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Moving to Address Appraisal Bias, Agencies and the Appraisal Foundation Issue Updates

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A&B ABstract:

 A year and a half after President Biden’s announcement of the Interagency Task Force on Property Appraisal and Valuation Equity (“PAVE”), the past weeks have seen a flurry of activity from federal agencies and the Appraisal Foundation to address issues of bias in residential property appraisal.  What should lenders, servicers, and appraisers know?

Background:

In June 2021, President Biden announced the formation of the PAVE Task Force, comprising 13 federal agencies, including the White House Domestic Policy Council.  He tasked the group with identifying and evaluating “the causes, extent, and consequences of appraisal bias and to establish a transformative set of recommendations to root out racial and ethnic bias in home valuations.”

In March 2022, the member agencies of the PAVE Task Force published an action plan, announcing a series of concrete commitments to address appraisal bias in five broad categories:

  • strengthening guardrails against discrimination in all stages of residential valuation;
  • enhancing fair housing and fair lending enforcement, and driving accountability in the appraisal industry;
  • building a diverse, well-trained, and accessible appraiser workforce;
  • empowering consumers to take action against bias; and
  • giving researchers and enforcement agencies better data to study and monitor valuation bias.

While the Task Force’s activity is ongoing, federal agencies in the past few weeks have announced a series of steps that are in line with the PAVE goal of addressing real property appraisal bias.

FHA: Draft Mortgagee Letter on Reconsiderations of Value and Appraisal Review

On January 3, 2023, the Federal Housing Administration (“FHA”) published for public comment a draft mortgagee letter, Borrower Request for Review of Appraisal Results, that would permit a second appraisal to be ordered if a Direct Endorsement underwriter determines that an original appraisal contains a material deficiency.  The letter would expressly identify as a material deficiency – one that would directly impact value and marketability of the underlying property – either indications of unlawful bias in the appraisal or of a violation of applicable federal, state, or local fair housing and non-discrimination laws.

Further, the draft mortgagee letter would require the underwriter in a transaction involving an FHA-insured loan to “review the appraisal and determine that it is complete, accurate, and provides a credible analysis of the marketability and value of the Property.”  Among other criteria, this would require the underwriter to make a determination of whether the appraisal is materially deficient – that is, whether the appraisal contains indications of unlawful bias or of a violation of applicable fair housing and non-discrimination laws.  Providing a “credible analysis” exceeds the scope of a quality control review.  If included in a finalized mortgagee letter, it would require lenders to determine whether underwriters must be state-licensed or -certified appraisers.

The draft mortgagee letter also sets forth standards for the submission and consideration of a borrower’s request for a review of appraisal results, including the submission of a reconsideration of value request to the appraiser.

VA: Enhanced Oversight Procedures to Combat Appraisal Bias

On January 18, the Department of Veterans Affairs (“VA”) issued Circular 26-23-05, detailing the enhanced oversight procedures that the VA has adopted “to identify discriminatory bias in home loan appraisals and act against participants who illegally discriminate based on race, color, national origin, religion, sex (including gender identity and sexual orientation), age, familial status, or disability.”

In the Circular, the VA indicated that it will review all appraisal reports submitted in connection with VA-guaranteed home loans to identify any potential discriminatory bias.  The VA will: (a) conduct an escalated review of any suspected incidents of bias; and (b) remove from its panel of approved appraisers any individual who is confirmed to have provided a biased appraisal as the result of such a review.

The VA also reminded panel appraisers that in submitting a Fannie Mae Form 1004 (Uniform Residential Appraisal Report), they certify that they have not based the opinion communicated in an appraisal report on discriminatory factors (e.g., the race) of either the property applicants or the residents of the area in which the property is located.

Appraisal Foundation: Proposed Revision of Appraisal Standards

In mid-December, the Appraisal Standards Board (“ASB”) of the Appraisal Foundation released its fourth exposure draft of proposed changes to the Uniform Standards of Professional Appraisal Practice (“USPAP”), the operational standards that govern real property appraisal practice.

