LOS Journal – Volume 1 Issue 12

Why Haven’t Loan Officers Been Told These Facts?

Know Before You “Show” – The Loan Estimate
Here are the answers to last week’s quiz:

Test 1
Regulation Z requires lenders to estimate and classify Private Mortgage Insurance (PMI) costs when determining good faith. On the Loan Estimate (LE), page 2, Closing Cost Details – under what Category and Subheading should the lender list PMI costs, and what is the allowable tolerance for variation at consummation?

1. Loan Cost, Subheading B Services You Cannot Shop For – Zero tolerance for change
2. Other Costs, Subheading F Prepaids – No specific tolerance
3. Other Costs, Subheading G Initial Escrow Payment at Closing – No specific tolerance
4. All of the above

Test 2
The lender provides a $500 gift card to applicants at closing. Is this permissible under Regulation Z, and if so, what impact does the gift card have on the TRID disclosures?

1. Yes – The lender must account for the $500 gift card on both the LE and CD.
2. No – Section 8 prohibits kickbacks for mortgages. The $500 is a thing of value in exchange for a mortgage loan.
3. Yes- As per FNMA, the lender does not need to disclose gift cards for $500 or less on the LE or CD.
4. No – Lenders may contribute to closing costs and prepaid expenses only. Regulation Z prohibits payment of cash or similar elements as part of the federally related mortgage loan settlement.

1026.17(c)(1) General disclosure requirements (1) The disclosures shall reflect the terms of the legal obligation between the parties.

1026.17(c)(1) Comment 19. Rebates and loan premiums. In a loan transaction, the creditor may offer a premium in the form of cash or merchandise to prospective borrowers. Similarly, in a credit sale transaction, a seller’s or manufacturer’s rebate may be offered to prospective purchasers of the creditor’s goods or services. Such premiums and rebates must be reflected in accordance with the terms of the legal obligation between the consumer and the creditor. Thus, if the creditor is legally obligated to provide the premium or rebate to the consumer as part of the credit transaction, the disclosures should reflect its value in the manner and at the time the creditor is obligated to provide it.

Lender credits for general or specific costs are zero-tolerance items. The credit promised to the applicant in the Loan Estimate (LE) must be the exact amount (absent a changed circumstance or principal reduction) credited to the applicant on the Closing Disclosure (CD). Regulation Z disclosure rules 1026.17(c)(1) likely demand that lenders reflect their obligations in the early financial disclosures. An inducement such as a $500 gift card could undoubtedly fall under the rubric of a legal obligation as detailed in the Regulation Z official commentary 1026.17(c)(1)-19.

When using the LE and CD, exactly where and how the lender might disclose the gift card or a Paid Outside of Closing (POC) item is debatable. However, POC at consummation is probably a good bet.

The main thrust is that lenders must clearly and conspicuously make the terms clear to the consumer. Notably, this required clarity includes “no closing costs” disclosure that can get technical and confusing. For instance, is the financing no Loan Costs, and the borrower pays the Escrows and Prepaids? Could the lender’s needless parsing of the legal jargon misrepresent its offering to the borrower? Whether the charge is a Loan Cost, Finance Charge, Prepaid, or Escrow, does the technical nature of these terms mislead consumers into agreements they don’t understand? Consistent nomenclature might help. Additionally, lenders should use simple addendums and agreements to detail the lender’s credit in nontechnical language. Most importantly, any addendums or agreements must align with the LE and CD.

Next week the Journal diagrams better disclosure techniques to allay miscommunications when explaining lender credits.

Behind the Scenes

General Qualified Mortgage (QM) loans could present unexpected challenges for Mortgage Brokers and Correspondents

Here is a recap of last week’s article on uncertainty with the General QM model. The APR threshold tests for Higher-Priced Mortgage Loans (HPML) and the new General QM (GQM) compliance model depend on accurate APR calculations. Therefore, an understated APR, even within allowable tolerance, could result in unintentionally closing an HPML. In addition, HPML compliance requirements differ significantly from non-HPML. For example, funding an HPML with appraisal waivers, no second appraisal, no escrows, or similar issues will result in repurchases and TILA violations. Due to this threat risk, lenders should be careful to overstate APRs to avoid unintentionally miscalculating the GQM and HPML thresholds.

