases, borrowers who believe that their house value is highly unlikely to depreciate, they might want to pay low interest for a few years and then sell the house to recuperate the principal. To manage the Payment Shock after the IO period, homeowners can either: Prepay. Pay down principal in a lump sum before the end of the interest only period. In most of the IO loans, borrowers can pay down their mortgage principal anytime they want. In most IO loans, if homebuyers prepay their principal in the same amount as the equity portion of an FRM, then the interest payment over the life of the loan would be no different than a regular FRM if the interest rate is the same. An IO loan just gives the borrower an OPTION not to pay a predetermined amount of principal. However, to provide this option to the borrower, the lender is going to charge the borrower a higher interest rate. Unless the borrower intends to use this option, it is better to use a regular FRM or a regular adjustable rate mortgage. (Note that some IO loans have prepayment penalties, so make sure to explain the loan payoff to the borrower.) Pay at the end of IO period. Some homeowners who use the extra savings in the initial period to invest in other ventures may liquidate their alternative investments to pay down a bulk of the principal at the end of the initial period. Refinance into an FRM. Some homeowners simply predict or bet on rising house prices and home values, increasing their equity. If the house rises from $300,000 to $400,000, then the homeowners hope that they can sell the house to make a profit of $100,000 or that they can refinance the house into a lower rate FRM as the lenders offer lower rates for mortgage with greater homebuyer equity and lower LTV.

73 Nontraditional Mortgages Some homeowners want to take a bet on lower interest rates in the future. They hope to refinance the mortgage from an IO mortgage to a traditional fixed rate mortgage or another adjustable rate mortgage with lower prevailing interest rates. IO Mortgage Potential Pitfalls Even for the affluent borrowers, there is always a risk of losing a well-paid job or suffering other financial setbacks. Therefore, it is important for those who borrow an IO loan to focus on paying down the principal with their bonus or savings when available. It is also important to note that a borrower losing a well-paid job or suffering other financial setbacks is likely to have similar payment concerns with a fixed rate mortgage as a borrower with an ARM or IO mortgage. Investors who vowed to take advantage of lower mortgage rates to invest the savings into alternative investments with higher potential return or who planned to use their home as an investment vehicle, should be disciplined and be aware of the risk they are taking. As described in the section B above, some IO borrowers who intend to manage their payment shock by praying that interest rate will go down or that home values would go up and they could either sell their house or withdraw equity in a refinancing, might find themselves in foreclosure if rates go up or values decline. That s why lenders should make sure that IO applicants have the resources to take these market risks. IO Example To illustrate how an IO mortgage works, let s contrast this mortgage to a similar 30 year fixed mortgage. We can assume that a borrower is choosing between the two loan types. How would you advise the borrower? We are going to assume an IO of 4.875% note rate and an IO period of 5 years In the example below, we show the amortization schedule of the IO mortgage versus the fixed rate mortgage:

74 $ Nontraditional Mortgages 5 Year Io Total Interest Owed $ 0 Total Interest Payment $ 97,574 Beginning Payment Period Ending Payment Period Monthly Interest Payment Monthly Principal Payment Monthly Mortgage Payment 1-Feb-10 1-Jan-15 $ 406 $0 $ Feb-15 1-Jan-40 Decreases from 406 to 0 Increases from 0 to $577 $ 577 Remember that the 30-year FRM payment is a steady $529. Thus, given the same interest rate of 4.875%, an IO results in a lower mortgage payment in the first five years and a higher payment in the remaining years because of the shorter time for repayment and potentially increased interest rate while the principal is the same as when loan closed five year before. When the IO mortgage payment went from $406 to $577, it would be a payment shock to the borrower (nearly 50% higher!). The below graph shows that the remaining principal balance of the IO mortgage remains unchanged for the first 5 years, whereas for a 30 year fixed rate mortgage, remaining principal balance begins to decline from the first payment. 120, ,000 Remaining Mortgage Balance IO Remaining Principal 30 Yr Fixed Remaining Principal 80,000 60,000 40,000 20, Years After Closing

75 Nontraditional Mortgages Negative Amortization Mortgage Definitions Amortization is the term used for describing the process of lowering the principal amount of a home loan. In most loan structures, as the borrower makes payments, the amount paid applies partially toward the loan interest amount and partially toward the principal. As more payments are made, the principal (or bottom line loan amount) slowly decreases. This process is called amortization. Negative amortization is when the principal amount of the loan actually increases by the unpaid Interest Due on the mortgage. This is because the mortgage Interest Payment Due, as structured with a negative amortization loan, is so low that it doesn't even cover the full amount of the Interest Due on the mortgage. Therefore, the interest continues to compound and the original principal amount is never reduced by homeowner s monthly mortgage payments as in an FRM. We will explain this concept below with an example, but keep in mind that the amount owed increases on a negative amortization mortgage. Negative Amortization Mortgage Features Negative Amortization Mortgage (NegAm) is in many ways similar to an IO Mortgage, but the monthly mortgage payment is even lower than an IO. Look at the example below assuming that the mortgage interest rate is the same for each loan: FRM. If a regular $300,000 FRM requires a principal and interest (P&I) payment of $1450, the payment would be allocated such that $1000 of the payment would be paid in interest in the first month and $450 in principal in the first month, then after the first P&I payment, the FRM principal balance is $299,550. IO. In an IO situation, the borrower pays only $1000 in the first month, but no principal. At the end of the first month, the IO borrower's outstanding principal balance is still $300,000. NegAm. In a NegAm situation, the borrower might only pay $500 in the first month even though the interest is $1000, most likely because it is an ARM. In that case, at the end of the first month, the IO borrower's outstanding principal balance is now $300,500. Since interest due on a mortgage is calculated based on the outstanding principal balance, the interest due on the second month would be highest for the ARM borrower, and that on the IO borrower would be higher than the FRM borrower.

76 Nontraditional Mortgages In all of the above, it is important to see that Interest Due on the mortgage is different from Interest Payment Due on the mortgage. In an FRM and IO, the Interest Due is the same as Interest Payment Due. However, in a NegAm situation, the Interest Due can be greater than the Interest Payment Due. The borrower may have $1010 Interest Due for the next month, but the borrower might only be required to pay $500 interest (i.e. have $500 Interest Payment Due). Of course, the unpaid $510 would be further added to the principal balance. If the NegAm borrower does not pay the $500 Interest Payment Due, the principal balance continues to grow and will most likely include a late fee and as well may be a strike on his credit history. NegAm Mortgage Pros and Cons In a NegAm situation, the clear benefit for the borrower is that the borrower's initial total mortgage payment initially would be lower than an FRM or IO; however, the downside is that the borrower will pay a higher mortgage payment in the later years of the mortgage. This is true because as the principal balance increases such that it reaches the maximum allowed by the loan terms, called the negative amortization cap, the payment is likely recast. A loan recast considers the current principal balance and the current fully-indexed rate and amortizes over the remaining term of the loan. The loan may also be recast even if a negative amortization cap has not been reached. The contractual terms of the mortgage may specificity after a certain number of years have elapsed that the loan is recast, or re-amortized over the remaining loan repayment term. A higher principal balance, increased interest rate, and shorter repayment term will cause the borrower to have a significantly higher mortgage payment. This is known as payment shock. Like an IO loan, a NegAm loan is largely appropriate for affluent borrowers, or borrowers with the ability to handle the increased payment, like the ones mentioned in the IO section. Think of NegAm as a more aggressive version of IO, just with a bigger Payment Shock. All the pros and cons of an IO loan apply to a NegAm loan and are just magnified. If the borrower has lived in a house for several years while paying on a NegAm loan, it is possible that LTV is over 100%, (i.e. the loan amount has become larger than what the borrower can actually sell the house for!). In other words, when they go to sell the house, not only will they not gain any profit, but they ll actually owe money to the bank! If a homeowner doesn t fully understand the long-term consequences of a negative amortization mortgage, it can lead to severe and unexpected financial difficulty with negative effects on credit and even foreclosure or bankruptcy. Some mortgage loans may have the NegAm feature with a fixed rate mortgage. This may better prepare a borrower for the increased payment. With knowledge of the interest rate at the loan closing, a borrower may be able to better determine if they are able afford to make the higher payment with the adjustment. When compared to the uncertainty of an adjustable rate mortgage, the NegAm loan with a fixed rate feature may alleviate the payment shock of an ARM

77 Nontraditional Mortgages borrower s payment shock. The initial period of low mortgage payments turn into a period of higher mortgage payments not only because the principal balance increased but the interest rate increased with an ARM. In both of these loans the higher payment is also applicable because the loan is amortized over a shorter period of time, but a fixed interest rate eliminates the rate uncertainty and allows the borrower to better prepare. NegAm Example There are various ways to structure a NegAm mortgage. To illustrate the theory, we constructed a simplifying example where the NegAm mortgage is a fixed rate mortgage and not an ARM. This NegAm mortgage also has an interest rate of 4.875%. However, in the first 5 years, the borrower only has to pay 2.875%. The rest of the 2% unpaid interest is added to the outstanding principal balance. As you see from below, at the end of the 5 year NegAm period, the mortgage principal balance rises from $100,000 to $110,508, or about 10% of the original mortgage amount. After the NegAm period, the first mortgage payment is calculated as 4.875%/12*$110,508 a higher interest rate based on a higher notional amount. As you see, after the NegAm period, the payment shock comes from both the higher interest and amortizing over a shorter period as compared to the initial principal payment. At this point, the borrower just saw their mortgage payment increase over 3 fold from the first payment period. As you can see, this product can be very dangerous from a credit perspective for a borrower who is unaware of the details of the product. GENERIC 5-YEAR NEGAM ON FIXED MORTGAGE (-2% interest for 5 years) Total Interest Owed $ 10,508 Total Interest Payment $ 106,504 Beginning Payment Period Ending Payment Period Monthly Interest Payment Monthly Principal Payment 1-Feb-10 1-Jan-15 From $240 to $264 $0 Monthly Mortgage Payment From $239 to $264 1-Feb-15 1-Jan-40 Decreases from 449 to 0 Increases from 0 to $577 $638 Fixed

78 $ Monthly Payment $ Nontraditional Mortgages Remaining Mortgage Balance 120, ,000 IO Remaining Principal 30 Yr Fixed Remaining Principal NegAm Remaining Principal 80,000 60,000 40,000 20, Years After Closing In the graph above, you can see that as compared to the IO and 30 year fixed mortgage, the remaining principal balance of the NegAm fixed rate mortgage increases in the first 5 years. $700 Monthly Mortgage Payments of FRM and NegAM $600 $500 $400 $ Yr Fixed Total Mortgage Payment NegAm Total Mortgage Payment $200 $100 IO Total Mortgage Payment $ Years Since Closing In the graph above, you can see that the monthly mortgage payment of the NegAm mortgage is lower than both the IO and a 30-year FRM in the first 5 years. Then, the monthly mortgage payment of the NegAm mortgage is higher than both the IO and the 30-year fixed.

