Dodd-Frank's New Rules for Residential Lending-Falling Down the Rabbit Hole

Article excerpt

"Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!" --THE RED QUEEN

As the Red Queen tells Alice in Lewis Carroll's Through the Looking-Glass, there are some unusual rules for her race. For mortgage lenders trying to prepare for the litany of regulations coming from last year's Dodd-Frank Wall Street Reform and Consumer Protection Act, the race is just as frantic ... and seemingly impossible.

The era of new rules

"Sentence first--verdict afterwards." --THE QUEEN

When President Obama signed the Dodd-Frank Act into law on July 21, 2010, its 2,300 pages directed roughly 30 different federal agencies

to write more than 250 rules and conduct more than 60 studies. For financial institutions, this plethora of regulations is just the beginning of what is shaping up to be "the era of new rules."

To illustrate the coming regulatory challenges, consider a May 19 speech by Acting Comptroller of the Currency John Walsh, in which he said: "While Dodd-Frank will change the way that all financial services companies operate, the changes are particularly dramatic for mortgage lenders. There are 15 Lo 20 new mortgage lending requirements in the regulatory pipeline, and their impact on the mortgage and servicing businesses will be more tsunami than simple wave."

The full scope of these "new rules" may be overwhelming, but a few issues deserve immediate attention--including the Federal Reserve Board's proposed ability-to-repay rule and a proposed interagency rule on credit risk retention. Taken together, these two rules will effectively set underwriting standards for most residential mortgages in the United States.

Dodd-Frank also creates a brand new regulator called the Consumer Financial Protection Bureau (CFPB). Effective July 21, 2011, the CFPB has responsibility for virtually all consumer financial protection laws, including the Real Estate Settlement Procedures Act (RESPA), Truth in Lending Act (TILA), Home Ownership and Equity Protection Act (HOEPA), Home Mortgage Disclosure Act (HMDA), Fair Credit Reporting Act (FCRA), Equal Credit Opportunity Act (ECOA) and Secure and Fair Enforcement for Mortgage Licensing Act (SAFE).

The CFPB also becomes the primary regulator for non-depository lenders--a function that it will share with state regulators. Importantly, CFPB has broad authority to promulgate rules to prevent "unfair, deceptive or abusive" acts and practices. Thus, future CFPB rulemakings present additional unknown regulatory risks.

Ability to repay

"Everything's got a moral, if only you can find it." --THE DUCHESS

In April, the Federal Reserve issued a 474-page proposed rule, which the CFPB will eventually finalize, that requires lenders to make a good faith determination that a borrower has the ability to repay a loan. While it may sound like Underwriting 101, nothing in the regulatory arena is that simple.

The proposed rule requires lenders to consider and verify eight basic underwriting factors as part of a basic ability-to-repay standard. The proposal also asks for comments on two alternatives for obtaining legal protection for loans meeting a Qualified Mortgage (QM) test. One option is a safe harbor and the other is a rebuttable presumption.

Aside from very different levels of legal protection, both options include product restrictions, limitations on points and fees, and other underwriting requirements. The penalties for violating the ability-to-repay standards are severe, including class-action lawsuits, statutory damages and the ability to use violations as a defense to foreclosure at any time during the life of the loan.

Given the significant compliance and legal risks, a workable QM standard is critical for the lending industry, and the Mortgage Bankers Association (MBA) has aggressively advocated its views from day one. …