Alston & Bird Consumer Finance Blog

Unfair, Deceptive and Abusive Acts or Practices (UDAAP)

Oh Snap! CFPB Sues Fintech Company under CFPA and TILA

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A&B Abstract:

On July 19, 2023, the Consumer Financial Protection Bureau (CFPB) sued a Utah-based fintech company and several of its affiliates (the Company) for allegedly deceiving consumers and obscuring the terms of its financing agreements in violation of the Consumer Financial Protection Act (CFPA), the Truth in Lending Act (TILA), and other federal regulations.

The Allegations

The Company provides lease-to-own financing, through which consumers finance purchases from merchants though the Company’s “Purchase Agreements,” and, in turn, make payments back to the Company.  The Company allegedly provides the merchants with advertisement materials and involves them heavily in the application and contracting process.

According to the CFPB, the Company’s advertising and servicing efforts were deceptive.  As part of its marketing efforts, the Company allegedly provided its merchant partners with display advertisements that featured the phrase “100 Day Cash Payoff” without further explanation of the terms of financing.  Consumers who received financing from the Company reasonably believed they had entered into a 100-day financing agreement, where their automatically scheduled payments would fulfill their payment obligations after 100 days.  But, in fact, consumers had to affirmatively exercise the 100-day early payment discount option, and if they missed the deadline pay significantly more than the “cash” price under the terms of their Purchase Agreements.  Additionally, as part of its servicing efforts, the Company allegedly threatened consumers with collection actions that it does not bring.

From the CFPB’s perspective, these efforts constituted deceptive acts or practices under the CFPA.  The marketing efforts were deceptive because the Company’s use of this featured phrase was a (1) representation or practice; (2) material to consumers’ decision to take out financing; and (3) was likely to mislead reasonable consumers as to the nature of the financing agreement, while the servicing efforts were deceptive because the Company threatened actions it does not take.

The CFPB also alleges that the Company’s application and contracting process was abusive.  The Company allegedly designed and implemented a Merchant Portal application and contracting process that frequently resulted in merchants signing and submitting Purchase Agreements on behalf of consumers without the consumer’s prior review of the agreement.  Further, the Company relied on merchants to explain the terms of the agreements but provided them with no written guidance for doing so.  And as part of the process, the Company required consumers to pay a processing fee before receiving a summary of the terms of their agreement and before seeing or signing their final agreement.

Altogether, the CFPB views these acts and practices as abusive under the CFPA because they “materially interfered” with consumers’ ability to understand the terms and conditions of the Purchase Agreements.

Lastly, the CFPB alleges that the Company’s Purchase Agreements did not meet TILA and its implementing Regulation Z’s disclosure requirements.  On this point, the CFPB is careful in alleging that the Purchase Agreements are not typical rent-to-own agreements to which TILA does not apply.  Rather, the CFPB alleges they are actually “credit sales” because the agreements permitted consumers to terminate only at the conclusion of an automatically renewing 60-day term, and only if consumers were current on their payment obligations through the end of that term.

Takeaways

This suit serves as a good reminder to every lending program to: (i) have counsel carefully vet all advertisements to ensure that they are not inadvertently deceptive or misleading to consumers; (ii) ensure that the mechanics of its application process facilitate rather than interfere with consumers’ ability to understand the terms and conditions; and (iii) consult with counsel regarding whether their agreements are subject to TILA and Regulation Z’s disclosure requirements.

CFPB Issues Special Edition of Supervisory Highlights Focusing on Junk Fees

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A&B ABstract:

In the 29nd edition of its Supervisory Highlights, the Consumer Financial Protection Bureau (“CFPB”) focused on the impact of so-called “junk” fees in the mortgage servicing, auto servicing, and student loan servicing industries, among others.

CFPB Issues New Edition of Supervisory Highlights:

On March 8, the CFPB published a special edition of its Supervisory Highlights, addressing supervisory observations with respect to the imposition of junk fees in the mortgage servicing and auto servicing markets – as well as for deposits, payday and small-dollar lending, and student loan servicing.  The observations cover examinations of participants in these industries that the CFPB conducted between July 1, 2022 and February 1, 2023.

