BILL ANALYSIS
AB 260
Page 1
Date of Hearing: March 23, 2009
ASSEMBLY COMMITTEE ON BANKING AND FINANCE
Pedro Nava, Chair
AB 260 (Lieu, Bass, and Nava) - As Introduced: February 11,
2009
SUBJECT : Lending
SUMMARY : Enacts duties, requirements and prohibitions relating
to higher priced mortgage loans. Specifically, this bill :
1)Provides the Department of Real Estate (DRE), Department of
Corporations (DOC) and Department of Financial Institutions
(DFI) with the authority to suspend or revoke the license of
their licensees for violating:
a) The federal Real Estate Settlement Procedures Act
(RESPA);
b) The federal Truth in Lending Act (TILA);
c) The federal Home Ownership Equity Protection Act
(HOEPA); and,
d) Any regulations promulgated under RESPA, TILA or HOEPA.
2)Defines "higher priced mortgage loan" as having the same
meaning set forth in Part 226 of Title 12 of the Code of
Federal Regulations (CFR). This citation provides that a
"higher priced loan" is a consumer credit transaction secured
by the consumer's principal dwelling for which the annual
percentage rate (APR) on the loan exceeds the yield on
comparable Treasury securities by at least three percentage
points for first-lien loans, or five percentage points for
subordinate-lien loans
3)Defines "licensed person" as a real estate broker licensed
under the Real Estate Law (Part 1 (commencing with Section
10000) of Division 4 of the Business and Professions Code), a
finance lender or broker licensed under the California Finance
Lenders Law (Division 9 (commencing with Section 22000)), a
residential mortgage lender licensed under the California
Residential Mortgage Lending Act (Division 20 (commencing with
Section 50000)), a commercial or industrial bank organized
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under the Banking Law (Division 1 (commencing with Section
99)), a savings association organized under the Savings
Association Law (Division 2 (commencing with Section 5000)),
and a credit union organized under the California Credit Union
Law (Division 5 (commencing with Section 14000)).
4)Defines "mortgage broker" as a licensed person who provides
mortgage brokerage services.
5)Defines "mortgage brokerage services" as arranging or
attempting to arrange, as exclusive agent for the borrower or
as dual agent for the borrower and lender, for compensation or
in expectation of compensation, paid directly or indirectly, a
higher-priced mortgage loan made by an unaffiliated third
party.
6)Provides that the maximum amount of a prepayment penalty for a
higher priced loan may not exceed 2% of the principle balance
prepaid for prepayment of the loan during the first 12 months
following loan consummation, or 1% of the principle balance of
the loan during the second 12 months following consummation.
7)Specifies that the provisions of the bill dealing with higher
priced loans apply to any licensed person who attempts in bad
faith, to avoid application, by:
a) Dividing any loan transaction into separate parts for
the purpose, and with intent of evading the law; or,
b) Any other subterfuge.
8)Provides that a licensed person shall not make, or cause to be
made, any false, deceptive, or misleading statement or
representation in connection with a higher priced loan.
9)Requires that a mortgage broker must disclose to a borrower in
writing and verbally if they only offer higher priced mortgage
loans.
10)Prohibits a mortgage broker from steering, counseling, or
directing a borrower to accept a loan at a higher cost than
that which the borrower could qualify based upon the loans
offered by the person with whom the broker regularly does
business.
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11)Provides that when a broker provides mortgage brokerage
services, the broker shall receive the same compensation
whether paid by the lender, borrower or a third party.
12)Prohibits the payment of compensation to a broker for
arranging a higher priced loan with prepayment penalty that is
more than they would have received for arranging a higher
priced loan without a prepayment penalty.
13)Prohibits a licensed person from making a higher priced loan
that contains a provision for negative amortization.
14)Allows negative amortization to take place if it is for
purposes of a loan modification.
15)Provides a cure provision for a licensed person who, when
acting in good faith, fails to comply and within 90 days of
the loan closing and prior to the institution of an action the
licensed person does the following:
a) Notify the borrower of the compliance failure;
b) Tender appropriate restitution; and,
c) Offer the borrower the option to correct the higher
priced loan or change the terms to make it beneficial to
the borrower.