79 Nontraditional Mortgages Adjustable Rate Mortgage (ARM) An Adjustable Rate Mortgage (ARM) is a mortgage that changes its rate over a given period of time. ARMs first appeared in the 1960s, but did not gain legislative or regulatory approval until the early 1980 s when volatile interest rates made it unwise for lenders to make 30 year amortized mortgages at fixed rates of interest. With a fixed-rate mortgage, the interest rate stays the same during the life of the loan. But with an ARM, the interest rate changes periodically, usually in relation to an index. The interest payment is calculated with the fully indexed rate. The fully indexed rate is sum of the lender-set margin on top of index, with margin being usually 1-2%, therefore interest payments may go up or down according to the index. Remember the concept of Higher Risk, Higher Return? Adjustable rates often offer mortgagors lower mortgage payments than a comparable FRM; however, this is only true IF interest rates remain the same over the next 30 years. If interest rates rise in the future and if the mortgagor cannot refinance, then the mortgagor might end up with higher total mortgage payments than the original FRM offered. The higher return comes from lower mortgage payments, and the higher risk comes from the risk of rising interest rates. Lenders are happy to let the mortgagors take this interest risk. To entice the borrower, lenders generally charge lower APRs for ARMs than for comparable fixed-rate mortgages. In a low rates environment, the APRs of ARMs are usually about 1% lower than an FRM, but the differential can go up to 5% for non-conforming mortgages. This makes the ARM easier on a borrower s pocketbook at first than a fixed-rate mortgage for the same amount. APRs of ARMs are lower because the interest rate is lower and the lenders package the loan with different discount points to further lower the APR. Lender's pricing includes different levels of discount points. Loans may be offered with options of no points, 1 point, 1.25 points, 2 points and maybe even more. The more points paid, the lower the interest rate offered. Whenever a rate is offered that is above the par rate, it increases the lender s opportunity to sell this loan with an increased return in the secondary market and therefore the lender offers a rebate or yield spread to compensate for this potential advantage. The par rate represents the observable measure or reference point for lending and purchasing mortgage loans at the current market value or yield in an open market. The higher the note interest rate is above par, the greater advantage the lender has to receive more value for that loan to investors, and the lower the note interest rate is below the par rate the lesser value for investors and therefore a need for the borrower to pay points directly to the lender.

80 Nontraditional Mortgages Adjustable rates increase the opportunity for lenders and investors to receive a greater return at later times in the mortgage term. For this potential, lenders are willing to offer a lower initial note rate as an incentive for borrowers to choose this option. However both the lender and the borrower are assuming a reasonable measure of risk with no true knowledge of how rates will later adjust. Against these advantages, you have to weigh the risk that an increase in interest rates would lead to higher monthly payments in the future. It s a trade-off. The borrower gets a lower rate with an ARM in exchange for assuming more risk. Again, this result falls in line with the theme of higher risk, higher return. ARM Mortgage Features MLOs must be very familiar with margins, payments caps and with reading indices even though the lender will communicate the index rate is on a moment-to-moment basis, as well as the rates. Index The interest rate charged to homeowners in an ARM is tied to an underlying index. When the index rate goes up, the ARM rate goes up. When the index rate goes down, the ARM rate goes down. The typical indices used are: COFI (Cost of Funds Index) MTA (12-month Treasury Average Index) CMT (Constant Maturity Treasury) CD rate LIBOR (London Interbank Offered Rate) Prime Rate Margin The rate the borrower pays is Index plus Margin, which is sometimes called Full indexed Rate. Roughly speaking, the lender borrows money from the market at the Index Rate. Then, they lend the money to the mortgagor at the Index Rate + Margin. Therefore, the Margin represents the lender s profit. Margin usually stays the same throughout the life of the loan. More precisely, the lenders might borrow the money at one Index Rate, but lend out the money at another Index Rate + Margin. The Prime Rate index is usually higher than COFI by a few % points. For example, when Prime Rate is 5%, COFI might be 2%. If the lender s profit is 3.5%, the lender might borrow at COFI and charge the borrower 3.5% + COFI or 0.5% + Prime.

81 Nontraditional Mortgages Teaser Rates and Payment Shock Most ARMs comes with a lower fixed interest rate for the first few years. Terms such as 2/28 and 3/27 indicate that the ARM has an initial 2 or 3 years of fixed interest rate period and then 28 or 27 years of adjustable rate mortgage. Many times, the initial interest rate is substantially lower than the comparable FRM rate, which is why the initial interest rates are sometimes referred to as Teaser Rates. Besides the lenders, sometimes sellers might offer to reduce initial rates to help people move into their new homes. Because the lenders reduce initial rates in the first few years of an ARM to reduce the overall APR, the benefit of having an ARM is mostly concentrated in the first few years. For homebuyers who intend to stay in their house for only a few years, ARMs have additional appeal to them. After this period, not only does the teaser rate period end and interest rates go higher, but also, if the prevailing index is higher than before, the interest payment due can be substantially higher than the original teaser rate. Payment Caps A Periodic Payment Cap is the amount of change that can take place in the payment in a given year or a given period. The Treasury bill may go up, one, two, three or four percent. Not all ARMs have periodic rate caps. Usually the Periodic Payment Cap is 1-2%. There s also a Life or Overall Payment Cap, meaning the loan cannot go more than a certain percentage higher than where it starts through the life of the loan. This cap is usually expressed as an absolute percentage value. For example, the contractual terms of the mortgage may state that the maximum interest rate may never exceed 15%. Adjustment Period The adjustment period is the time between potential interest rate adjustments. The adjustment periods may vary per the mortgage loan terms. Adjustments may vary from monthly, twice per year, and more commonly, annually. There is usually also a period in the first few years (i.e. 1, 3, 5, 7, or 10 years), of the mortgage where there is no change in the interest rate and then remainder of the loan term, where then adjustments are made accordingly.

82 Nontraditional Mortgages Terms and Caps Terms such as 2/1/3 or 1/1/5 are often used to describe the cap structure for an ARM. This format lists the initial adjustment cap, then the adjustment cap for subsequent periods and finally a cap on total adjustments (equivalent to the lifetime cap minus the initial interest rate). In the first example above, 2/1/3, the ARM interest rate is capped at 2% the first time it is adjusted, it is capped at 1% for subsequent adjustments and the ARM has a lifetime cap of 3% more than the initial interest rate. Specifically, if the initial interest rate on this ARM is 6%, the interest rate cannot go to more than 8% after the first period and then only 1% per year afterward; however, in this example, even with multiple adjustment periods, the interest rate cannot go above 9% because of the lifetime cap. Sometimes, a loan may be described using two numbers if the initial period cap and the subsequent periods cap are the same. For example, the 1/1/5 cap structure mentioned above can also be shown as 1/5. Carryovers/Negam ARM caps with specific clauses may produce negative amortization and allow adjustments even when there is no change to the index value. These are known as carryover and NegAm clauses. Payment Caps may produce negative amortization. If ever the payment cap causes the required Interest Payment Due to fall below the Interest Due the difference in the amount of Interest Payment Due below the actual Interest Due can be added to the principal balance. This would produce negative amortization as the principal balance would increase by this difference with each mortgage billing cycle. For example, a payment cap limits the payment to a specific dollar amount; let s say $900. This dollar amount does not represent the true amortized payment using the fully indexed rate with the current outstanding principal balance, which should reflect $1000. The difference of $100 would be added to the principal balance. Each billing cycle would increase the variance with the $900 capped payment and the calculated interest due plus applicable principal payment, considering that interest compounds as the principal balance continues to grow thus producing negative amortization. Some ARMs have interest-rate caps with clauses where the payment amount may increase even though the index rate has stayed the same or declined. This clause is known as a carryover. A carryover happens when an interest-rate cap restricts an interest rate adjustment below the fully