Auto Servicing

With respect to auto servicing, the CFPB noted three principal categories of findings the Bureau claims constitute acts or practices prohibited by the Consumer Financial Protection Act (“CFPA”).

First, examiners asserted that auto servicers engaged in unfair acts or practices by assessing late fees: (a) that exceeded the maximum amount stated in consumers’ contracts; or (b) after consumers’ vehicles had been repossessed and the full balances were due.  With respect to the latter, the acceleration of the contract balance upon repossession extinguished not only the customers’ contractual obligation to make further periodic payments, but also the servicers’ contractual right to charge late fees on such periodic payments. The report notes that in response to the findings, the servicers ceased their assessment practices, and provided refunds to affected consumers.

Second, examiners alleged that auto servicers engaged in unfair acts or practices by charging estimated repossession fees that were significantly higher than the average repossession cost.  Although servicers returned excess amounts to consumers after being invoiced for the actual costs, the CFPB found that the assessment of the materially higher estimated fees caused or was likely to cause concrete monetary harm – and, thus, “substantial injury” as identified in unfair, deceptive, and abusive acts and practices (“UDAAP”) supervisory guidance – to consumers.  Further, consumers could have suffered injury in the form of loss of their vehicles to the extent that they did not want – or could not afford – to pay the higher estimated repossession fees if they sought to reinstate or redeem the vehicle.  Examiners found that such injuries: (a) were not reasonably avoidable by consumers, who could not control the servicers’ fee practices; and (b) were not outweighed by a countervailing benefit to consumers or competition.  The report notes that in response to the findings, the servicers ceased the practice of charging estimated repossession fees that were significantly higher than average actual costs, and also provided refunds to consumers affected by the practice.

Third, examiners claimed that auto servicers engaged in unfair and abusive acts or practices by assessing payment processing fees that exceeded the servicers’ actual costs for processing payments.  CFPB examiners noted that servicers offered consumers two free methods of payment: (a) pre-authorized recurring ACH debits; and (b) mailed checks.  Only consumers with bank accounts can utilize those methods; all those without a bank account, or who chose to use a different payment method, incurred a processing fee.  The CFPB reported that as a result of “pay-to-pay” fees, servicers received millions of dollars in incentive payments totaling approximately half of the total amount of payment processing fees collected by the third party payment processors.

Mortgage Servicing

In examining mortgage servicers, CFPB examiners noted five principal categories of findings that related to the assessment of junk fees, which were alleged to constitute UDAAPs and/or violate Regulation Z.

First, CFPB examiners found that servicers assessed borrowers late fees in excess of the amounts permitted by loan agreements, often by neglecting to input the maximum fee permitted by agreement into their operating systems.   The examiners found that by instead charging the maximum late fees permitted under state laws, servicers engaged in unfair acts or practices.  Further, servicers violated Regulation Z by issuing periodic statements that reflected the charging of fees in excess of those permitted by borrowers’ loan agreements. In response to these findings, servicers took corrective action including: (a) waiving or refunding late fees that were in excess of those permitted under borrowers’ loan agreements; and (b) corrected borrower’s periodic statements to reflect correct late fee amounts.

Second, CFPB examiners found that servicers engaged in unfair acts and practices by repeatedly charged consumers for unnecessary property inspections (such as repeat property preservation visits to known bad addresses). In response to the finding, servicers revised their policies to preclude multiple charges to a known bad address, and waived or refunded the fees that had been assessed to borrowers.

Third, CFPB examiners noted two sets of findings related to private mortgage insurance (“PMI”).  When a loan is originated with lender-paid PMI, PMI premiums should not be billed directly to consumers.  In certain cases, the CFPB found that servicers engaged in deceptive acts or practices by mispresenting to consumers – including on periodic statements and escrow disclosures – that they owed PMI premiums, when in fact the borrowers’ loans had lender-paid PMI.  These misrepresentations led to borrowers’ overpayments reflecting the PMI premiums; in response to the findings, servicers refunded any such overpayments. Similarly, CFPB examiners found that servicers violated the Homeowners Protection Act by failing to terminate PMI on the date that the principal balance of a current loan was scheduled to read a 78 percent LTV ratio, and continuing to accept borrowers’ payments for PMI after that date.  In response to these findings, servicers both issued refunds of excess PMI payments and implemented compliance controls to enhance their PMI handling.