16)Provides that if a compliance failure was not intentional and
resulted from a bona fide error and within 120 days after
receipt of a compliance or discovery of the failure, the
licensed person shall not be liable if they do the following:
a) Notify the borrower of the compliance failure;
b) Tender appropriate restitution; or,
c) Offer the borrower the option to make the loan comply
with the terms of this bill or change the terms of the loan
so that it is beneficial to the borrower.
17)Provides that a licensed person in violation of the
provisions of this bill is also in violation of their
licensing law.
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18)Gives authority to the respective licensing agencies (DOC,
DFI, and DRE) to, by order and after appropriate
administrative hearing, prohibit licensees from engaging in
acts or practices in connection with higher priced mortgage
loans that the licensing agency finds to be unfair, deceptive,
or designed to evade the laws of this state.
19)Allows the licensing agency or the Attorney General to bring
an enforcement action with a civil penalty of $10,000 per
violation.
20)Provides that a provision of a prepayment penalty that
violates TILA or this bill is a violation subject to the
penalties in this bill.
21)Allows a borrower to bring a civil action for actual damages
and to recover attorney's fees.
22)Provides that a mortgage broker providing mortgage brokerage
services is a fiduciary of the borrower and any violation of
that duty is a violation of the mortgage broker's licensing
law.
23)Specifies that the fiduciary duty that a broker owes to a
borrower includes a requirement that the mortgage broker place
the interest of the borrower ahead of his or her own interest.
24)Provides that a mortgage broker who provides mortgage
brokerage services to a borrower owes a fiduciary duty to the
borrower regardless of whether the mortgage broker is acting
as an agent for any other party in the connection with the
loan transaction.
25)Enacts the provisions relating to higher priced loans on July
1, 2009.
EXISTING FEDERAL LAW :
1)Authorizes federally-chartered financial institutions to
engage in the business of mortgage lending, brokering, and
servicing and governs the rules under which such activities
may be conducted under a wide variety of laws, including, but
not limited to, the HOEPA, RESPA, TILA, HMDA, and regulations
that interpret those acts (most notably Regulation C, which
interprets the Home Mortgage Disclosure Act and Regulation Z
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(Reg Z), which interprets the TILA).
2)Regulates, the financial institutions that engage in mortgage
lending and brokering under five different agencies, including
the Office of the Comptroller of the Currency (OCC), Federal
Reserve Board (FRB), Office of Thrift Supervision (OTS),
Federal Deposit Insurance Corporation (FDIC), and National
Credit Union Administration (NCUA);
3)Regulates the brokerage and lending activities conducted under
federal law using two additional federal agencies, including
the United States Housing and Urban Development (HUD) and the
Federal Trade Commission.
EXISTING STATE LAW :
1)Establishes that a "covered loan" means a consumer loan in
which the original principal balance of the loan does not
exceed $250,000 in the case of a mortgage or deed of trust,
and where one of the following conditions are met:
a) For a mortgage or deed of trust, the APR at consummation
of the transaction will exceed by more than eight
percentage points the yield on Treasury securities having
comparable periods of maturity on the 15th day of the month
immediately proceeding the month in which the application
for the extension of credit is received by the creditor;
and,
b) The total points and fees payable by the consumer at or
before closing for a mortgage or deed of trust will exceed
6% of the total loan amount. [Financial Code, Section
4970(b)(1)]
2)Specifies that the loan limit for covered loans shall be
adjusted every five years in accordance with the California
Consumer Price Index. [Financial Code, Section 4970(b)(2)]
3)Establishes that "points and fees" include the following:
a) All items required to be disclosed as finance charges
under specified sections of the CFR, including the Official
Staff Commentary, as amended from time to time, except
interest;
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b) All compensation and fees paid to mortgage brokers in
connection with the loan transaction; and,
c) All items as specified in the CFR, only if the person
originating the covered loan receives direct compensation
in connection with the charge. [Financial Code, Section
4970(c)(1)]
1)Includes a list of 14 prohibited acts and limitations for
covered loans, including:
a) A covered loan shall not include a prepayment fee or
penalty after the first 36 months after the date of
consummation of the loan. Prepayment penalties are subject
to various limitations and restrictions as specified;
b) A covered loan with a term of five years or less may not
provide at origination for a payment schedule with regular
periodic payments that when aggregated do not fully
amortize the principal balance as of the maturity date of
the loan;
c) A covered loan may not contain a negative
amortization provision unless the loan is a first
mortgage and the lender discloses specified information
about the provision;
d) A covered loan shall not contain a provision that
increases the interest rate as a result of a default;