83 Nontraditional Mortgages indexed rate. Carryovers allow an increase to the interest rate on the next or subsequent adjustment though the index value may not have changed. Since the adjustment was not imposed because of the rate cap, the adjustment may carry-over to future rate adjustments. For example, if the interest rate cap is 1% for each periodic adjustment, a loan with a current interest rate of 5%, where the index changes such that the increase is equivalent to a 7% fullyindexed rate, could not be fully imposed as the cap would limit that change. The most the interest rate could adjust to in this example is 6%. A carryover clause would allow the 1% that was not applied or imposed in this adjustment period, to be applied to at a later adjustment period. Even if the next periodic adjustment period does not indicate a change to the index value, the previous 1% that could not be imposed is now allowable. The 1% carried over will now cause the fully indexed rate to increase from 6% to 7% (which is also in line with the 1% periodic adjustment cap) though no change occurred to the index value. Qualifying RATE The qualifying rate is a rate at which a client must qualify. To qualify for an ARM, the MLO cannot qualify a borrower on the initial rate with teaser rates. If the adjustable rate is, say 6%, then a borrower must qualify at 6% plus a certain number of points. Lenders will qualify the applicant s income with the worst case interest rate that can occur within the first 5 years of the loan and are more suitable for subprime borrowers. See below section for discussion of the pitfalls of ARMs. ARM Mortgage Refinance As rates go down in the marketplace it s typical that refinance business skyrockets. You can imagine, if rates used to be eight, nine or 10 percent, as rates once were, and are reduced to five, six, seven percent, as has happened, then consumers start refinancing to save money on their mortgages with lower mortgage payments. Refinancing To Arm If a borrower is going to refinance to get a quarter of a percent rate cut, it s probably not worth it. If a borrower can refinance an ARM rate and go from a 6.5% adjustable now to a 4.5% adjustable, then it is may be worth it. Some loan programs require specific variance. For

84 Nontraditional Mortgages example, FHA has specific requirements to have a 2% variance between current and new interest rate when refinancing between a Fixed Rate and an ARM and an ARM to a Fixed Rate. As well, many lenders require documentation of a net tangible benefit for refinance transactions, to clearly document the benefit for the refinance for the borrower. Refinance From Arm To Fixed Rate Sometimes a borrower may have an ARM and wants to refinance to an FRM. This process can often result in an increase in the rate because the fixed interest rate risk is less volatile and lender pricing may reflect a much higher interest rate. It s very unusual to find an adjustable rate higher than a fixed rate, although rates vary by lender and may be impacted by the economic environment. Nevertheless, the borrower s ability to refinance would be based on the lender s credit underwriting guidelines, the current market value of the home, and their ability to meet current DTI, LTV, and any cash or reserve requirements. These standard risks for eligibility are always applicable and could hinder a borrower from refinancing if these eligibility factors are not met. It's also possible that the borrower at first opted for an ARM because the borrower was unsure as to how long he or she would stay in the home. Remember that an ARM tends to have a lower rate initially, so for homeowners who don t intend to stay in the home for many years, they might want an ARM for the additional savings on the mortgage payment. If, however, later on, the borrower later decides to stay in the home for many more years to come, it may be beneficial to swap that fluctuating adjustable rate for a fixed one. The good news is that a fixed rate mortgage helps a borrower to lock in the prevailing interest rate in order to feel more secure knowing that the monthly payment will remain steady for years to come regardless of the current market environment. Remember, the purpose of doing a refinance is to benefit the borrower. Benefits of ARMs Qualification. In some situations, borrowers might have an easier time getting qualified for a mortgage. As discussed above, because the qualifying rate of ARMs can be lower than that for FRMs, some borrowers with less than perfect credit might have an easier time being qualified for ARMs. In some situations, lenders of ARMs have less stringent underwriting rules than those of FRMs. Using ARMs, you can qualify a borrower who otherwise, can t get an FRM. Under the same reasoning, the borrower might get a larger loan because the DTI (Debt to Income Ratio) will be lower because the payment is lower than an FRM.

85 Nontraditional Mortgages Lower APRs. As discussed above, ARMs usually have lower APRs than FRMs. The savings in the first few years are especially significant. ARMs can represent real savings for borrowers. If you are comfortable that a borrower can take the interest rate risk of the ARM, then why not try to save some money? In general, if the borrower knows he will be living in the house for five years or less, an ARM might be a wise choice because the monthly payments will be less. Make sure the borrower has a fixed rate for the first few years and a low Periodic Payment Cap. ARM Mortgage Considerations The risks associated with an ARM can be very dangerous for the wrong borrower and must be highlighted. In order to increase the awareness of these risks, Regulation Z requires that every lender provide a copy of the Consumer Handbook on Adjustable-Rate Mortgages (known as the CHARM booklet) or a suitable substitute to ARM applicants. Unfortunately, many consumers fail to realize that the traditional mortgage type, while requiring a higher payment, is potentially in their best interest. Many consumers are overly focused on looking for a lower monthly payment. That s just human nature. Risks associated with ARMs versus FRMs include: Risk of the interest rate increasing: The biggest detriment to an ARM is that there is an unknown, given that rates may change. If rates are 8% at the moment, but rise to 12% in the future, then an ARM interest can become higher than a fixed rate loan. Though the probably of this happening is low, the risk exists, which is not the case in an FRM. This problem is to some extent alleviated by the installation of a maximum rate cap. To be safe, prudent borrowers would want to make sure that they can still afford to pay the interest at the maximum rate cap. If ARMs were issued when interest rates were very low, then in the course of the 30 years, interest rates are bound to increase. At that time, the borrower of an ARM will be paying more interest than an FRM. The probably of this happening can be quite high depending on how low was the index rate at that time. Note that a low interest rate scenario poses much more risk to borrowers than high interest rate scenario above because rates in a low interest rate environment are likely to go up at some point in time. For example, transplanting a mortgage type relatively appropriate in the 1970s, where interest rates were very high, to the 2004 environment, made this mortgage type much more risky than in the 70s. The interest rate environment was different (much higher), meaning that investors in 2004 were assuming much more interest rate risk.

86 Nontraditional Mortgages One reason why interest rates go up is inflation. So, an ARM offers less inflation protection to homebuyers than a regular FRM. The mitigating factor to interest rate risk is that there is a Periodic and Overall Payment Cap. Unfortunately, the Periodic Payment Cap from private lenders tends to be quite high, at around 2%. Hidden Program Features. As discussed earlier, NegAm clauses may be included in an ARM loan terms. In some ARMs, Periodic Payment Caps limit the amount of increases to the Interest Payment Due, and not only the amount of increase in Interest Due on the mortgage based on these periodic rate caps. In these situations, the borrower might be paying the full Interest Payment Due, but does not realize that the Interest Payment is less than the actual Interest Due. This means that the interest shortage is automatically added to the principal and interest will also be charged on the amount that s now added to the principal. This is due to compounding interest. The borrower might therefore owe the lender more principal later in the loan term than at the start. As mentioned in the NegAm section, though an increase in the value of the home may make up for the NegAm, this situation increases the risk of default and should be carefully explained to any customer. Prepayment Penalties. Often times, ARMs have prepayment penalties. A prepayment penalty is a clause in a mortgage loan s terms that stating if the mortgage is prepaid within a certain time period, a penalty will be assessed. The penalty can be based on a percentage of the principal balance or a certain number of months of interest. When it applies to both the sale of a home and a refinance transactions it s often referred to as a hard prepayment penalty. A prepayment penalty that applies only to refinance transactions is called a soft prepayment penalty. Lenders write prepayment penalties into mortgage loan terms to compensate for prepayment risk. The incentive is great for a borrower to prepay as a way to avoid payment shock with an increase in the interest rate. When the payment terms change like with fully amortizing payments and increasing interest rates, lenders recognize that borrowers will look for ways to lessen their payment and remove the uncertainty of payment adjustments, so many loans including alternative mortgages and even conventional mortgage loans may have prepayment penalties. Borrower Considerations Whether an ARM is suitable for a borrower depends on whether the borrower is capable of taking the risk of a fluctuating interest rate. For a borrower whose income is sufficient to make the payment on the ARM at the maximum cap rate, then an ARM can offer real savings. For example, if a borrower enters into an ARM with 2% interest rates, they can derive significant savings as compared to a FRM of say 6%.

87 Nontraditional Mortgages An ARM could be unsuitable for a borrower if the borrower s income is not enough to pay off the ARM at the maximum cap rate. It is highly risky if the borrower needs to finance the home purchase with an ARM's lower initial rate just to afford the house purchase. They can't afford the FRM rate, let alone the Max Cap Rate. Borrowers must be urged to consider these additional risks carefully before choosing ARM over FRM. The bottom line is that some homebuyers use ARMs to buy a house that is more expensive than what they can prudently afford. These homebuyers ought to be advised to opt for a cheaper house, take more time to save for a larger down payment and consider all the risks of using an ARM as listed above to avoid financial difficulties down the road. Back when President Jimmy Carter was in office and prime rates were at 19 and 19.5 percent, adjustable rates at that time were 7.5 and 8 percent. It was very difficult to qualify people under those terms. Nobody was taking a fixed rate mortgage; everyone was going for the adjustable rates. That was back in the days when we had a lot of negative amortization loans and they were horrible. To fully take advantage and avoid pitfalls of an ARM, borrowers should look for those with Periodic Rate Cap Overall Rate Cap No prepayment penalty Monthly payment reduction if interest rate drops The right to convert to a fixed-rate mortgage. ARM High/Low Interest Rate Examples Remember we said that an ARM borrower has interest rate risk? Below, let s look at the interest rate payments of an ARM under high and low interest rate scenarios. To make sure that a borrower enters into an ARM mortgage well informed, it is a good idea to provide the best and worst case scenarios to the borrower. In our example, the mortgage balance is again $100,000. In this case, the ARM index is Treasury, which was 0.5% at the day of closing. The teaser rate in the first 3 years is 3.75%. Then the ARM resets every year. The annual rate cap is plus or minus 1%. The lifetime cap is 7.75%. We looked at two scenarios: Treasury rate stayed at 0.5% for 30 years and Treasury rate jumped to 7% in year 3.