In response to comments received in response to the last draft, the ASB proposes to add to the USPAP Ethics Rule a section expressly discussing non-discrimination.  The proposed section would prohibit appraisers from engaging in both unethical discrimination and illegal discrimination, and would provide guidance as to the type of conduct constituting each form.

Unethical Discrimination:

First, the ASB proposes to include an express statement that an appraiser must not engage in unethical discrimination.  First, that prohibition would preclude an appraiser from developing and/or reporting an opinion or value that is based, in whole or in part, on the actual or perceived protected characteristics of any person.

Second, the rule would prohibit an appraiser from performing an assignment with bias with respect to the actual or perceived protected characteristics of any person – meaning that the appraiser may not engage in any discriminatory conduct (regardless of whether it arises in the course of developing and/or reporting an opinion of value). For purposes of this prohibition, the rule would utilize the USPAP definition of bias: “a preference or inclination that precludes an appraiser’s impartiality, independence, or objectivity in an assignment.”

The rule would make a limited exception for activity that qualifies with “limited permissive language,” permitting an appraiser to use or rely upon a protected characteristic in an assignment only where:

  • laws and regulations expressly permit or otherwise allow the consideration of a protected characteristic;
  • use of or reliance on that characteristic is essential to the assignment and necessary for credible assignment results; and
  • consideration of the characteristic is not based upon bias, prejudice, or stereotype.

The exposure draft provides as an example of activity that might qualify for the exception the completion of an appraisal review in order to determine whether the initial appraisal was discriminatory.

The ASB proposal makes clear that because “an appraiser’s ethical duties are broader than the law’s prohibitions,” an appraiser may commit unethical discrimination without violating any applicable law; however, an act that “constitutes illegal discrimination … will also constitute unethical discrimination.”

Illegal Discrimination:

Complementing the prohibitions discussed above, the ASB proposes to include an express statement that an appraiser must not engage in illegal discrimination – conduct that violates the minimum standards of anti-discrimination set forth in the Fair Housing Act (“FHA”), the Equal Credit Opportunity Act (“ECOA”), and Section 1981 of the Civil Rights Act of 1866 (“Section 1981”).  The rule would impose on appraisers a duty to understand and comply with such laws as they apply to the appraiser and the appraiser’s assignments, including the concepts of disparate treatment and disparate impact.  Further, the rule would prohibit an appraiser from using or relying on a non-protected characteristic as a pretext to conceal the use of or reliance upon protected characteristics when performing an assignment.

Further Guidance:

 The exposure draft indicates that the ASB would follow the adoption of the new non-discrimination section of the ethics rule with detailed guidance on the scope of these prohibitions, including:

  • Background on federal, state, and local anti-discrimination laws;
  • Guidance on the application of FHA, ECOA, and Section 1981 to appraisals of residential real property;
  • Explanation of the disparate treatment and disparate impact theories of discrimination, including examples relating to appraisal practice;
  • Guidance on neighborhood discrimination in real property appraisals; and
  • Clarification on acceptable uses of protected characteristics, in connection with the “limited permissive language” exception for the prohibition against unethical discrimination.

OMB: AVM Rule on Regulatory Agenda

 Automated valuation models  (“AVMs”) are considered a useful tool to help mitigate appraisal discrimination.  On January 4, the Office of Management and Budget (“OMB”) released its Fall 2022 Regulatory Agenda.  Among other topics, OMB indicated that an interagency proposed rule addressing quality control standards for AVMs is expected in March 2023. The Dodd-Frank Act’s amendments to the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”) require the federal banking regulatory agencies to undertake this rulemaking.

 ASC: Hearing on Appraisal Bias

 On January 24, the Appraisal Subcommittee (“ASC”) of the Federal Financial Institutions Examination Council held a hearing on appraisal bias.  Of note, Consumer Financial Protection Bureau Director Rohit Chopra ended the hearing by articulating the objective that the “lodestar” of appraisals is an appraisal that neither too high nor too low, but rather is accurate.    Director Chopra then questioned the regulatory structure governing appraisals, calling it “byzantine.”  His remarks focused on the funding mechanism between the Appraisal Institute and the Appraisal Foundation, implying that there may be a conflict of interest.

