Dodd-Frank Mortgage Servicing Rules, Focus on Mortgage Origination Risk Issues

January 02, 2014

To All SLG Clients and Affiliates.

From: Spencer Scheer
Subject: Dodd-Frank Mortgage Servicing Rules, Focus on Mortgage Origination Risk Issues.

Background: The Dodd-Frank Wall Street Reform and Consumer Protection Act will dramatically impact lenders. I think it is fair to say that, outside of the enactment of the Bankruptcy Code in 1979, no single legislative enactment has had a greater impact on residential mortgage lenders. The effective date for compliance is January 10, 2014, for most provisions.

Scheer Law Group has recently focused its efforts on providing information to its lender servicing/collection clients to assist in preparing for the impact of Dodd- Frank on error resolution and default management policies and procedures. If you did not sign up for our webinar on 12.10.13, I encourage you to go to the SLG website, where the webinar can be obtained on line at www.scheerlawgroup.com

Impact on Loan Origination: Besides the Mortgage Servicing Rules, the Dodd-Frank Loan Origination Rules will have a major impact on lenders. There are a wide variety of changes that require implementation of policies and procedures and strategic planning to avoid lawsuits. The single biggest impact on the origination side is the requirement that the lender determine the borrower’s ability to repay (ATR) and document ATR. To mitigate some of the risks of lenders being sued for wrongful failure to properly assess ATR, Dodd-Frank has established classes of mortgage loans described as “qualified mortgages”. The rules and requirements to make such mortgages are too extensive to discuss here.

What SLG would like you to understand is that under the new rules, different types of qualified mortgages provide different levels of lender protection. Understanding risks and rewards that result from originating both qualified and non-qualified loans, and the impact on borrower lawsuits and claims, is critical. When combining the rights of borrowers to maintain private rights of actions for real or perceived errors relating to loan servicing and default processing, with the rights to challenge non-qualified mortgages and certain classes of qualified mortgages, borrowers now have significantly enhanced “tools” to challenge their obligations.  Prudent lenders will “level the playing field” by understanding such risks and determining if they have effective procedures in place to properly evaluate, originate, and service loans along the risk continuum set up by Dodd-Frank.

Take for example the hierarchy of loans under the soon to be implemented “Qualified Mortgage (“QM”) rules. Strong incentives in the way of legal protections from borrower lawsuits are given to Lenders who make such loans. The goal of the rule is to require lenders to underwrite such loans so that risky features i.e. balloon payments, excessive fees etc. are removed, and  that the borrowers’ ability to pay the loan is verified. Generally, two levels of protection are given to lenders from borrower lawsuits, depending on the pricing of a QM loan.

• Lower-priced QM mortgage loans (those with an interest rate at or near the Average Prime Offer Rate [AOR]) will provide lenders with a broad  “safe harbor,”  a conclusive presumption that the borrower has the ability to pay the debt.
• Higher-priced loans (those with an APR that is “1.5 percentage points[1] or more over the Average Prime Offer Rate”) will  provide lenders with a more limited safe harbor, allowing the lender a  more narrow “rebuttable presumption” that the borrower can pay. The borrower can provide evidence that the presumption should be disregarded.

It is safe to say that as “word gets around”, every covered loan that is not a lower priced QM will be subject to claims that the borrower did not have the ability to repay it.  This doesn’t mean that every borrower will raise such claims, but that it is a built in risk on every non-low priced qualified mortgage and that this risk should be factored into portfolio structure. “Hard Money” lenders making covered loans that are not QM loans clearly have the greatest risk. Factoring in the certainty of greatly increased borrower challenges on these types of loans will become an essential part of the lending business under Dodd-Frank.

Lenders that have the flexibility to underwrite both lower and higher priced QM loans must also factor these risks into portfolio structure. On higher priced QMs, yield is maximized but salability will be restricted in many instances. Well run lenders who originate and service their own loans, and who have proficiency and expertise on both the origination and servicing sides, may have an opportunity to seize market share and thrive in the new era of QMs, even in the face of increased borrower challenges.

Those who fail to appreciate the risks will suffer “death by a thousand cuts”, as borrowers and borrowers’ counsel will use the new tools allowed to challenge loans based on claims that the Lender never should have originated the loan and that it was serviced improperly.

If you have questions on the new QM rules, please contact SLG.

[1] Note that small creditor QM loans, made by lenders making less than 500 closed end first mortgage loans in the last year, and having a net worth less than $2 Billion, allow rates up to 3.5% over APOR to qualify for the conclusive presumption.