88 $ Monthly Payment Nontraditional Mortgages ARM Interest Payments for High and Low Interest Scenarios $ $ $ ARM Total Mortgage Payment (low interest scenario) $ $ $ ARM Total Mortgage Payment (high interest scenario) $ $ Years Since Closing For the low interest rate environment, the mortgage payment ranges from $463 to $401. For the high interest rate environment, the mortgage payment ranges from $463 to $685. Note also that the annual cap, life cap and the initial 3-year fixed rate help to lower the ARM mortgage payments in the high interest scenario. With the life cap, the interest rate used to calculate the mortgage payment is capped at 7.75%. Without the life cap, the highest interest rate used would be 9% instead. 3 Year ARM (Constant 0.5% Index rate for 30 years, 1% Annual Cap) Total Interest Owed $ - Total Interest Payment $ 46,672 Index Interest Rate Used Beginning Monthly Payment Period Ending Monthly Payment Period Monthly Mortgage Payment 0.5% Index +2% Margin Fixed at 3.75% 1 Feb Jan-13 $463 Fixed 0.5% Index +2% Margin Fixed at 2.75% (due to 1 year cap) 1-Feb Jan-14 $413 Fixed 0.5% Index +2% Margin Fixed at 2.5% 1-Feb Jan-40 $401 Fixed

89 Nontraditional Mortgages 3 Year ARM (Constant 7% Index Rate, 1% Annual Cap, 7.75% Life Cap) Total Interest Owed $ - Total Interest Payment $ 134,606 Index Interest Rate Used Beginning Payment Period Ending Payment Period Monthly Mortgage Payment 7% Index +2% Margin Fixed at 3.75% 1-Feb Jan-13 $463 Fixed 7% Index +2% Margin 7% Index +2% Margin 7% Index +2% Margin 7% Index +2% Margin Fixed at 4.75% (due to 1 year cap) Fixed at 5.75% (due to 1 year cap) Fixed at 6.75% (due to 1 year cap) Fixed at 7.75% (Life cap at 7.75%) 1-Feb Jan-14 $517 Fixed 1-Feb Jan-15 $572 Fixed 1-Feb Jan-16 $628 Fixed 1-Feb Jan-40 $685 Fixed Option Adjustable Rate Mortgage Option ARM is an ARM that combines the features of an ARM, IO, and NegAm. The borrower has a choice of making a fully-amortizing payment, an interest-only payment, or a minimum payment that did not cover the interest. Like in a regular ARM, in the first few years, the borrower of Option ARM typically pays a fixed interest rate, which is lower than comparable FRM. The pros and cons of Option ARMs are the same as that of IO, ARM and NegAm loans. The benefit of Option ARMs is that it gives borrower many OPTIONS. The downside of the Option ARM is that it gives borrowers more risk and significantly increases risk from a lender standpoint. The Payment Shock is greater. The loss from a decline in housing prices is also greater because no equity was built up before. Interest rate risk is even higher.

90 Nontraditional Mortgages Because the principal of the loan may not have been paid down in the initial few years, rising interest rates further increased the dollar amount of interest payments. There is also the consideration for recasting a loan that may contribute to a much larger or significant payment shock for a borrower with an Option ARM. Recasting occurs when after a specified number of years, or if a loan reaches a certain negative amortization cap (like 110%, 115% or 125% LTV), or maybe even after an interest only period the required monthly payment amount is recast to require payments that will fully amortize the outstanding balance over the remaining loan term. So if a borrower was accustomed to choosing a minimum payment with a teaser rate which could only increase by a certain percent (typically around 7%) annually and then is suddenly faced with a payment with amortized over a shorter period of time, based on current interest rates and a much larger principal balance, it could be a significant payment shock that may be difficult for the borrower to make. This could inevitably lead to foreclosure due to non-payment. This is a huge risk factor of loan with negative amortization. Borrowers who cannot afford a mortgage might take on a loan with IO, NegAm and ARM features without realizing that the initial low monthly payment will not last. In some predatory lending situations, borrowers were convinced that an Option ARM was a suitable loan for them, but did not realize that they could also afford a traditional FRM with less risk. It is very important to note that the options tied to a loan come with a cost. The risk factors a loan with more options could mean higher interest rates with future rate adjustments, potential recasting, and increasing principal balances coupled with a need to refinance and the costs associated with a new mortgage transaction may mean that some borrowers might save more money by choosing a FRM from the start. Cross-Comparisons Alternative Mortgage Loan Summary In this session we ve discussed various alternative mortgages types. These mortgages have features different from traditional mortgages, which have a fixed payment amount due each year for 30 years. Alternative mortgages mostly have maturity dates that are shorter, fluctuation in the interest rate, and varying repayment terms. It is very important to understand their intended use. Alternative mortgages have mortgage payments that change through time. Mortgage payments might initially be lower. For example, this is the case with ARMs, NegAms and IOs. Other loans might depend on a changing index, as is the case with ARMs. When the mortgage payments increase, mortgagors would experience Payment Shock. The determination of the

91 Nontraditional Mortgages tangible benefit for the borrower with these types of mortgage loans is based on their ability to handle the risks. We have discussed the important topic of High Risk, Higher Potential Return. The reason why these alternative loans are less expressive and allow a lower mortgage payment than FRMs is that the mortgagor takes on greater risks than with a FRM. The risks associated with these loans include increasing interest rate risk, eligibility for refinance risk, and sustaining property market value risk (home price value). For each borrower, the impact of this risk exposure will be different. Terms And Assumptions 30 Year Fixed 5 Year IO 5 Year NegAm 3/27 ARM Low 3/27 ARM High Mortgage Amount $100,000 $100,000 $100,000 $100,000 $100,000 Term 30 years 30 years 30 years 30 years 30 years Initial Period NA 5 years 5 years 3 years 3 years Interest Rate at Close 4.875% 2.875% 2.000% 3.75% 3.75% Note Rate 4.875% 4.875% 4.875% NA NA Index after close NA NA NA 0.5% 7.0% Margin NA NA NA 2.0% 2.0% Annual Rate Cap NA NA NA 1.0% 1.0% Lifetime Rate Cap NA NA NA 7.75% 7.75%

92 Nontraditional Mortgages Comparison Charts Interest Rate 30 Year Fixed 5 Year IO 5 Year NegAm 3/27 ARM Low 3/27 ARM High Year % 2.875% 2.000% 3.750% 3.750% Year % 2.875% 2.000% 3.750% 3.750% Year % 2.875% 2.000% 3.750% 3.750% Year % 2.875% 2.000% 2.750% 4.750% Year % 2.875% 2.000% 2.500% 5.750% Year % 4.875% 4.875% 2.500% 6.750% Year 30* 4.875% 4.875% 4.875% 2.500% 7.750% Remaining Principal 30 Year Fixed 5 Year IO 5 Year NegAm 3/27 ARM Low 3/27 ARM High Year 1 $99,877 $100,000 $100,167 $99,849 $99,849 Year 2 98, , ,188 98,005 98,005 Year 3 96, , ,251 96,090 96,090 Year 4 95, , ,355 94,074 94,127

93 Nontraditional Mortgages Year 5 93, , ,502 91,673 92,379 Year 6 91,508 99, ,319 89,126 90,805 Year 30* Monthly Mortgage Payment 30 Year Fixed 5 Year IO 5 Year NegAm 3/27 ARM Low 3/27 ARM High Year 1 $529 $406 $240 $463 $463 Year Year Year Year Year Year 30* Summary 30 Year Fixed 5 Year IO 5 Year NegAm 3/27 ARM Low 3/27 ARM High Total Interest Payment $90,515 $97,574 $95,996 $46,672 $134,606 Total Principal Payment 100, , , , ,000 Payment Shock $ (51) 54 Payment Shock Adjustment Year 0% 42% 146% (11%) 12% Payment Shock Lifetime 0% 42% 166% (13%) 48%

94 RDH Education Services S E C T I O N F O U R CALIFORNIA PROFESSIONALS RULEBOOK Section Four: California Professionals Rulebook Introduction Welcome to the California State Law component of your SAFE training. Upon completion of this course, you will have met the minimum education requirements of the State of California Department of Business Oversight (DBO) for an individual seeking to maintain their license as a mortgage loan originator doing business in California. This course includes many laws and regulations required to be covered in the license renewal exam.

95 California Professionals Rulebook This course focuses on License Maintenance, the Powers of the Commissioner and the Attorney General, Required Conduct as well as the Homeowner s Bill of Rights. All the questions on the exam come from these sections. The requirements and prohibitions listed here are also the primary focus of the enforcement units of the Department of Business Oversight. You need to know this information to pass the test. More importantly, you need to know what you can and cannot do in order to conduct your business in an ethical and trustworthy manner. In order to maximize your time in this course you must: 1. Give 100% of your attention to this class. Turn off your cell phone, turn down the ringer on your home or office phone, and let everyone know that you should not be disturbed for the next hour. If you are at home, turn off the TV and your music player as well. 2. Participate by taking notes and asking questions. Taking notes helps to solidify information in your memory and asking questions will help both you and other students to understand the material covered. 3. California law is extensive and complex. This is a 1-hour course and includes License Maintenance, the Powers of the Commissioner and the Attorney General, Required Conduct as well as the Homeowner s Bill of Rights. 4. Study the materials provided. We will be covering a great deal of information today. You will need to study and review the materials several times before you are prepared to take the license renewal exam. 5. Take the license renewal exam within 10 days of completing this course. We all start to forget what we learn within hours of finishing a class. The sooner you take the exam, the more likely you are to pass. The course covers the CA Finance Lenders Law (CA Fin. Code ) and the CA Residential Mortgage Lending Act (CA Fin. Code ). The California Residential Mortgage Lending Act governs a number of lending activities and applies to those involved in making or servicing mortgage loans on one- to four-family dwellings. The California Finance Lenders Law (Division 9) will be liberally construed and applied to promote its underlying purposes and policies, which are: To ensure an adequate supply of credit to borrowers in this state. To simplify, clarify, and modernize the law governing loans made by finance lenders. To foster competition among finance lenders. To protect borrowers against unfair practices by some lenders, having due regard for the interests of legitimate and scrupulous lenders. To permit and encourage the development of fair and economically sound lending practices.