Fourth, CFPB examiners found that servicers engaged in unfair acts or practices by failing to waive charges (including late fees and penalties) accrued outside of forbearance periods for federally backed mortgages subject to the protections of the CARES Act.  The CARES Act generally prohibits the accrual of fees, penalties, or additional interest beyond scheduled monthly payment amounts during a forbearance period; however, the law does not address fees and charges accrued during periods when loans are not in forbearance.  Under certain circumstances, HUD required servicers of FHA-insured mortgages to waive fees and penalties accrued outside of forbearance periods for borrowers exiting forbearances and  entering permanent loss mitigation options.  CFPB examiners found that servicers sometimes failed to complete the required fee waivers, constituting an unfair act or practice under the CFA.

Finally, CFPB examiners found that servicers engaged in deceptive acts and practices by sending consumers in their last month of forbearance periodic statements that incorrectly listed a $0 late fee for the next month’s payment, when a full late fee would be charged if such payment were late.  In response to the finding, servicers updated their periodic statements and either waived or refunded late fees incurred in the referenced payments.

Deposits

The CFPB determined that two overdraft-related practices constitute unfair acts or practices: (i) authorizing transactions when a deposit’s balance was positive but settled negative (APSN fees); and (ii) assessing multiple non-sufficient funds (NSF) fees when merchants present a payment against a customer’s account multiple times despite the lack of sufficient funds in the account.  The CFPB has criticized both fees before in Consumer Financial Protection Circular 2022-06, Unanticipated Overdraft Fee Assessment Practices.

According to the report, tens of millions of dollars in related customer injury are attributable to APSN fee practices, and redress is already underway to more than 170,000 customers.  Many financial institutions have abandoned the practice, but the CFPB noted that even some such institutions had not ceased the practice and were accordingly issued matters requiring attention to correct the problems.  As for NSF fees, the CFPB found millions of dollars of consumer harm to tens of thousands of customers.  It also determined that “virtually all” institutions interacting with the CFPB on the issue have abandoned the practice.

Student Loan Servicing

Turning to student loan servicing, the CFPB found that servicers engaged in unfair acts or practices prohibited by the CFPA where: (a) customer service representative errors delayed consumers from making valid payments on their accounts, and (b) those delays led to consumers owing additional late fees and interest associated with the delinquency.  Contrary to servicers’ state policies against the acceptance of credit cards, customer service representatives accepted and processed credit card payments from consumers over the phone.  The servicers initially processed the credit card payments, but then reversed those payments when the error in payment method was identified.

Payday and Small Dollar Lending

The CFPB determined that lenders, in connection with payday, installment, title, and line-of-credit loans, engaged in a number of unfair acts or practices.  The first conclusion they made was that lenders simultaneously or near-simultaneously re-presented split payments from customers’ accounts without obtaining proper authorization, resulting in multiple overdraft fees, indirect follow-on fees, unauthorized loss of funds, and inability to prioritize payment decisions. The second such conclusion concerned charges to borrowers to retrieve personal property from repossessed vehicles, servicer charges, and withholding subject personal property and vehicles until fees were paid.  The third such determination related to stopping vehicle repossessions before title loan payments were due as previously agreed, and then withholding the vehicles until consumers paid repossession-related fees and refinanced their debts.

Takeaways

The CFPB’s focus on “junk” fees is not new – it follows on an announcement last January that the agency would be focused on the fairness of fees that various industries impose on consumers.  (We have previously discussed how the CFPB’s actions could impact mortgage servicing fee structures.)  Similarly, the Federal Trade Commission has previously considered the issue of “junk fees” in connection with auto finance transactions.

By focusing specifically on the issue in a special edition of the Supervisory Highlights, the CFPB is drawing special attention to the issue of these fees in the servicing context.  Mortgage, auto, and student loan servicers might use this as an opportunity to review their current practices and see how they stack up against the CFPB’s findings.

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.

HELOCs On the Rise: Is Your Servicing CMS Ready?