e) A person who originates covered loans shall not make or
arrange a covered loan unless at the time the loan is
consummated, the person reasonably believes the consumer,
or consumers, when considered collectively in the case of
multiple consumers, will be able to make the scheduled
payments to repay the obligation based upon a consideration
of their current and expected income, current obligations,
employment status, and other financial resources, other
than the consumer's equity in the dwelling that secures
repayment of the loan; and,
f) A person who originates a covered loan shall not
refinance or arrange for the refinancing of a consumer loan
such that the new loan is a covered loan that is made for
the purpose of refinancing, debt consolidation or cash out,
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that does not result in an identifiable benefit to the
consumer, considering the consumer's stated purpose for
seeking the loan, fees, interest rates, finance charges,
and points. [Financial Code, Section 4973]
1)Establishes various penalties and enforcement provisions for
lenders and real estate brokers who violate the covered loan
law, including:
a) Administrative penalties of not more than $2,500 for
each violation;
b) Civil penalties of not more than $25,000 for each
knowing and willful violation; and,
c) Civil liability to the consumer in an amount equal to
any actual damages, plus attorney's fees and costs. For a
willful and knowing violation, the lenders shall be liable
to the consumer for $15,000 or the consumer's actual
damages, whichever is greater, plus attorney's fees and
costs.
FISCAL EFFECT : Unknown
COMMENTS :
Need for the bill .
In justifying the need for this bill the author states:
This bill represents a balanced and common sense approach
to reign in the abuses that occurred in the
subprime market. California will lead the nation in following
up on the recent amendments to
Federal Regulation Z by adopting additional stringent standards
and regulations for brokers and
lenders.
AB 260 strikes the correct balance between eliminating the
abuses in the subprime market and
maintaining viable home ownership options across California's
diverse communities. With
California's high housing prices, it is vital that products and
practices that can save the consumer
money be available so long as those products and practices are
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used responsibly. It would be
unacceptable to further widen the minority home ownership gap or
inadvertently harm consumers with
lower incomes.
Some subprime lending has helped millions of people achieve
the American Dream. It is
irresponsible subprime lending that needs to be eliminated. AB
260, with its strong focus on
preventing misconduct by brokers and lenders-seeks to eliminate
irresponsible subprime lending,
while preserving access to homeownership.
Background : This bill is intended to address issues that have
led to the subprime mortgage crisis by ensuring that on a going
forward basis, subprime lending will be responsible and
beneficial to consumers. AB 260 is complimentary to the recent
changes to TILA. Those changes are discussed in more detail
later in this analysis.
Provisions of AB 260 :
1)Fiduciary duty standard:
AB 260 codifies a fiduciary duty standard for mortgage brokers
across all loan products. A violation of this duty will make a
broker subject to a violation of their license, as well as,
strong civil liability and penalties.
2)Eliminates compensation incentives that can lead to steering:
The subprime marketplace has incentives, including yield spread
premiums that entice brokers to put borrowers into costlier
loans without the knowledge of the borrower. The current
structure of compensation provides a perverse incentive to steer
borrowers to a riskier loan in order to increase the broker's
compensation. AB 260 attempts to eliminate this incentive by
requiring that regardless of who pays the broker (borrower,
lender or third party); the compensation must be the same. This
will ensure that a broker can receive no more from a lender than
the borrower would pay to the broker in up-front costs.
The intention is to remove the incentive to steer borrowers
while ensuring that consumers can make informed choices about
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how to pay for their loan costs. For instance, a broker cannot
make more in compensation from a loan with a yield spread
premium than the same loan without a yield spread premium.
3)Prohibits loan steering:
AB 260 directly prohibits a broker from steering borrowers to
accept a loan at a higher cost than the consumer could otherwise
qualify. Additionally, a mortgage broker that only originates
subprime loans must disclose that fact to a borrower prior to
offering services.
4)Prohibits deceptive statements:
AB 260 contains a broad prohibition against brokers and lenders
from making false or deceptive statements connected with a
subprime loan. This will require lenders and brokers to be
upfront and honest in subprime loan transactions and ensure that
borrowers are not misled with false statements about their loan.
5)Cap on prepayment penalties:
Prepayment penalties have been a constant feature in the
subprime marketplace. They have made it possible for subprime
borrowers to get into a home even though they have increased
credit risks. When used correctly, prepayment penalties can
potentially benefit borrowers through lower interest rates.