The APR may be thought of as the finance charges expressed as an annualized percentage cost of the credit. For closed-end credit, the APR must be disclosed as a single rate only, whether the loan has a single interest rate, a variable interest rate, a discounted variable interest rate, or graduated payments. Since an APR measures the total cost of credit, including transaction charges or premiums for mortgage insurance, it is not an “interest” rate, as the term is used.

As a result of the APR’s central role in TILA compliance, your lender might surprise you by regularly overstating the APR. If this surprise occurs mid or late-stream in the loan manufacture, higher loan costs and closing delays are possible.

For example, you submit a non-HPML loan to the lender for sale to FNMA. Your Loan Origination System (LOS) calculated the APR at 1.45 over the Average Prime Offer Rate (APOR). The lender calculates the APR on their system at 1.60 over APOR. As a result, the lender defers on funding until the broker resolves the APR issue. At that point, the three-day waiting period for a corrected Closing Disclosure might be the least of your worries. The lender could decline the loan if the broker cannot get the calculated APR under the HPML threshold. If the lender offers HPML, the pricing and terms may be a substantive departure from the submitted loan. Undoubtedly, further complications arise when pivoting from non-HPML to HPML (e.g., escrow or second appraisal). In any event, significant mid or late-stream pivots are often problematic.

These challenges could potentially mirror the disruption caused in implementing the Mortgage Disclosure Improvement Act of 2008 (MDIA). Regulation Z changes at that time resulted in widely experienced closing delays due to APR tolerance issues with the final Truth In Lending Statements (TILS).

The MDIA requires creditors to mail or deliver early TILA disclosures at least seven business days before consummation and provide corrected disclosures if the disclosed APR changes over the specified tolerance. The consumer must receive the corrected disclosures no later than three business days before consummation. Hence, implementation uncertainties surrounding APR calculations and the delivery of the corrected TILS resulted in significant headaches early in the MDIA implementation.

Under the Truth In Lending Act and Regulation Z, the holistic credit costs vary depending on the interest rate, the loan amount, charges connected to the loan, and the repayment schedule. The APR, which lenders must disclose in nearly all consumer credit transactions, is designed to consider all relevant factors and provide a uniform measure for comparing the cost of various credit transactions.

Things can get tricky because of the uncertainty surrounding the APR calculus and threshold tests. Furthermore, Regulation Z allows for different APR calculation methods. Whichever method the financial institution uses, the rate calculated will be accurate if it can “amortize” the amount financed while generating the finance charge under the method selected.

Charges included in the APR calculation vary but generally include projected interest paid and charges imposed on the consumer in connection with the financing. Regulation Z defines projected interest payments and the ancillary charges connected to the financing as Finance Charges. Charges imposed by third parties are Finance Charges if the creditor requires the use of the third party. Charges imposed on the consumer by a settlement agent are finance charges only if the creditor requires the particular services for which the settlement agent is charging the borrower. In some cases, including a fee as a Finance Charge is optional or depends on the transaction. For example, the lender may exclude customary Finance Charges such as origination fees or discounts from the APR calculation if the seller pays. As a result of these variables, the likelihood of the calculated APR varying between a lender’s loan origination system and the submitting TPO’s system is probable.

Financial institutions rely on allowable accuracy tolerances to create a compliance buffer, permitting somewhat imprecise but still legal APRs to be disclosed. Nevertheless, lenders still err on the side of caution and choose to overstate the APR by overstating the Finance Charges.

TPOs, sometimes understate the APRs to appear more competitive. Lenders overstate the APR, TPOs understate the APR – herein lies the potential issue.

Next week, the Journal will unpack risk management practices for coping with potential APR misalignment.