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A&B ABstract:

The Consumer Financial Protection Bureau (“CFPB” or “Bureau”) has moved to clarify its regulatory authority at a time when the economic climate is ripe for a resurgence in HELOC lending. In an amicus brief filed by the CFPB on November 30, 2022 (the “Amicus Brief”), the Bureau acknowledged that its Mortgage Servicing Rules, which, in 2013, amended Regulation X, RESPA’s implementing regulation, and Regulation Z, TILA’s implementing regulation, do not apply to home equity lines of credit (“HELOCs”).  This is consistent with the Bureau’s guidance in the preamble to the CFPB Mortgage Servicing Rules under RESPA, wherein the Bureau recognized that HELOCs have a different risk profile, and are serviced differently, than first-lien mortgage loans, and that many of the rules under Regulation X would be “irrelevant to HELOCs” and “would substantially overlap” with the longstanding protections under TILA and Regulation Z that apply to HELOCs.

During this past refinance boom, consumers refinanced mortgage loans at record rates. Moreover, according to a recent report by the Federal Reserve, consumers are sitting on nearly 30 trillion dollars in home equity.  HELOCs allow consumers the opportunity to extract equity from their homes without losing the low interest rate on their first-lien loan. Generally, a HELOC is a revolving line of credit that is secured by a subordinate mortgage on the borrower’s residence that typically has a draw period of 5 or 10 years.  At the end of the draw period, the outstanding loan payment converts to a repayment period of 5 to 25 years with interest and principal payments required that fully amortize the balance.

Issues to Consider in Servicing HELOCs

Servicing HELOCs raise unique issues given the open-end nature of the loan, the typical second lien position, and the different regulatory requirements.  HELOC servicers will need to ensure their compliance management systems (“CMS”) are robust enough to account for a potential uptick in HELOC lending. Among many other issues, servicers will want to ensure their operations comply with several regulatory requirements, including:

Offsets: In the Amicus Brief, the CFPB argues that HELOCs accessible by a credit card are subject to the provisions of TILA and Regulation Z that prohibit card issuers from using deposit account funds to offset indebtedness arising out of a credit card transaction.

Disclosures: Long before the CFPB Mortgage Servicing Rules, TILA and Regulation Z contained disclosures applicable to HELOCs. As a result, the provisions of the CFPB Mortgage Servicing Rules under Regulation Z governing periodic billing statements, adjustable-rate mortgage (ARM) interest rate adjustment notices, and payment crediting provisions do not apply to HELOCs as these provisions are specifically limited to closed-end consumer credit transactions. However, the payoff statement requirements under Regulation Z are applicable both to HELOCs and closed-end consumer credit transactions secured by a dwelling. In addition to certain account-opening disclosures, a HELOC creditor (or its servicer) must make certain subsequent disclosures to the borrower, either annually (e.g., an annual statement) or upon the occurrence of a specific trigger event, such as the addition of a credit access device, a change in terms or change in billing cycle, or a notice to restrict credit. It is also worth noting that Regulation Z’s mortgage transfer notice (commonly referred to as the Section 404 notice) applicable when a loan is transferred, sold or assigned to a third party, applies to HELOCs. In contrast, RESPA’s servicing transfer notice does not apply to HELOCs.

Periodic Statements: TILA and Regulation Z contain a different set of periodic statement requirements, predating the CFPB Mortgage Servicing Rules, which are applicable to HELOCs. Under TILA, a servicer must comply with the open-end periodic statement requirements. That is true even if the HELOC has an open-end draw period followed by a closed-end repayment period, during which no further draws are permitted. Such statements can be complex given that principal repayment and interest accrual vary based on draws; there will be a conversion to scheduled amortization after the draw period ends; and balloon payments may be required at maturity, resulting in the need for servicing system adjustments.

Billing Error Resolution: Instead of having to comply with the Regulation X requirements for notices of error, HELOCs are subject to Regulation Z’s billing error resolution requirements.

Crediting of Payments: A creditor may credit a payment to the consumer’s account, including a HELOC, as of the date of receipt, except when a delay in crediting does not result in a finance or other charge, or except as otherwise provided in 12 C.F.R. § 1026.10(a).