Prepayment penalties, however, have also been abused in the
subprime market and it is the abuse that AB 260 seeks to
eliminate.
AB 260 establishes clear regulations for prepayment penalties.
In addition to the restrictions put in place by recent
amendments to Reg Z, AB 260 caps the amount of the penalty to no
more than 2% of the principle balance in year one of the loan
and no more than 1% of the principle balance in subsequent
years.
AB 260 also prohibits anyone who arranges a subprime loan from
receiving increased compensation for originating a loan that
includes a prepayment penalty.
6)Bans negative amortization loans:
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Many option ARM loans included scheduled payments that would
lead the borrower to owe more on the loan than its original
balance. Once this happens, the borrower is subject to an
extreme payment shock to make the adjustment or a balloon
payment to cover the difference. AB 260 prohibits any subprime
loan that could lead to negative amortization.
The following discussion examines other legislative and
regulator efforts to reform mortgage lending.
Covered Loan Law : With the enactment of AB 489 in 2001
[Division 1.6 of the Financial Code] and the subsequent clean-up
bill [AB 344 (Migden) Chapter 733, Statutes of 2001], lenders
who make "covered loans" must meet various requirements that
give borrowers additional protections against predatory
practices. The covered loan law was the Legislatures attempt to
prohibit the most egregious lending practices. This law
effectively provided for a usury ceiling beyond which no one
would pass. For example, the points trigger is 8% above
comparable yield on treasury securities or 6% of the loan amount
in fees. AB 489 started as a bill to cover loans five points
above comparable securities. Much later, it was amended to
establish the covered loan law with points and fees triggers
more closely related to the HOEPA standard. AB 489 was a hard
fought bill that was amended nine times throughout the
legislative process. The intent of AB 489 was to prohibit
egregious practices related to those loans, such as loan
flipping, equity stripping, and other predatory practices. What
in effect happened was the covered loan law become a threshold
or cap that lenders would not cross.
Many lenders had underwriting automation processes that would
prohibit them from underwriting a covered loan. Depending on
how one perceives the covered loan law, it has been a great
success in that it has prohibited loans with extremely high
rates and fees. The downside is that the covered loan law is
viewed by many as the last stop on the road of mortgage
regulation. The problem has become, that the covered loan law
did not address subprime loans that have become so common in the
marketplace. With such a high threshold, millions of loans
could be made below the thresholds, and without appropriate
underwriting standards.
On February 28, 2005 the Assembly Committee on Banking Finance
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held an information hearing "Covered and Subprime Loans in
California: Are Consumers Getting the Protection They Need?"
At that hearing New Century Financial, a lender with 16 offices
in California working with thousands of independent mortgage
brokers, testified to the following:
The current mortgage lending law, AB 489, is working because
it strikes the proper balance between outlawing predatory
lending practices and placing appropriate limits and
restrictions on so-called covered loans while allowing
deserving consumers access to mortgage credit. Given the
state of the California mortgage market and the rising cost
of housing, a great degree of caution should be exercised
when altering consumers' ability to access much needed
mortgage credit.
New Century was one of the first victims of the subprime crisis,
filing for bankruptcy on April 7, 2007.
Federal Guidance on non-traditional products : In September
2006, the five federal banking agencies (OCC, OTS, FRB, FDIC,
and NCUA) issued guidance on nontraditional mortgage product
risks. The guidance applies to both prime and nonprime loans
and covers federally-regulated financial institutions, their
subsidiaries and affiliates, and federally-insured financial
institutions. Nontraditional loans are those that allow
borrowers to defer repayment of principal, and in some cases,
interest. They are also known as alternative or exotic
mortgages. Borrowers who obtain these loans are given the
opportunity to make relatively low payments during an initial
low interest rate period in exchange for agreeing to make much
higher payments during a later amortization period.
Nontraditional loans are not unique to the subprime market; they
are sold in the prime, alt-A, and subprime markets. Common loan
types covered by the federal guidance include payment option
mortgages and interest-only mortgages (readers are directed to
the background paper for Senate Banking & Finance Committee's
January 31, 2007 hearing for the definitions and common terms of
these loan products).