To understand Director Chopra’s comment requires knowledge of the current regulatory framework, which Title XI of FIRREA established in 1989.   It includes three principal parties: the ASC, the Appraisal Foundation, and the Appraisal Institute:

  • The ASC is a federal agency with oversight responsibility of the state appraisal regulatory structure for real property appraisers as well as to monitor activities of the Appraisal Foundation.
  • The Appraisal Foundation is a private non-profit educational organization. Through the ASB and the Appraiser Qualifications Board (“AQB”), the Appraisal Foundation sets the ethical and performance standards of appraisers in the USPAP.  The AQB establishes the minimum education, experience, and examination requirements for real property appraisers, which are then enforced by state regulatory agencies.  The Appraisal Foundation is funded through sales of publications and services, as well as by its sponsoring organizations.
  • The Appraisal Institute is a private professional organization of appraisal professionals, and is one of the sponsoring organizations of the Appraisal Foundation.

Takeaway

 Viewed through the lens of the overall PAVE Task Force efforts, actions by the FHA and the VA show early and concrete action to address residential appraisal bias.  Because they implicate government insurance and guarantee programs, the focus is particularly important for lenders and appraisers to take heed of – such that documentation submitted to the agencies is accurate.

Appraisers should also take note of the updated USPAP exposure draft as it moves toward final adoption, so that they are aware of their responsibilities with respect to avoiding bias in appraisal reports. Finally, with regulators scrutinizing the appraisal framework – as seen in the OMB and ASC announcements – more significant changes are expected.

District Court Dismisses CFPB’s Redlining Case Against Townstone Financial

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A&B ABstract:

On Friday, in the CFPB v. Townstone Financial fair lending case, the U.S. District Court for the Northern District of Illinois dismissed with prejudice the complaint filed by the Consumer Financial Protection Bureau (CFPB), holding that the plain language of the Equal Credit Opportunity Act (ECOA) does not prohibit discrimination against prospective applicants.

Complaint

 The complaint, filed by the CFPB in July 2020, alleged that Townstone Financial, Inc., a nonbank retail-mortgage creditor and broker based in Chicago, engaged in discriminatory acts or practices in violation of ECOA, including: (1) making statements during its weekly radio shows and podcasts through which it marketed its services, that discouraged prospective African-American applicants from applying for mortgage loans; (2) discouraging prospective applicants living in African-American neighborhoods from applying for mortgage loans; and (3) discouraged prospective applicants living in other areas from applying for mortgage loans for properties located in African-American neighborhoods.

Court Opinion

The court, in its opinion, summarized the allegations as follows: “The CFPB alleges that Townstone’s acts and practices would discourage African-American prospective applicants, as well as prospective applicants in majority- and high-African-American neighborhoods in the Chicago MSA from seeking credit.” To determine whether the CFPB’s allegation of discrimination against “prospective applicants” was permissible under ECOA, the court applied the framework set forth in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).

The court found, upon applying the first step of the Chevron analysis, that “Congress has directly and unambiguously spoken on the issue at hand and [that ECOA] only prohibits discrimination against applicants” (emphasis added). In granting Townstone’s motion to dismiss, the court reasoned that the plain text of the ECOA applies to “applicants,” which the ECOA “clearly and unambiguously defines as a person who applies to a creditor for credit” – and not to “prospective applicants.” Given this, the court was not required to move on to the second step of the Chevron analysis and consider the CFPB’s interpretation of the statute. Accordingly, the CFPB’s claim under ECOA was dismissed with prejudice, as “the CFPB cannot amend its pleading in a way that would change the language of the ECOA.”