Restrictions on Servicing Fees: Regulation Z restricts certain new servicing fees that may be imposed, where such fees are not provided for in the contract, because the credit may not, by contract or otherwise, change any term except as provided in 12 C.F.R § 1026.40.  With the CFPB’s increased focus on fees, this provision may be an area of focus for the Bureau and state regulators.

Restriction on Changing the APR: The creditor may not, by contract or otherwise, change the APR of a HELOC unless such change is based on an index that is not under the creditor’s control and such index is available to the general public.  However, this requirement does not prohibit rate changes which are specifically set forth in the agreement, such as stepped-rate plans or preferred-rate provisions.

Terminating, Suspending or Reducing a Line of Credit: TILA and Regulation Z restrict the ability of the creditor to prohibit additional extensions of credit or reduce the credit limit applicable to an agreement under those circumstances set forth in 12 C.F.R § 1026.40.  Similarly, TILA and Regulation Z impose restrictions on when the creditor may terminate and accelerate the loan balance.

Rescission: Similar to closed-end loans, the consumer will have a right of rescission on a HELOC; however, the right extends beyond just the initial account opening. During the servicing of a HELOC, the consumer has a right of rescission whenever (i) credit is extended under the plan, or (ii) the credit limit is increased. But there is no right of rescission when credit extensions are made in accordance with the existing credit limit under the plan. If rescission applies, the notice and procedural requirements set forth in TILA and Regulation Z must be followed.

Default: Loss mitigation and default recovery actions may be limited by the firstien loan. That’s because default or acceleration of the first-lien loan immediately triggers loss mitigation and default recovery to protect the second-lien loan.  The protection of the second-lien loan may involve advancing monthly payments on the first-lien loan.  Foreclosure pursued against the first-lien loan will trigger second lien to participate and monitor for protection and recovery. Even though not applicable to HELOCs, some servicers may consider complying with loss mitigation provisions as guidelines or best practices.

ECOA and FCRA: Terminating, suspending, or reducing the credit limit on a HELOC based on declining property values could raise redlining risk, which is a form of illegal disparate treatment in which a lender provides unequal access to credit or unequal terms of credit because of a prohibited characteristic of the residents of the area in which the credit seeker resides or will reside or in which the residential property to be mortgaged is located. Thus, lenders and servicers should have policies and procedures in place to ensure that actions to reduce, terminate or suspend HELOCs are carried out in a non-discriminatory manner.  Relatedly, the CFPB’s authority under the Dodd-Frank Act to prohibit unfair, deceptive or abusive acts or practices will similarly prohibit certain conduct in connection with the servicing of HELOCs that the CFPB may consider to be harmful to consumers.  It is also important to remember that ECOA requires that a creditor notify an applicant of action taken within 30 days after taking adverse action on an existing account, where the adverse action includes a termination of an account, an unfavorable change in the terms of an account, or a refusal to increase the amount of credit available to an applicant who has made an application for an increase.  Similar to ECOA, FCRA also requires the servicer to provide the consumer with an adverse action notice in certain circumstances.

State Law Considerations: And let’s not forget state law issues. While most of the CFPB’s Mortgage Servicing Rules do not apply to HELOCs, many state provisions may cover HELOCs.  As most HELOCs are subordinate-lien loans, second lien licensing law obligations arise. Also, sourcing, processing and funding draw requests could implicate loan originator and/or money transmitter licensing obligations. Also, at least one state prohibits a licensee from servicing a usurious loan.  For HELOCs, the issue is not only the initial rate but also the adjusted rate (assuming it is an ARM).  There may also be state-specific disclosure obligations, as well as restrictions on product terms (such as balloon payments or lien releases), fees, or credit line access devices, to name a few.

Takeaway

The servicing of HELOCs involve many of the same aspects as servicing first-lien residential mortgage loans.  However, because of the open-end credit line features and the typical second-lien position, there are several unique aspects to servicing HELOCs.  And, because there are no industry standard HELOC agreements, the terms of the HELOC (e.g., the length of draw and amortization periods, interest-only payment features, balloon, credit access, etc.) can vary greatly.  The economic climate is poised for a resurgence in home equity lending.  Now is the time to ensure your CMS is up to the task.