96 California Professionals Rulebook To encourage and foster a sound economic climate in this state. 1 1 California Financial Code 22001(a)

97 California Professionals Rulebook License Maintenance Definitions Borrower: means the loan applicant. 2 Commissioner: means the Commissioner of Business Oversight. 3 4 Lender: means a person that is an approved lender for the Federal Housing Administration, Veterans Administration, Farmers Home Administration, Government National Mortgage Association, Federal National Mortgage Association, or Federal Home Loan Mortgage Corporation; directly makes residential mortgage loans; and makes the credit decision in the loan transactions. 5 Licensee: means any finance lender or broker who receives a license in accordance with Division 9. 6 Makes or making residential mortgage loans or mortgage lending: means processing, underwriting, or as a lender using or advancing 7 one s own funds, or making a commitment to advance one s own funds, to a loan applicant for a residential mortgage loan. 8 Mortgage loan, residential mortgage loan, or home mortgage loan: means a federally related mortgage loan or a loan made to finance construction of a one-to-four family dwelling. 9 Mortgage loan originator: means an individual who, for compensation or gain, or in the expectation of compensation or gain, takes a residential mortgage loan application or offers or negotiates terms of a residential mortgage loan. 10 Mortgage loan originator does NOT include any of the following: 2 California Financial Code 50003(b) 3 California Financial Code California Financial Code 50003(d) 5 California Financial Code 50003(m) 6 California Financial Code California Financial Code 50003(o) 9 California Financial Code 50003(p) 10 California Financial Code 22013(a)

98 California Professionals Rulebook An individual who performs purely administrative or clerical tasks on behalf of a person meeting the definition of a mortgage loan originator. The terms administrative or clerical tasks means the receipt, collection, and distribution of information common for the processing or underwriting of a loan in the mortgage industry and communication with a consumer to obtain information necessary for the processing or underwriting of a residential mortgage loan, to the extent that the communication does not include offering or negotiating loan rates or terms, or counseling consumers about residential mortgage loan rates or terms. 11 An individual who solely renegotiates terms for existing mortgage loans held or serviced by his or her employer and who does not otherwise act as a mortgage loan originator, unless the United States Department of Housing and Urban Development or a court of competent jurisdiction determines that the SAFE Act requires that employee to be licensed as a mortgage loan originator under state laws implementing the SAFE Act. 12 An individual that is solely involved in extensions of credit relating to timeshare plans. 13 An individual licensed as a mortgage loan originator pursuant to Article 2.1 (commencing with Section ) of Chapter 3 of Part 1 of Division 4 of the Business and Professions Code and the SAFE Act. 14 An individual who is an employee of a federal, state, or local government agency or housing finance agency and who acts as a loan originator only pursuant to his or her official duties as an employee of the federal, state, or local government agency or housing finance agency California Financial Code (b)(1) 12 California Financial Code (b)(2) 13 California Financial Code (b)(3) 14 California Financial Code (b)(4) 15 California Financial Code (b)(5)

99 California Professionals Rulebook Mortgage servicer or residential mortgage loan servicer: means a person that is an approved servicer for the Federal Housing Administration, Veterans Administration, Farmers Home Administration, Government National Mortgage Association, Federal National Mortgage Association, or Federal Home Loan Mortgage Corporation; and directly services or offers to service mortgage loans. 16 Nationwide Mortgage Licensing System and Registry (NMLS): means a mortgage licensing system developed and maintained by the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators for the licensing and registration of licensed mortgage loan originators. Person: means an individual, a corporation, a partnership, a limited liability company, a joint venture, an association, a joint stock company, a trust, an unincorporated organization, a government, or a political subdivision of a government. 19 Residential mortgage loan: means any loan primarily for personal, family, or household use that is secured by a mortgage, deed of trust, or other equivalent consensual security interest on a dwelling or residential real estate upon which is constructed or intended to be constructed a dwelling. Dwelling means a residential structure that contains one to four units, whether or not that structure is attached to real property. The term includes an individual condominium unit, cooperative unit, mobile home, or trailer, if it is used as a residence. 20 Residential real property or residential real estate: means real property located in this state that is improved by a one-to-four family dwelling California Financial Code 50003(q) 17 California Financial Code 22012(d) 18 California Financial Code 50003(r) 19 California Financial Code California Financial Code 22012(e) 21 California Financial Code 50003(v)

100 California Professionals Rulebook License Renewal A mortgage loan originator wishing to renew his/her license must, at a minimum: Continue to meet the minimum requirements contained under or Have paid all the required fees (if the mortgage loan originator is employed by a residential mortgage lender or servicer, the latter should have settled the fees) Continue to meet the annual continuing education requirements If the minimum standards required to renew the mortgage loan originator license have not been met by the last day of December, then the license will expire at midnight on that day. The commissioner may put in place procedures to permit the reinstatement of licenses which have lapsed provided those procedures are in keeping with the standards established by the NMLS. Educational Requirements A licensed mortgage loan originator wishing to renew their license must complete at least eight hours of continuing education, which must include at least the following: Three hours of instruction on federal laws and regulations; Two hours of ethics, which must include instruction on fraud, consumer protection, and fair lending issues; Two hours of training related to lending standards for the nontraditional mortgage product marketplace; One hour of CA-BDO defined electives. Continuing education courses will be reviewed and approved by the NMLS. Review and approval of a continuing education course will include review and approval of the course provider. 22 California Financial Code 50144(b)(1) 23 California Financial Code (b)(1) 24 California Financial Code 50144(b)(3) 25 California Financial Code (b)(3) 26 California Financial Code 50144(b)(2) 27 California Financial Code (b)(2) 28 California Financial Code 50144(b)(4) 29 California Financial Code (c) 30 California Financial Code (a) 31 California Financial Code 50145(a) 32 California Financial Code (b) 33 California Financial Code 50145(b)

101 California Professionals Rulebook Nothing in and will preclude any continuing education course approved by the NMLS that is provided by the employer of the mortgage loan originator or an entity which is affiliated with the mortgage loan originator by an agency contract, or any subsidiary or affiliate of the employer or entity. Continuing education courses may be offered in a classroom, online, and by any other means approved by the NMLS. Except as provided in (i) or in 50145(i), a licensed mortgage loan originator: May only receive credit for a continuing education course in the year in which the course is taken May not take the same approved course in the same or successive years to meet the annual requirements for continuing education. A licensed mortgage loan originator who is an approved instructor of an approved continuing education course may receive credit for the licensed mortgage loan originator s own annual continuing education requirement at the rate of two hours credit for every one hour taught. Any individual who has successfully completed continuing education requirements approved by the NMLS for any state other than California will be granted credit toward completion of continuing education requirements in California. A licensed mortgage loan originator who subsequently becomes unlicensed must complete the continuing education requirements for the last year in which the license was held prior to issuance of a new or renewed license. If an individual was previously licensed under Division 9 as a mortgage loan originator, they must, when applying to be licensed again, prove that they have completed all of the continuing education requirements for the year in which a license was last held. 34 California Financial Code (c) 35 California Financial Code 50145(c) 36 California Financial Code (d) 37 California Financial Code 50145(d) 38 California Financial Code (e) 39 California Financial Code 50145(e) 40 California Financial Code (f) 41 California Financial Code 50145(f) 42 California Financial Code (g) 43 California Financial Code 50145(g) 44 California Financial Code (h) 45 California Financial Code 50145(h) 46 California Financial Code (f) 47 California Financial Code 50142(f)

102 California Professionals Rulebook If a licensed mortgage loan originator fails to maintain a valid license for 5 years or more, they will be required to retake the test. The five-year period does not include any time during which the individual is a registered mortgage loan originator. A person meeting the requirements of paragraphs (1) and (3) of (b) and 50144(b) may correct any deficiency in continuing education as established by rule or regulation of the commissioner. Record Keeping Licensed mortgage loan originators must keep and use in the conduct of their business books, accounts, and records in order to enable the commissioner to establish if they are complying with the provisions of Division 9 as well as with the rules and regulations made by the commissioner. 52 These books, accounts, and records, including cards used in the card system, if any, should be retained for at least three years after the final entry on any loan recorded on them has been made. 53 Licensed mortgage loan originators are not required to maintain or preserve original records. However, they should be able to provide any information requested by the commissioner within 48 hours excluding Saturdays, Sundays, and holidays of a request. 54 A licensed mortgage loan originator may not knowingly alter, destroy, mutilate, conceal, cover up, falsify, or make a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the administration or enforcement of any provision of Division The commissioner may require a licensed mortgage loan originator to maintain a file of all advertising copy for a period of two years from the date of its use. The file must be available to the commissioner upon request California Financial Code (g) 49 California Financial Code 50143(d)(4) 50 California Financial Code (i) 51 California Financial Code 50145(i) 52 California Financial Code California Financial Code California Financial Code California Financial Code 22170(a) 56 California Financial Code 50512(a) 57 California Financial Code 22166