Notably, the fact that the anti-discouragement provision of Regulation B refers to “prospective applicants” was not sufficient to convince the court. Further, because the court found that ECOA unambiguously applies only to “applicants,” the court did not analyze whether the ECOA’s prohibition on “discrimination” encompasses “discouragement.” The court likewise did not reach Townstone’s argument that the CFPB is attempting to create affirmative obligations with respect to marketing and the hiring of loan officers, nor its arguments under the First and Fifth Amendments.

Takeaway

Ultimately, the court’s dismissal of the CFPB’s case against Townstone casts significant doubt on the agency’s ECOA discouragement theory and its approach to fair lending enforcement, particularly the agency’s redlining investigations. We expect the CFPB to appeal the court’s order, though it is possible that existing investigations based on allegations of discouragement may experience a temporary slowdown in the interim.

Illinois Proposes Rules Implementing Its Community Reinvestment Act for Banks, Mortgage Lenders, and Credit Unions

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A&B ABstract:

The Illinois Department of Financial and Professional Regulation (“IDFPR”) has issued a notice of proposed rules to implement the newly passed Illinois Community Reinvestment Act (“ILCRA”), aimed at serving the credit needs of low- and moderate-income communities and individuals.  The proposal includes a separate set of rules applicable to state-chartered banks, non-depository mortgage lenders, and credit unions.  Each set of proposed rules address topics that include, among other things, performance tests and ratings by institution size or business model, assessment area delineation, data collection and reporting, and examination procedures. The IDFPR is soliciting comments from interested stakeholders through March 16, 2023 and will be holding three public hearings related to the rules.

What’s New?

The proposal outlines CRA responsibilities and performance evaluation measures for banks and would subject them to a CRA examination by the IDFPR, in addition to their federal CRA examinations.  The rules themselves, however, are essentially the same as under the federal CRA.

Under the ILCRA, non-depository mortgage lenders and credit unions are subject to CRA requirements.  As described in the proposal, credit unions and non-depository mortgage lenders would be subject to a CRA evaluation based on a testing framework that looks similar to the current federal CRA framework, meaning that the IDFPR will examine these institutions under tests that look similar to the current federal CRA tests depending on their operations and asset sizes.

Credit Unions

The proposal’s requirements for Illinois-chartered credit unions look comparable to those for banks under the current federal CRA and the proposal.  Akin to banks, credit unions would have CRA responsibilities in delineated assessment areas, which are communities based on where credit unions have their main offices, branches, and deposit-taking ATMs.  These responsibilities take the form of lending, investment, and service tests based on asset size thresholds and then add resultant evaluation elections depending on asset size.  Additionally, the proposal provides an alternative evaluation framework for wholesale and limited purpose credit unions, involving a community development test, and strategic plan evaluation option.  The lending test includes home mortgage, small business, and small farm loans, though it also adds potential consumer loans, such as motor vehicle, credit card, home equity, other secured, and other unsecured loans, depending on the credit union’s loan portfolio.  Credit unions would also have data collection, reporting, and disclosure requirements, though those requirements are reduced for small credit unions.

Non-depository Mortgage Lenders

Under the proposal, non-depository mortgage lenders licensed pursuant to the Residential Mortgage License Act of 1987 which made 50 or more HMDA-reportable home mortgage loans in the previous calendar year will have CRA responsibilities.  There are a number of key aspects of the proposal specific to mortgage lenders that differ from the rules for credit unions and banks:

  • In contrast to banks or credit unions, CRA activities would be assessed state-wide, not based on delineated assessment areas.
  • The proposal outlines that mortgage lenders would be subject to lending and service tests, but not an investment test. Instead, the proposal states that a mortgage lender that warrants a satisfactory rating can be considered for an outstanding rating based on its level of qualified investments and community development loans, which is essentially the traditional CRA investment test.
  • Importantly, and in contrast to the lending test evaluations of banks or credit unions, mortgage lender performance criteria for the lending test explicitly includes not only the portfolio of loans’ geographic distribution, borrower characteristics, and innovative or flexible lending practices, but also (i) loss mitigation efforts, (ii) fair lending performance, and (iii) contribution to the loss of affordable housing units. These are new areas not contained in the federal CRA, either.
  • Finally, mortgage lenders will also have data collection and reporting requirements, which would include “additional data fields beyond what is required under HMDA.” These data fields are not specified in the proposal.