Key components of the federal guidance include the following:
1)Financial institutions' analyses of borrowers' repayment
capacity should include an evaluation of ability to pay the
fully indexed rate, not just the initial low introductory
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rate. Analyses of repayment capacity should avoid
over-reliance on credit scores as a substitute for income
verification.
2)Institutions should avoid the use of loan terms and
underwriting practices that will heighten the need for a
borrower to rely on the sale or refinancing of the property
once amortization begins.
3)Higher pricing of loans with elevated risks should not replace
the need for sound underwriting.
4)Second mortgages with minimal or no owner equity should not
have a payment structure that allows for delayed or negative
amortization unless the risk is mitigated.
5)Institutions with high concentrations of nontraditional
products should have good risk management practices in place
and capital levels commensurate with the risk.
6)Institutions that offer nontraditional mortgage products
should make the potential consumer of these products aware of
all possible risks and should provide this information to
potential borrowers in a clear, balanced, and timely manner.
Payment shock, negative amortization, prepayment penalties,
and the cost of reduced documentation loans should be
explained. Monthly statements on payment-option adjustable
rate mortgages should explain the consequences of each payment
option.
In issuing the guidance, the federal regulators urged states to
work quickly to apply similar guidance to state-regulated
entities engaged in mortgage lending and brokering. Last year,
this committee passed SB 385 (Machado), Chapter 301, Statutes of
2007 which implemented the Guidance for state licensed entities.
Where does the Guidance and AB 260 differ? First, AB 260 also
addresses higher cost loans, specifically in regards to certain
practices and products. The Guidance did not address the issue
of YSPs, or the downside risk of prepayment penalties. Instead,
the Guidance takes an approach that examines the risk of certain
products and offers that these risks should be disclosed to
borrowers. AB 260 takes a different approach, by limiting
certain types of product behavior. While there is some overlap
of these approaches, they are complementary in regulation.
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The imposition of the Guidance was a good first step, but not
the only solution, as recognized by the Federal Reserve Board in
the official staff commentary by the Federal Reserve Board:
The guidance issued by the federal banking agencies has
helped to promote safety and soundness and
protect consumers in the subprime market. Guidance, however,
is not necessarily
implemented uniformly by all originators. Guidance also does not
provide individual
consumers who have suffered harm because of abusive lending
practices and opportunity for redress.
Regulation Z (TILA) :
On January 9, 2008 the Federal Reserve Board (Board) published
proposed rules that would amend Reg Z, which implements TILA and
the Home HOEPA. The proposal included new restrictions or
requirements for mortgage lending and servicing designed to
protect consumers from abusive mortgage product features and
deceptive acts. This proposal creates a new class of loans for
coverage called "higher-priced loans." These loans are
considered to be those that have most dominated the subprime
marketplace. Whereas, previous efforts, such as the Interagency
Guidance on Subprime Lending defined subprime lending in terms
of borrower characteristics, the changes to Reg Z focus on the
features of the actual loan products. In the Board staff
comments on the final Reg Z changes the commentary acknowledged
that the best way to identify the subprime market is through
"loan price, rather than by borrower characteristics."
The Board received 4700 comments on the proposal from community
banks, mortgage brokers, bank holding companies, secondary
market participants, credit unions, state and national financial
services trade associations, realtors, realtor trade groups,
individual consumers, state and federal regulators, and national
community groups and consumer organizations.
The specifics of the proposal and final rule follow.
Higher-priced loan definition :
The proposal defined higher-priced mortgage loans as a consumer
credit transaction secured by the consumer's principal dwelling
for which the APR on the loan exceeds the yield on comparable
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Treasury securities by at least three percentage points for
first-lien loans, or five percentage points for subordinate-lien
loans. This definition excludes reverse mortgages,
construction-only loans and bridge loans.
After taking into consideration numerous arguments during the
comment period the Board decided to adopt a definition that is
similar to the proposal, but different in the particulars.
Instead of tying the definition to the yield on Treasury
securities, the final definition will use the average offer
rates for the lowest-risk prime mortgages, termed "average prime
offer rates." The Board identified two main difficulties with
using Treasury yields to set APR thresholds into law. First,
the spread between mortgage rates and Treasuries changes in both
the short term and long term. Second, it is difficult to
determine the comparable Treasury security for a given mortgage
loan.
The final threshold will be 1.5 percentage points above the
average prime offer rate as published by Freddie Mac on
comparable transactions for first-lien loans, and 3.5 percentage
points for subordinate-lien loans.