103 California Professionals Rulebook Surety Bond A mortgage loan originator must maintain a surety bond in a minimum amount of $25,000. The bond will be payable to the commissioner and issued by an insurer authorized to do business in this state. An original surety bond, including any and all riders and endorsements executed subsequent to the effective date of the bond, will be filed with the commissioner within 10 days of execution. For licensees with multiple licensed locations, only one surety bond is required. The bond will be used for the recovery of expenses, fines, and fees levied by the commissioner in accordance with Division 9 or for losses or damages incurred by borrowers or consumers as a result of a licensee s noncompliance with the requirements of Division When an action is commenced on a licensee s bond, the commissioner may require the filing of a new bond. Immediately upon recovery of any action on the bond, the licensee must file a new bond. Failure to file a new bond within 10 days of the recovery on a bond, or within 10 days after notification by the commissioner that a new bond is required, constitutes sufficient grounds for the suspension or revocation of the license. 59 The commissioner may by rule require a higher bond amount for a licensee who employs one or more mortgage loan originators and who makes or arranges residential mortgage loans, based on the dollar amount of residential mortgage loans originated by that licensee and any mortgage loan originators employed by that licensee. Every mortgage loan originator employed by the licensee will be covered by the surety bond. 60 Surrender, Revocation or Suspension of License A license issued to a mortgage loan originator must be renewed annually. Once renewed, it will remain in effect until it is surrendered, revoked, or suspended. 61 Surrender of a license becomes effective 30 days after receipt of an application to surrender the license or within a shorter period of time that the commissioner may determine, unless a revocation or suspension proceeding is pending when the application is filed or a proceeding to revoke or suspend or to impose conditions upon the surrender is instituted within 30 days after the application is filed. If a proceeding is pending or instituted, surrender of a license becomes effective at the time and upon the conditions that the commissioner determines California Financial Code 22112(a) 59 California Financial Code 22112(b) 60 California Financial Code 22112(c) 61 California Financial Code 22700(b) 62 California Financial Code 22700(c)

104 California Professionals Rulebook A mortgage loan originator may surrender a license by delivering to the commissioner written notice that they wish to surrender their license. Surrender of the license does not affect the licensee s civil or criminal liability for acts committed prior to the surrender of the license. 63 The commissioner will suspend or revoke the license of a mortgage loan originator, upon notice and reasonable opportunity to be heard, if the commissioner finds that: The mortgage loan originator has failed to comply with any demand, ruling, or requirement of the commissioner made pursuant to and within the authority of Division The mortgage loan originator has violated any provision of Division 9 or any rule or regulation made by the commissioner under and within the authority of Division A fact or condition exists that, if it had existed at the time of the original application for the license, reasonably would have warranted the commissioner in refusing to issue the license in the first instance. 66 A master license may not be suspended or revoked pursuant to this section as a result of any action or failure to act by a subsidiary licensee unless grounds exist for the suspension or revocation of the master license pursuant to this section. An order suspending or revoking a license or imposing sanctions against a licensee will not affect other licensed locations unless expressly stated in the order. 67 The commissioner may immediately revoke the license of a mortgage loan originator if the licensee fails to comply with any order issued under 50318, 50319, 50321, 50322, or The commissioner may not revoke the license if, within 10 days from the effective date of the revocation order, the licensee secures a court order restraining the enforcement of the commissioner s revocation order. 68 The commissioner may by order summarily suspend or revoke the license of a mortgage loan originator if that person fails to file the report required by within 10 days after notice by the commissioner that the report is due and not filed. If, after an order is made, a request for a hearing is filed in writing within 30 days and the hearing is not held within 60 days thereafter, the order is deemed rescinded as of its effective date California Financial Code California Financial Code 22714(a)(1) 65 California Financial Code 22714(a)(2) 66 California Financial Code 22714(a)(3) 67 California Financial Code 22714(b) 68 California Financial Code California Financial Code 22715

105 California Professionals Rulebook The power of investigation and examination by the commissioner is not terminated by the surrender, suspension, or revocation of any license issued by him or her. 70 Powers of the Commissioner and the Attorney General/Required Conduct Definitions Broker: includes any person who is engaged in the business of negotiating or performing any act as broker in connection with loans made by a finance lender. 71 Depository institution: has the same meaning as in Section 3 of the Federal Deposit Insurance Act, and includes any credit union. Engage in the business: means the dissemination to the public, or any part of the public, by means of written, printed, or electronic communication or any communication by means of recorded telephone messages or spoken on radio, television, or similar communications media, of any information relating to the making of residential mortgage loans, the servicing of residential mortgage loans, or both. Engage in the business also means, without limitation, making residential mortgage loans or servicing residential mortgage loans, or both. 74 Federal banking agencies: means the Board of Governors of the Federal Reserve System, the Comptroller of the Currency, the National Credit Union Administration, and the Federal Deposit Insurance Corporation. 75 Finance lender: includes any person who is engaged in the business of making consumer loans or making commercial loans. The business of making consumer loans or commercial loans may include lending money and taking, in the name of the lender, or in any other name, in whole or in part, as security for a loan, any contract or obligation involving the forfeiture of rights in or to personal property, the use and possession of which property is retained by other than the mortgagee or lender, or any lien on, assignment of, or power of attorney relative to wages, salary, earnings, income, or commission. The definition of finance lender must be interpreted to include a personal 70 California Financial Code California Financial Code California Financial Code 22012(b) 73 California Financial Code 50003(f) 74 California Financial Code 50003(g) 75 California Financial Code 50003(h)

106 California Professionals Rulebook property broker. 76 Finance lender and broker do not include employees regularly employed at the location specified in the license of the finance lender or broker, except that an employee, when acting within the scope of his or her employment, will be exempt from any other law from which his or her employer is exempt. 77 Service or servicing: means receiving more than three installment payments of principal, interest, or other amounts placed in escrow, pursuant to the terms of a mortgage loan and performing services by a licensee relating to that receipt or the enforcement of its receipt, on behalf of the holder of the note evidencing that loan. 78 Powers of the Commissioner The commissioner is authorized to establish relationships or contracts with the NMLS or other entities designated by the NMLS to collect and maintain records and process transaction fees or other fees related to licensees or other persons subject to this division. 79 For the purpose of participating in the NMLS, the commissioner is authorized to waive or modify, in whole or in part, by rule, regulation, or order, any or all of the requirements of this division and to establish new requirements as reasonably necessary to participate in the NMLS. 80 The commissioner may use the NMLS as a channeling agent for requesting information from, and distributing information to, the Department of Justice or any governmental agency. 81 The commissioner may use the NMLS as a channeling agent for requesting and distributing information to and from any source so directed by the commissioner. 82 The commissioner will establish a process where applicants and licensees may challenge information entered into the NMLS by the commissioner. 83 The commissioner will establish the timelines, fees, and assessments applicable to individuals applying for mortgage loan originator license renewals and license changes. 84 The commissioner may require mortgage loan originator licensees to pay assessments through the NMLS California Financial Code California Financial Code California Financial Code 50003(x) 79 California Financial Code 50150(a) 80 California Financial Code 50150(b) 81 California Financial Code 50150(c) 82 California Financial Code 50150(d) 83 California Financial Code 50150(e) 84 California Financial Code 50140(c) 85 California Financial Code 50140(d)

107 California Professionals Rulebook The license issued will state the name of the mortgage loan originator. If the licensee is a partnership, the license will show the names of its general partners. If the licensee is a corporation or an association, the license will indicate the date and place of the corporation s incorporation or organization and the address of the licensee s principal business location. The license will also state that the licensee is licensed as a mortgage loan originator. 86 The commissioner may: Suspend, revoke, condition, or decline to renew a mortgage loan originator license for a violation of Division 9, or any rules or regulations adopted there under. Suspend, revoke, condition, or decline to renew a mortgage loan originator license if a licensee fails at any time to meet the requirements of , 50141, or or withholds information or makes a material misstatement in an application for a license renewal. Order restitution against a mortgage loan originator or any finance lender or broker licensee employing a mortgage loan originator for a violation of Divisions 9 and/or Impose fines on a mortgage loan originator or any finance lender or broker licensee employing a mortgage loan originator pursuant to subdivisions (b), (c), and (d) of or Issue orders or directives to mortgage loan originators under Divisions 9 and/or 20 as follows: o o Order or direct a mortgage loan originator or any finance lender or broker licensee, or any residential mortgage lender or servicer licensee employing a mortgage loan originator to desist and refrain from conducting business, including immediate temporary orders to desist and refrain. Order or direct a mortgage loan originator or any finance lender or broker licensee, or any residential mortgage lender or servicer licensee employing a mortgage loan originator to cease any harmful activities or violations of Divisions 9 and/or 20, including immediate temporary orders to desist and refrain. 86 California Financial Code California Financial Code 22172(a)(1) 88 California Financial Code 50513(a)(1) 89 California Financial Code 22172(a)(2) 90 California Financial Code 50513(a)(2) 91 California Financial Code 22172(a)(3) 92 California Financial Code 50513(a)(3) 93 California Financial Code 22172(a)(4) 94 California Financial Code 50513(a)(4) 95 California Financial Code 22172(a)(5)(A) 96 California Financial Code 50513(a)(5)(A) 97 California Financial Code 22172(a)(5)(B) 98 California Financial Code 50513(a)(5)(B)