What’s Surprising?

The proposed regulations implementing ILCRA, as applicable to Illinois-chartered banks, largely mirror the federal CRA regulations applicable to state-chartered institutions.  But those federal CRA regulations are on the precipice of a major overhaul.  As proposed by the interagency Notice of Proposed Rulemaking to the federal CRA, where a bank will have CRA responsibilities, the substance of those responsibilities, the measurement of those responsibilities, and the record keeping and reporting of those responsibilities are slated for significant change under a completely new framework.  Whether those changes will be finalized as currently proposed by the three prudential banking regulators remains to be seen, but the fact that the IDFPR’s suggested framework for bank compliance with the ILCRA is based on a likely soon-to-be outdated set of regulations is surprising.  The proposal does note that the ILCRA regulations are intended to follow the federal standards.  Accordingly, there could be a revision in the works sooner-than-later should the federal CRA regulations change contemporaneously with or soon after the ILCRA regulations are finalized.

Takeaway

Compliance with the ILCRA as proposed would be relatively easy to plan for and implement because it generally applies the current and 28-year-old federal CRA regulations to Illinois banks, non-depository mortgage lenders, and credit unions, as relevant to the type of financial institution.  However, these Illinois financial institutions would be wise to monitor the federal CRA modernization efforts with an eye to the future.  As the ILCRA proposal comment window is open, affected stakeholders should consider voicing any concerns with their future CRA responsibilities.

CFPB Proposes Nonbank Registry to Focus on Compliance “Recidivism”

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A&B ABstract:

On December 12, 2022, the Consumer Financial Protection Bureau (CFPB) announced a proposed rule to require certain non-banks to register with the agency when they become subject to a public written order or judgment imposing obligations based on violations of certain consumer protection laws. The CFPB also proposes to maintain a public online registry of those nonbanks subject to agency or court orders, to “limit the harms from repeat offenders.” We provide below a description of the CFPB’s proposed rule, along with the potential implications for the financial services industry.

Background on Proposed Rule

Earlier this year, CFPB Director Rohit Chopra presented remarks at the University of Pennsylvania, where he asserted that “[c]orporate recidivism has become normalized and calculated as the cost of doing business; the result is a rinse-repeat cycle that dilutes legal standards and undermines the promise of the financial sector and the entire market system.” To address this problem, Director Chopra suggested establishing “dedicated units in our supervision and enforcement divisions to enhance the detection of repeat offenses and corporate recidivists and to better hold them accountable.” With respect to accountability for “serial offenders of federal law,” Director Chopra warned that the CFPB would be focusing on “remedies that are more structural in nature,” including “limits on the activities or functions” of the entity.

Subsequently, in November 2022, and leading up to the proposed rule, the CFPB announced, as part of its Supervisory Highlights, that it would be establishing a Repeat Offender Unit as part of its supervision program. The Repeat Offender Unit would be focused on: reviewing and monitoring the activities of “repeat offenders;” identifying the root cause of recurring violations; pursuing and recommending solutions and remedies that hold entities accountable for failing to consistently comply with Federal consumer financial law; and designing a model for order review and monitoring that reduces the occurrences of repeat offenders. The Bureau asserts that its authority for these efforts, along with any proposed rulemaking, is derived from the Consumer Financial Protection Act’s mandate that the Bureau “monitor for risks to consumers in the offering or provision of consumer financial products or services” and “gather information from time to time regarding the organization, business conduct, markets, and activities of covered persons and service providers.” See 12 U.S.C. § 5512(c)(1), (4).