It is possible that the selected thresholds for the definition
of higher-priced loans could spill over and capture part of the
Alt-A market. In the staff commentary to the final proposal
(12 CFR Part 226, Truth in Lending: Final Rule. Federal
Register, Wednesday July 30, 2008) the Board concluded:
If the selected thresholds cover more than the
subprime market, then they likely extend into what has
been known as the alt-A market. The alt-A market is
generally understood to be for borrowers who typically
have higher credit scores than subprime borrowers but
still pose more risk than prime borrowers because they
make small down payments or do not document their
incomes, or for other reasons. The definition of this
market is not precise, however. The Board judges that
the benefits of extending 226.35's restrictions into
some part of the alt-A market to ensure coverage of
the entire subprime market outweigh the costs. This
market segment also saw undue relaxation of
underwriting standards, one reason that its share of
residential mortgage originations grew six fold from
2003 to 2006 (from 2 percent of originations to 13
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percent). To the extent 226.35 covers the
higher-priced end of the alt-A market, where risks in
that segment are highest, the regulation will likely
benefit consumers more than it would cost them.
Ability to repay :
The proposal prohibited creditors from extending credit without
regard of the borrower's ability to repay from sources other
than collateral. The ability to repay also requires that the
borrower must be able to repay the loan plus applicable real
estate taxes and hazard insurance premiums. The proposal
requires that creditors verify income and assets using reliable
third party documentation. The proposed rule included a "pattern
and practice" standard to determine when a violation has
occurred.
The Board found that the most risky types of loans often were
made to borrowers without any consideration of their ability to
repay the loan over its entire life cycle. For example, on a
2/28 ARM the borrower was qualified to pay the loan on the first
two years of the fixed rate but no consideration was given to
repayment ability after the interest rate adjustment at the end
of year two.
The final rule is substantially similar to the proposal. The
major difference is the final rule removed the "pattern and
practice" language. The Board commented:
The Board believes that removing ''pattern or
practice'' is necessary to ensure a remedy for
consumers who are given unaffordable loans and to
deter irresponsible lending, which injures not just
individual borrowers but also their neighbors and
communities. The Board further believes that the
presumption of compliance the Board is adopting will
provide more certainty to creditors than either
''pattern or practice'' or the proposed safe harbor.
The presumption will better aid creditors with
compliance planning, and it will better help them
mitigate litigation risk.
Prepayment penalties (PPPs) :
One of the most controversial and least understood features of
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subprime lending has been PPPs. PPPs are typically a feature of
subprime mortgage loans that require that a borrower pay a
percentage amount of their loan should they pay-off (refinance)
the loan within a certain time-frame. On average, a PPP is
around 3% of the outstanding balance of the loan. With the high
cost of homes in California this can range from $2500-$6,000.
According to First American LoanPerfomance data, three-quarters
of securitized subprime loan pools originated from 2003 through
the first half of 2007 had a PPP. Furthermore, approximately
55% of subprime 2/28 ARMS originated from 2000-2005 prepaid
while the PPP was in effect.
As recent media accounts have portrayed, these penalties are a
source of much controversy. Media reports abound with stories
of borrowers "trapped" into ARMs with rates set to rise above
what they can afford, but they are unable to refinance due to
the prepayment penalty.
On the other side of this debate, some contend that PPPs can
actually provide for an interest rate reduction for the borrower
because loans with this feature command more value on the
secondary market. For a borrower who is educated on their
mortgage loan options, a PPP may make perfect sense for them to
reduce their interest rate. However, far too many stories
reveal that most borrowers do not understand the trade off they
are making, nor is the imposition of the penalty properly
explained in context of the interest rate. Furthermore, due to
the secondary market appetite for these provisions, the
incentive to offer a loan with a prepayment penalty may have
altered some lender's concerns with risk.
The Board's proposal only allowed PPPs if:
1)The penalty period does not exceed five years from loan
consummation.
2)The borrower's debt to income ratio, at consummation does not
exceed 50%.
3)The penalty period expires 60 days prior to an interest rate
reset.
4)The penalty does not apply if there is a refinancing by the
same creditor or its affiliate.