108 California Professionals Rulebook o Enter immediate temporary orders to cease business under a license issued pursuant to the authority granted under or if the commissioner determines that the license was erroneously granted or the mortgage loan originator is currently in violation of Divisions 9 and/or 20. o Order or direct any other affirmative action as the commissioner deems necessary The commissioner may impose a civil penalty on a mortgage loan, or any residential mortgage lender or servicer licensee employing a mortgage loan originator, if the commissioner finds, on the record after notice and opportunity for a hearing, that the mortgage loan originator, or any residential mortgage lender or servicer licensee employing a mortgage loan originator has violated or failed to comply with any requirement of Divisions 9 and/or 20 or any regulation prescribed by the commissioner under these divisions or order issued under authority of these divisions. The maximum amount of penalty for each act or omission described in 22172(b) and 50513(b) will be $25,000. Each violation or failure to comply with any directive or order of the commissioner is a separate and distinct violation or failure. Whenever, in the opinion of the commissioner, any person is engaged in the business as a mortgage loan originator without a license, the commissioner may order that person or licensee to desist and to refrain from engaging in the business or further violating Division 9. If, within 30 days after the order is served, a written request for a hearing is filed and no hearing is held within 30 days thereafter, the order is rescinded. 109 Notwithstanding 22712(a), if, after an investigation, the commissioner has reasonable grounds to believe that a person is conducting business in an unsafe or injurious manner, the commissioner will, by written order addressed to that person, direct the discontinuance of the unsafe or injurious practices. The order will become effective immediately, but will not become final except in accordance with the provisions of California Financial Code 22172(a)(5)(C) 100 California Financial Code 50513(a)(5)(C) 101 California Financial Code 22172(a)(5)(D) 102 California Financial Code 50513(a)(5)(D) 103 California Financial Code 22172(b) 104 California Financial Code 50513(b) 105 California Financial Code 22172(c) 106 California Financial Code 50513(c) 107 California Financial Code 22172(d) 108 California Financial Code 50513(d) 109 California Financial Code 22712(a) 110 California Financial Code 22712(b)

109 California Professionals Rulebook The commissioner may, pursuant to 50321, order a residential mortgage loan servicer or a residential mortgage lender licensee to cease any other business conducted at any location where the licensee operates under the authority of a residential mortgage servicer/lender license, if the commissioner finds that the conduct of that business has facilitated evasions of this division or the rules adopted pursuant to this division, or that the conduct of that business is in violation of any law to which that business is subject. The commissioner may, at his discretion, issue a loan servicer or a mortgage lender license for a business located outside this state. However, this will constitute an agreement by the mortgage servicer/lender to either: make his/her books, accounts, papers, records, and files available to the commissioner or the commissioner s representatives in this state within 10 calendar days of a request from the commissioner or pay the reasonable expenses for travel, meals, and lodging of the commissioner or the commissioner s representatives incurred during an investigation or examination made at the licensee s location outside this state. The commissioner may, after appropriate notice and opportunity for a hearing, by order censure or suspend for a period not exceeding 12 months, or bar from any position of employment, management, or control any mortgage loan originator, or any other person, if the commissioner finds that the censure, suspension, or bar is in the public interest and that the person has committed or caused a violation of Division 20 or rule or order of the commissioner, and: The violation was either known or should have been known by the person committing or causing it; or The violation has caused material damage to the mortgage loan originator or to the public. 117 Persons suspended or barred under are prohibited from participating in any business activity of a mortgage loan originator and from engaging in any business activity on the premises where a licensed mortgage loan originator is conducting its business. This subdivision will not be construed to prohibit suspended or barred persons from having their personal transactions processed by a licensed mortgage loan originator California Financial Code 50130(d) 112 California Financial Code 50120(d) 113 California Financial Code 50130(e)(1) 114 California Financial Code 50120(e)(1) 115 California Financial Code 50130(e)(2) 116 California Financial Code 50120(e)(2) 117 California Financial Code 50318(a)(1) 118 California Financial Code 50318(d)

110 California Professionals Rulebook Powers of the Attorney General Whenever the Attorney General considers that the public interest requires, he or she may, with or without the concurrence of the district attorney, direct the grand jury to convene for the investigation and consideration of those matters of a criminal nature that he or she desires to submit to it. He or she may take full charge of the presentation of the matters to the grand jury, issue subpoenas, prepare indictments, and do all other things incident thereto to the same extent as the district attorney may do. 119 Whenever the Attorney General considers that the public interest requires, he or she may, with or without the concurrence of the district attorney, petition the court to impanel a special grand jury to investigate, consider, or issue indictments for any of the activities subject to fine, imprisonment, or asset forfeiture under of the Welfare and Institutions Code. He or she may take full charge of the presentation of the matters to the grand jury, issue subpoenas, prepare indictments, and do all other things incident thereto to the same extent as the district attorney may do. If the evidence presented to the grand jury shows the commission of an offense or offenses for which venue would be in a county other than the county where the grand jury is impaneled, the Attorney General, with or without the concurrence of the district attorney in the county with jurisdiction over the offense or offenses, may petition the court to impanel a special grand jury in that county. 120 Required Conduct Mortgage loan originators employed and compensated by a licensee who engages in making or brokering residential mortgage loans must maintain a mortgage loan originator license from the commissioner or have obtained a license endorsement from the Commissioner of Business Oversight. 121 A mortgage loan originator employed or compensated by a residential mortgage lender who engages in the business of making, servicing, or making and servicing residential mortgage loans must maintain a mortgage loan originator license from the commissioner. 122 Licensed mortgage loan originators must maintain a valid unique identifier issued by the NMLS. 119 California Penal Code 923(a) 120 California Penal Code 923(b) 121 California Financial Code 22100(b) 122 California Financial Code (a) 123 California Financial Code 22100(e)

111 California Professionals Rulebook Before engaging in the business of a mortgage loan originator with respect to any dwelling located in this state, an individual should first obtain and maintain a license. However, a registered mortgage loan originator is exempt from licensure if they are employed by: A depository institution A subsidiary of a depository institution that is owned and controlled by a depository institution and regulated by a federal banking agency An institution regulated by the Farm Credit Administration. 127 It is a violation of Division 9 for a mortgage loan originator to do any of the following: Directly or indirectly employ any scheme, device, or artifice to defraud or mislead borrowers or lenders or to defraud any person. 128 Engage in any unfair or deceptive practice toward any person. 129 Obtain property by fraud or misrepresentation. 130 Solicit or enter into a contract with a borrower that provides in substance that the mortgage loan originator may earn a fee or commission through best efforts to obtain a loan even though no loan is actually obtained for the borrower. 131 Solicit, advertise, or enter into a contract for specific interest rates, points, or other financing terms unless the terms are actually available at the time of soliciting, advertising, or contracting. 132 Conduct any business covered by Division 9 without holding a valid license as required under Division 9, or assist or aid and abet any person in the conduct of business under Division 9 without a valid license as required under Division Fail to make disclosures as required by Division 9 and any other applicable state or federal law, including regulations there under. 134 Fail to comply with Division 9 or rules or regulations promulgated under Division 9, or fail to comply with any other state or federal law, including the rules and regulations there under, applicable to any business authorized or conducted under Division California Financial Code California Financial Code 22100(f) 126 California Financial Code California Financial Code 22100(g) 128 California Financial Code 22755(a) 129 California Financial Code 22755(b) 130 California Financial Code 22755(c) 131 California Financial Code 22755(d) 132 California Financial Code 22755(e) 133 California Financial Code 22755(f) 134 California Financial Code 22755(g) 135 California Financial Code 22755(h)

112 California Professionals Rulebook Make, in any manner, any false or deceptive statement or representation including, with regard to the rates, points, or other financing terms or conditions for a residential mortgage loan, or engage in bait and switch advertising. 136 Negligently make any false statement or knowingly and willfully make any omission of material fact in connection with any information or reports filed with a governmental agency or the NMLS or in connection with any investigation conducted by the commissioner or another governmental agency. 137 Make any payment, threat, or promise, directly or indirectly, to any person for the purposes of influencing the independent judgment of the person in connection with a residential mortgage loan, or make any payment, threat, or promise, directly or indirectly, to any appraiser of a property, for the purposes of influencing the independent judgment of the appraiser with respect to the value of the property. 138 Collect, charge, attempt to collect or charge, or use or propose any agreement purporting to collect or charge any fee prohibited by Division Cause or require a borrower to obtain property insurance coverage in an amount that exceeds the replacement cost of the improvements as established by the property insurer. 140 Fail to truthfully account for moneys belonging to a party of a residential mortgage loan transaction. 141 A mortgage loan originator licensed under Division 9 may not pay any commission, fee, or other compensation to an unlicensed individual for conducting activities that require a license, unless that unlicensed individual is exempt from licensure pursuant to Division A residential mortgage lender, or a person or employee acting under the authority of a residential mortgage lender s license, including a mortgage loan originator, may not provide brokerage services to a borrower, except as provided in 50700(c) below. 143 A mortgage loan originator employed by a residential mortgage lender may provide brokerage services under the authority of the lender s license if the lender first enters into a written brokerage agreement with the borrower that satisfies the requirements of A mortgage loan originator may only provide brokerage services as an employee of a licensed residential mortgage lender California Financial Code 22755(i) 137 California Financial Code 22755(j) 138 California Financial Code 22755(k) 139 California Financial Code 22755(l) 140 California Financial Code 22755(m) 141 California Financial Code 22755(n) 142 California Financial Code California Financial Code 50700(a) 144 California Financial Code 50700(c)