Proposed Requirements

The CFPB’s proposed rule would require certain nonbanks covered person entities (with exclusions for insured depository institutions, insured credit unions, related persons, States, certain other entities, and natural persons) to register with the Bureau upon becoming subject to a public written order or judgment imposing obligations based on violations of certain consumer protections laws. Such entities would be required to register in a system established by the Bureau, provide basic identifying information about the company and the order (including a copy of the order), and periodically update the registry for accuracy and completeness. For purposes of the proposed rule, “covered person” would have the same meaning as in 12 U.S.C. § 5481(6). Further, “service providers” would be deemed covered persons to the extent that they engage in the offering or provision of their own consumer financial product or services or where they act as service providers to covered person affiliates.

In addition, certain larger participant nonbanks subject to the Bureau’s supervisory authority would be required to designate a senior executive, who is responsible for and knowledgeable of the nonbank’s efforts to comply with the orders identified in the registry, to attest regarding compliance with covered orders and submit an annual written statement attesting to the steps taken to oversee the activities subject to the applicable order for the preceding calendar year, and whether the executive knows of any violations of, or other instances of noncompliance with, the covered order.

Further, the CFPB is considering whether to release, via its publicly available website, the above registry information for non-banks.

Implications for Non-Banks

While the CFPB’s proposed enforcement order registry would provide greater transparency about a lender’s regulatory track record to the various federal and state regulators and the general public, it remains to be seen how the information maintained in this registry might be used against lenders. At a minimum, however, the proposed rule raises the following significant implications for non-banks:

  • Supervision and examination considerations. The CFPB intends to use the information in the registry to coordinate its “risk-based supervisory prioritization,” for those non-bank markets covered by the Bureau’s supervision and examination authority under CFPA section 1024(a). Thus, entities with a local, state, or federal prior enforcement order may be subject to more targeted supervision.
  • Investigation and enforcement presumptions. The CFPB intends to use the information in the registry in connection with its investigation and potential enforcement activities, which presents various risks, including:
    • Increased civil money penalties. Specifically, the CFPB believes that the information contained in the proposed registry can assist the agency in determining the civil penalties that may be assessed for a future violation of federal consumer financial law, given that federal law permits the CFPB to consider the entity’s “history of previous violations.” Indeed, it is possible that the CFPB may use evidence of prior enforcement against an entity, brought by itself or another agency, to establish that the entity acted knowingly or recklessly in violating federal consumer financial law, perhaps even where the prior enforcement order involved a different consumer-related issue.
    • Presumption of consumer harm. Further, the CFPB believes there is a “heightened likelihood” that entities that are subject to public orders relating to consumer financial products and services may pose risks to consumers in the markets for those products and services, since entities that have previously been subject to enforcement actions “present an increased risk of committing violations of laws.” Thus, there may be a presumption of consumer harm against an entity where a prior enforcement order exists. Yet this approach by the CFPB likely will overstate the actual harm to consumers, as most consent orders do not contain an admission by the entity of any liability or wrongdoing.
  • Increased reputational risk. Given that the CFPB maintains Memoranda of Understanding with federal parties (such as the Federal Trade Commission and the U.S. Department of Justice), as well as with at least 20 state attorneys general offices, it appears that the information reported to the registry already would be available to such agencies. However, the registry will permit all agencies, as well as the general public, a readily accessible, one-stop shop to an entity’s entire enforcement track record, which may present significant reputational risk to that entity, as well as a potentially increased risk of class action lawsuits and other consumer claims.
  • Facilitating of private enforcement. The CFPB believes that the proposed registry may “facilitate private enforcement of the Federal consumer financial laws by consumers, to the extent those laws provide private rights of action, where consumers have been harmed by a registered nonbank.” In other words, the “information that would be published under the proposal might be useful in helping consumers understand the identity of a company that has offered or provided a particular consumer financial product or service, and in determining whether to file suit or otherwise make choices regarding how to assert their legal rights.”