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5)The Board's final proposal was stronger than many had
predicted. In their commentary on the final proposal the
Board concluded:
The Board concludes that prepayment penalties' injuries outweigh
their benefits in the case of higher-priced mortgage loans and
HOEPA loans designed with planned or potential payment increases
after just a few years. For other types of higher priced and
HOEPA loans, however, the Board concludes that the injuries and
benefits are much closer to being in equilibrium. Thus, the
final rule prohibits penalties in the first case and limits them
to two years in the second.
The final rule bans PPPs for higher priced loans if the payment
can change with the first four years after consummation. With
most adjustable rate loans ranging from two to three years, this
provision effectively bans PPP for ARMS. Additionally, for
loans that do not have a payment change the PPP is limited to
the just the first two years after consummation.
Escrows for taxes and insurance :
While escrows are common in the prime mortgage market, the
opposite is true in the subprime market where a majority of
borrowers do not have escrow accounts for taxes and insurance.
Creditors who do not offer escrows can quote lower monthly
payments than those creditors who do offer escrows.
Furthermore, the lack of escrows provides for additional
problems as it can take advantage of borrowers who are shopping
for the lowest monthly payment. A loan with an escrow account
built in will inherently cost more per month than one without.
In the Board's staff commentary on the final change regarding
escrows they found:
The lack of escrows in the subprime market increases the risk
that consumers will base borrowing decisions on unrealistically
low assessments of their mortgage-related obligations.
The proposed rule required creditors to establish an escrow
account for property taxes and homeowners insurance on
higher-priced loans secured by the first lien on the principle
dwelling. The creditor may allow the consumer to cancel the
escrow account 12 months after consummation. The final rule
adopts the proposal.
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Creditor payments to mortgage brokers (YSPs) :
The Board had proposed to prohibit a creditor from paying a
mortgage broker, in a covered transaction, more than the
consumer agreed to in writing that the broker would receive.
This was the Board's attempt to regulate what are known as yield
spread premiums. YSPs are points paid by the lender to the
broker for originating a loan at an above par rate, meaning
slighting higher than that for which the borrower may qualify.
A YSP is financed over a particular time period during the loan.
This practice, in recent years, has come under increasing
scrutiny due to the appearance that it is an enticement for
brokers to steer borrowers into more costly loans than they
could otherwise get. Industry has responded that YSPs serve as
a way for borrowers to pay no money toward the transactional
costs of the loan, as the YSP is used to refund the broker their
payment for costs associated with the transaction. This view is
a subject of dispute among several parties.
The Board attempted to design model language for an agreement
and disclosures. The Board conducted tests and interviews with
consumers and based on the results of those tests decided to
abandon the proposal. The Board concluded that the proposed
agreement and disclosures would actually confuse consumers and
undermine their decision-making ability. The Board committed to
revisiting this issue at a future date.
On March 11, 2009, the Fed's director of consumer affairs Sandra
Braunstein, testified before the House Financial Services
Committee, and revealed that the Fed was reviewing several
options to address YSPs, including restrictions and potential
bans.
Coercion of appraisers :
The Board proposed to prohibit creditors and mortgage brokers
and their affiliates from coercing, including, or otherwise
encouraging appraisers to misstate or misrepresent the value of
a consumer's principle dwelling. The Board adopted the rule as
proposed with some limited changes regarding examples of
prohibited conduct.
Servicing abuses :
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The Board proposed to prohibit certain practices of servicers.
The proposal provided that no servicer shall:
1)Fail to credit a consumer's periodic payment as of the date
received;
2)Impose a late fee or delinquency charge where the late fee or
delinquency charge is due only to a consumer's failure to
include in a current payment a late fee or delinquency charge
imposed on earlier payments;
3)Fail to provide a current schedule of service fees and charges
within a reasonable time of request; or,
4)Fail to provide an accurate payoff statement within a
reasonable time of request.
The final rule adopted most of the proposal except for the fee
schedule language. Some consumer groups argued that the fee
disclosure would not help because borrowers can not shop for
servicers. Additionally, some industry groups argued that the
disclosure of fees would be difficult due to the use of third
party providers and the possibility that the listing of all
potential fees could take numerous pages. The Board chooses not
to act on this part at this time but may reexamine the issue of
servicer fees in upcoming reviews of Reg Z.
Advertising restrictions :
The Board proposed new advertising rules for open-end home
equity plans (HELOCs) and closed end loans. The new disclosure
for HELOCs require that their terms be disclosed in a clear and
conspicuous manner with clear disclosure of an initial
promotional term associated with the loan. Specifically, the
advertising must disclose the following in a clear and
conspicuous manner:
1)The period of time during which the promotional rate or
promotional payment will apply.