113 California Professionals Rulebook The Homeowner s Bill of Rights The Homeowner Bill of Rights (HBOR) complements existing laws by adding new protections to help prevent avoidable foreclosures. It calls for enhanced notifications to ensure that borrowers know their rights and know how to contact their loan servicer to pursue a loan modification or some other form of relief. It limits the ability of loan servicers to advance the foreclosure process when loan modification applications are under consideration. It promotes better communication between borrower and loan servicer by requiring loan servicers to provide an accountable, consistent point of contact to assist the homeowner through the loan modification and/or foreclosure process. The Homeowner Bill of Rights requires lenders to provide borrowers with proper documentation before the foreclose process can take place. It also gives borrowers tools to enforce their rights. Applicability of the Law The Homeowner s Bill of Rights, which came into effect on January 1, 2013, applies to first trust deeds which are secured by owner-occupied properties consisting of one-to-four residential units. Definitions An owner-occupied property is the principal residence of a borrower. It is secured by a personal, family, or household loan made for personal, family, or household purposes. 146 A borrower is a natural person who may be eligible for a foreclosure prevention alternative program offered by the mortgage servicer. A borrower may not be someone who has filed bankruptcy, surrendered the secured property, or contracted with an organization which mainly advises the public on ways to extend the foreclosure process and avoid fulfilling contractual obligations. 147 Foreclosure prevention alternative may refer to a first lien loan modification or to a loss mitigation program (including short sales). 148 Some sections of the Homeowner s Bill of Rights only apply to banks, which foreclosed on more than 175 one-to-four residential units in the preceding annual reporting period California Financial Code 50700(e) 146 California Civil Code California Civil Code (c) 148 California Civil Code (b) 149 California Civil Code (b)

114 California Professionals Rulebook Additional Guidelines and Rules No Dual Tracking during Short Sale Until December 31, 2017, when a foreclosure prevention alternative has been approved in writing by all parties (first lien investor, junior lienholder, mortgage insurer etc.) and proof of funds or financing has been provided to the servicer, the servicer or lender may not: Record a notice of default; Record a notice of sale; or Conduct a trustee s sale From January 1, 2018, a lender or mortgage servicer will not be allowed to record a notice of sale or conduct a trustee's sale: If the borrower's complete application for a foreclosure prevention alternative is pending; and Until the borrower has been given a written determination by the mortgage servicer. From January 1, 2018, this legislation will also apply to banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period. 150 Cancelling a Pending Trustee s Sale A mortgage servicer must rescind a pending trustee s sale when: A short sale has been approved by all parties (first lien investor, junior lienholder, mortgage insurer etc.); and Proof of funds or financing has been provided to the lender / authorized agent. For all other forms of foreclosure prevention alternatives, a lender is either required to record a rescission of a notice of default or cancel a pending trustee's sale if a borrower executes a permanent foreclosure prevention alternative. Such requirements, which do not apply to banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period, will be phased out on January 1, California Civil Code California Civil Code

115 California Professionals Rulebook Single Point of Contact A direct means of communication with a single point of contact must promptly be made available to borrowers who request a foreclosure prevention alternative. This single point of contact must remain in place until: All loss mitigation options offered are exhausted; or The borrower s account becomes current. The responsibilities of the single point of contact, who may be an individual or a team, will include: Managing the application for the foreclosure prevention alternative Providing status reports in a timely and accurate manner Coordinating with those able and authorized to suspend the foreclosure proceedings Referring the borrower to a manager upon the borrower s request When the single point of contact is a team, each team member should be aware of the borrower s circumstances and should know their status in the foreclosure alternative process. Banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period are exempt from such requirements. 152 No Dual Tracking during Loan Modification As a rule, a mortgage servicer may not conduct a trustee s sale or record a notice of default or a notice of sale in cases of a nonjudicial foreclosure if: The borrower s application for a first lien loan modification is still pending; or The borrower has fully complied with the terms of: o a written trial; o a permanent loan modification; o a forbearance; or o a repayment plan In cases where a loan modification application is rejected, the borrower will be given the opportunity to appeal. However, they must do so within 30 days of the denial. 153 A mortgage servicer may not foreclose on a property during that 30-day period California Civil Code

116 California Professionals Rulebook N.B.: A mortgage servicer is NOT required to evaluate a first lien loan modification application if: The borrower was assessed prior to 2013 The borrower was given a fair opportunity to be assessed The borrower does not submit documented material changes in their financial circumstances 155 Such requirements will expire on December 31, From January 1, 2018, lenders and mortgage servicers will not be allowed to record a notice of sale or conduct a trustee s sale: If the borrower s complete application for a foreclosure prevention alternative is pending; and Until the borrower has been given a written determination by the mortgage servicer. Banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period will remain exempt from these requirements until January 1, No Late Fees or Application Fees A mortgage servicer may not collect late fees while: A first lien loan modification application is being considered; An appeal for a loan modification is ongoing; The borrower is up to date with their modification payments; or The evaluation or exercise of a foreclosure prevention alternative is ongoing A mortgage servicer may not levy a fee for the application or the processing of a first lien loan modification or other foreclosure prevention alternative. Such requirements, which do not apply to banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period, will be phased out on January 1, California Civil Code (d) 154 California Civil Code (e) 155 California Civil Code (g) 156 California Civil Code California Civil Code

117 California Professionals Rulebook Additional Loan Modification Safeguards Mortgage servicers must, within five business days, acknowledge receipt, in writing, of a borrower's submission of a complete first lien modification application (or of any other document in connection with a first lien modification application). Such requirements will remain in place until December 31, The acknowledgement of receipt must, among other things: Describe the loan modification process; State when the mortgage servicer is expected to make a decision; Include any other relevant timeframes; and Highlight deficiencies, if any, in the borrower's application. 158 When a first lien loan modification is denied, a mortgage servicer is required to provide the borrower with a written notice explaining the reasons behind the denial as well as other relevant information. Such requirements will not apply to banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period until January 1, Binding if Loan is Transferred Once a foreclosure prevention alternative has been approved in writing, it must be honored by any subsequent mortgage servicer should the borrower s loan be sold or transferred. Such a requirement, which does not apply to banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period, will be phased out on January 1, Review of Foreclosure Documents The recording of a notice of default or the initiation of the foreclosure process can only be performed by: The holder of the beneficial interest under the deed of trust; An authorized designated agent of the holder of the beneficial interest; or The original or substituted trustee under the deed of trust. 158 California Civil Code (a) 159 California Civil Code California Civil Code California Civil Code

118 California Professionals Rulebook Mortgage servicers must verify the accuracy and completeness of the following foreclosure documents: Initial contact declaration Notice of default Notice of sale Assignment of deed of trust Substitution of trustee Declarations and affidavits filed in the judicial foreclosure proceeding. Mortgage servicers must also ensure that these documents are supported by competent and reliable evidence to substantiate a borrower s default and their right to foreclose. Mortgage servicers who repeatedly fail in their obligation to review foreclosure documents will be liable for a civil penalty of up to $7,500 per deed of trust should any action be brought by the Attorney General, the district attorney, or the city attorney. Mortgage servicers may be faced with the same penalty in an administrative proceeding brought by the Department of Business Oversight (DBO), the Department of Corporations (DOC) or the Department of Financial Institutions (DFI) Such provisions apply to all trust deeds irrespective of occupancy or number of units. Extending Initial Contact Requirements A mortgage servicer or lender must contact a borrower in person of by telephone to assess their financial situation and discuss potential avenues to avoid foreclosure. A notice of default may only be recorded 30 days after this initial contact, in which the borrower must: Be advised of their right to request an additional meeting within 14 days; and Be provided with a toll-free number to identify a HUD-certified housing counseling agency. Any notice of default must either confirm that the initial contact has taken place or that the mortgage servicer is exempt from making such a contact. This legislation applies to first trust deeds secured by owner-occupied residential properties consisting of one-to-four units. 162 California Civil Code 2924(a)(6) 163 California Civil Code (c) 164 California Civil Code

119 California Professionals Rulebook Notifying Borrowers before Notice of Default In cases of nonjudicial foreclosures, mortgage servicers may not record a notice of default until the borrower(s) has/have been informed of their right to: Request copies of the promissory note, deed of trust, payment history, and assignment of loan, if any, to demonstrate the mortgage servicer's right to foreclose; and Certain protections under the Servicemembers Civil Relief Act if the borrower is a service member or a dependent. This requirement, which does not apply to banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period, is due to be phased out on January 1, Notifying Borrowers after Notice of Default As a rule, a mortgage servicer is required to provide the borrower with a written notice detailing the manner in which they can apply for the mortgage servicer s foreclosure prevention alternatives, if any are available. The written notice should be provided within 5 business days following the recording of the notice of default. However, this requirement does not apply if the borrower has already exhausted the first lien loan modification process offered by the mortgage servicer. This requirement, which does not apply to banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period, is due to be phased out on January 1, Postponing a Trustee s Sale In cases where a trustee s sale is postponed for more than 10 business days, the lender or authorized agent will write to the borrower to confirm the new date and time of the sale. This written notice must be provided within 5 business days of the postponement. However, failure to comply with this requirement will in no way invalidate any trustee's sale that is otherwise valid. 165 California Civil Code California Civil Code California Civil Code

120 California Professionals Rulebook This requirement, which applies to all trust deeds irrespective of occupancy or number of units, will be phased out on January 1, Legal Remedies for Borrowers Borrowers are generally provided with a private right of action to enjoin or stop a trustee's sale while the mortgage servicer corrects some of the material violations of this law. In cases where the recording of the trustee s deed has already taken place, the borrower may be entitled to monetary damages as a result of these violations. If these violations are found to have been intentional and reckless, the mortgage servicer may be liable for 3 times actual damages or $50,000, whichever is greater. Any borrower who receives compensation may also be awarded reasonable attorney s fees and costs. From January 1, 2018, this legislation will also apply to banks which foreclosed on fewer than 175 one-to-four residential units in the preceding annual reporting period. 169 Lenders Standard of Care to Investors The goal of this legislation is to ensure that mortgage servicers provide borrowers with loan modifications or workout plans which meet their contractual or other authority. A mortgage servicer s duty to maximize net present value under a pooling and servicing agreement should benefit all investors. A mortgage servicer will be deemed to have acted in the best interest of all investors if the loan modifications or workout plans were set up in keeping with a number of specific parameters California Civil Code 2924(a)(5) 169 California Civil Code California Civil Code