Takeaway:

Given the significant implications raised by the CFPB’s proposed rule, non-bank financial institutions should consider submitting comments, which are due 60 days after publication in the Federal Register. In particular, the CFPB seeks comment on “its preliminary conclusion that collecting and registering public agency and court orders imposing obligations based upon violations of consumer law would assist with monitoring for risks to consumers in the offering or provision of consumer financial products and services.” The CFPB also seeks comment on “whether the types of orders described in the proposal, and the types of information that would be collected about those orders and covered nonbanks under the proposal, would provide useful information to the Bureau,” as well as “any other risks that might be identified through collecting the information described in the proposal.” Finally, the Bureau seeks comment on whether it should consider collecting any other information in order to identify risks to consumers associated with orders.

Assumptions on the Rise: Are You Ready for Mortgage Assumptions?

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A&B ABstract:

Mortgage assumptions – where a buyer assumes the existing mortgage loan of a seller – have fluctuated in popularity since the 1980s. However, inflation and the high interest rate environment, coupled with an observable shift to a buyer’s market, are raising the prospect that assumable mortgages – especially those with historically low interest rates – are likely to become a selling point for potential sellers. Statements by the real estate broker industry, U.S. Department of Housing and Urban Development (HUD), and former Ginnie Mae officials, to name a few, corroborate this hunch. Ultimately, given these rumblings, it appears that lenders, and more so mortgage servicers, will need to prepare for a potential increase in mortgage assumption volume. Below are several key considerations with respect to mortgage assumptions.

Servicer Capabilities

Servicers generally will need to diligently evaluate the assuming buyer’s creditworthiness. In certain cases, servicers may need to offer and service home equity lines of credit (HELOCs) and second liens to support the cost difference between the amount of the loan to be assumed and the cost of the property. Further, as servicers will likely have to evaluate the assuming consumer’s credit eligibility in connection with the processing of most mortgage assumptions, such activities may give rise to additional state mortgage lender and/or loan originator licensing obligations. While the federal SAFE Mortgage Licensing Act and its implementing Regulation G and H generally do not consider mortgage loan origination activity to encompass a servicer’s activities in connection with the processing of a loan modification, when the borrower is reasonably likely to default, there is no such exemption for mortgage assumptions. Moreover, states that license mortgage loan origination activities may vary as to whether a license is required to process an assumption.

 Investor Restrictions

Even if a buyer is deemed creditworthy to assume the seller’s mortgage payments, the agency or investor backing the seller’s mortgage loan must approve the assumption. Most government-backed mortgage loans, such as those guaranteed or insured by the Federal Housing Administration (FHA), U.S. Department of Veteran Affairs (VA), and U.S. Department of Agriculture (USDA) are assumable, provided specific requirements are met.  On the other hand, conventional mortgages (i.e., loans meeting the requirements for purchase by Fannie Mae and Freddie Mac (the “GSEs”)) may be more difficult to assume.

It is important to note that the requirements for processing and/or approving an assumption vary from agency to agency and among the GSEs. By way of example:

  • FHA loans are assumable if the buyer meets certain credit requirements, according to FHA guidelines. Buyers who assume FHA mortgages pay off the remaining balance at the current rate, and the lender releases the seller from the loan.
  • VA mortgage assumption guidelines are similar to FHA, with some notable differences. The VA or the VA-approved lender must evaluate the creditworthiness of the buyer, who generally must also pay a VA funding fee of 0.5% of the loan balance as of the transfer date. Unlike new loans, buyers can’t finance the funding fee when assuming a loan, it must be paid in cash at the time of transfer. Moreover, the only way the seller can have their VA entitlement restored would be to have the home assumed by a fellow eligible active-duty service member, reservist, veteran, or eligible surviving spouse.
  • USDA permits loan assumptions but operates differently from FHA-insured or VA-guaranteed loans. For example, according to USDA guidelines, when most buyers assume a USDA loan, the lender will generally issue new terms, which may include a new rate.
  • Fannie Mae and Freddie Mac may permit an assumption under certain circumstances. For example, Fannie Mae may permit the assumption of certain first-lien adjustable-rate mortgage (ARMs) loans that have not been converted to a fixed-rate-mortgage loan.