2)In the case of a promotional rate, any APR that will apply
under the plan.
3)In the case of a promotional payment, the amount and time
periods of any payments that will apply under the plan.
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4)In variable-rate transactions, payments determined based on
application of an index and margin to an assumed balance would
be required to be disclosed based on a reasonably current
index and margin.
5)For closed end loans, the Board also proposed advertising
changes to ensure that rates and promotional rates are
disclosures clearly. The Board also proposed changes for
Prohibited Acts or Practices relating to mortgage
advertisements. The Board proposed to prohibit the following
seven acts or practices.
6)The use of the term ''fixed'' to refer to rates or payments of
closed-end home loans, unless certain conditions are
satisfied.
7)Comparison advertisements between actual and hypothetical
rates and payments, unless certain conditions are satisfied.
8)Falsely advertising a loan as government supported or
endorsed.
9)Displaying the name of the consumer's current lender without
disclosing that the advertising mortgage lender is not
affiliated with such current lender.
10)Claiming debt elimination when one debt merely replaces
another debt.
11)The use of the term ''counselor'' or ''financial advisor'' by
for-profit brokers or lenders.
12)Foreign language advertisements that provide required
disclosures only in English.
The final rule concerning advertising is substantially similar
to the proposal.
Consumer disclosures :
The Board proposed a requirement that creditors deliver required
loan disclosures three business days after application and
before the consumer has paid any fee, other than a fee for
obtaining the consumer's credit report. The Board concluded
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that current requirements were not enough to ensure that
borrowers had the opportunity to fully review their loan
documents. When borrowers receive their documents at the
closing table, they may feel trapped in the transaction or
falsely believe that they have reached a point of no return.
The final rule is substantially similar to the proposal.
Operative dates :
Finally, the final changes to Reg Z will go into effect October
1, 2009, with an exception regarding the escrow requirement for
higher priced loans. The implementation of the rule concerning
escrow accounts is effective April 1, 2010.
Arguments in Support.
California ACORN writes in support:
It is California ACORN's belief that yield spread premiums,
prepayment penalties, and steering practices should be banned
outright to protect families from the tactics used to pad the
pockets of the greedy.
Nevertheless, we are in strong support of AB 260, because
we believe that it takes an extremely necessary, common sense
approach to fix a broken system in order to protect families in
the future by doing the following:
v AB 260 would limit prepayment penalties and prohibit
broker compensation for arranging a higher priced loan
with prepayment penalties
v AB 260 would confirm/codify that a mortgage broker
owes a fiduciary duty to a borrower and require the
mortgage broker to place the economic interest of the
borrower ahead of his own
v AB 260 would make a licensed person who violates any
of the provisions liable to the borrower in the amount of
borrower's damages, and would authorize the court to
award court costs and attorney's fees to a prevailing
plaintiff.
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v AB 260 would prohibit a licensed person from making
false, deceptive, or misleading statements or
representations in connection with higher-priced mortgage
loans.
v AB 260 provides that a mortgage broker shall not
steer a borrower to accept a loan at a higher cost than
that for which the borrower could qualify
Arguments in opposition.
The Civil Justice Association writes in opposition:
To begin with, the part of the bill statutorily creates a
fiduciary obligation from the
mortgage broker to the client is unnecessary. (See page 6, lines
27-36.) This obligation is
already required under established case law. Wyatt v. Union
Mortgage Co., 598 P.2d 45
(1979).
Additionally, we are concerned that other provisions in the
bill will encourage abusive
lawsuits. These include additional duties and requirements
placed upon lenders and
mortgage brokers, and the award of attorney's fees and costs to
a prevailing plaintiff
only.
Previous Legislation :
AB 1830 (Lieu, Bass, Nava & Wolk) of 2008 was substantially
similar to the bill currently under consideration. This bill
was vetoed by the Governor.
REGISTERED SUPPORT / OPPOSITION :
Support
California ACORN (Sponsor)
California Labor Federation (AFL-CIO)
Center for Responsible Lending (CRL) - Support if Amended
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Opposition
California Association of Realtors
The Civil Justice Association of California (CJAC)
Analysis Prepared by : Mark Farouk / B. & F. / (916) 319-3081