Due-on-Sale Clauses

Many conventional mortgages today contain “due-on-sale” clauses that authorize a lender, at its option, to declare due and payable sums secured by the lender’s security interest if all or any part of the property, or an interest therein, securing the loan is sold or transferred without the lender’s prior written consent. However, the Garn-St. Germain Depository Institutions Act prohibits a lender from exercising its option pursuant to a due-on-sale clause in connection with certain exempt transfers or dispositions, including, among others: (1) a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety; (2) a transfer to a relative resulting from the death of a borrower; (3) a transfer where the spouse or children of the borrower become an owner of the property; and (4) a transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property. 12 U.S.C. § 1701j–3(d).

Fees

Whether an assumption fee can be charged, and the amount of such fee, will depend on many factors including application of the Garn-St. Germain Act, the CFPB mortgage servicing rules, investor and agency guidelines, and state laws. Further, the Fair Debt Collection Practices Act (FDCPA) may impact whether a servicer may assess and collect an assumption fee. While most states neither expressly permit nor prohibit assumption fees, several other states, such as Idaho and Michigan, explicitly recognize and permit assumption fees in limited cases (e.g., only where the fee is included in the purchase contract or other agreement). Other states may regulate the amount of an assumption fee. For example, Colorado law limits assumption fees to one-half of 1% of the outstanding principal mortgage amount.

General Federal Consumer Financial Compliance

Assumption transactions also raise compliance considerations under federal consumer financial laws. Under TILA and Regulation Z, an assumption occurs if the transaction meets the following elements: (1) includes the creditor’s express acceptance of the new consumer as a primary obligor; (2) includes the creditor’s express acceptance in a written agreement; and (3) is a “residential mortgage transaction” as to the new consumer. 12 C.F.R. § 1026.20(b). A “residential mortgage transaction” is a transaction: (a) in which a security interest is created or retained in the new consumer’s principal dwelling; and (b) which finances the acquisition or initial construction of the new consumer’s principal dwelling. 12 C.F.R. 1026.2(a)(24). If the transaction is an assumption under Regulation Z (12 C.F.R. § 1026.20(b)), then, as noted by the CFPB in its TILA-RESPA Factsheet, creditors must provide a Loan Estimate and Closing Disclosure, unless the transaction is otherwise exempt. Moreover, the assumption transaction may also trigger requirements under Regulation Z’s loan originator compensation and ability-to-repay rules.

With respect to RESPA and Regulation X, however, assumptions are exempt unless the mortgage instruments require lender approval for the assumption and the lender approves the assumption. Specifically, Regulation X expressly exempts from its coverage any “assumption in which the lender does not have the right expressly to approve a subsequent person as the borrower on an existing federally related mortgage loan.” 12 C.F.R. § 1024.5(b)(5). By way of example, the Fannie/Freddie Uniform Security Instrument provides that:

Subject to the provisions of Section 18, any Successor in Interest of Borrower who assumes Borrower’s obligations under this Security Instrument in writing, and is approved by Lender, shall obtain all of Borrower’s rights and obligations under this Security Instrument.  Borrower shall not be released from Borrower’s obligations and liability under this Security Instrument unless Lender agrees to such release in writing.  The covenants and agreements of this Security Instrument shall bind (except as provided in Section 20) and benefit successors of Lender.

Finally, with respect to the CFPB’s Mortgage Servicing Rules, if a successor in interest assumes a mortgage loan obligation under state law or is otherwise liable on the mortgage loan obligation, the protections that the consumer enjoys under Regulation X go beyond the protections that apply to a confirmed successor in interest. 12 C.F.R. § 1024.30(d).

Takeaway

The processing of mortgage assumptions involves many of the same regulatory considerations as originating a new loan. However, because of varying requirements under agency and investor guidelines, there are several unique aspects to processing assumptions, which may pose challenges for servicers that do not regularly engage in mortgage origination. The economic climate appears to be ripe for an uptick in mortgage loan assumption activity. Accordingly, servicers should ensure their compliance management systems are prepared to manage the associated compliance risks.