Skip to main content

Search

Mortgage Lending: 7.2.2.1 Overview

Underwriting is the process of determining whether a borrower is qualified for a loan. The Office of the Comptroller of the Currency (OCC) states that “[p]rudent underwriting is of paramount importance to effective lending.”40 According to the OCC:

Mortgage Lending: 7.2.3.1.1 HOEPA

High-cost and higher-priced mortgages on a consumer’s home75 are subject to the Home Ownership and Equity Protection Act (HOEPA).76 Since the Act became effective, loans subject to it (sometimes known as “HOEPA loans” or “Section 32 loans”) cannot be made without regard to the homeowner’s ability to repay.77 This section summarizes HOEPA’s requirements.

Mortgage Lending: 7.2.3.1.2 Higher-priced mortgage rules

Although HOEPA only covers the most expensive loans, the 2008 HOEPA rules added coverage of “higher-priced” mortgages, a category designed to be roughly equivalent to the subprime market.82 These rules only apply to loans for which the creditor received an application on or after October 1, 2009.83 Until 2014, the HOEPA protections did not apply to home equity lines of credit (HELOCs), even if the line of credit met the price trigger.84

Mortgage Lending: 7.2.3.1.3 Ability-to-repay rules for HOEPA and higher-priced mortgage loans from October 2009 to January 2014

For loans originated between October 2009 and January 2014,86 lenders had to take into account the homeowner’s ability to repay when making both HOEPA loans and higher-priced mortgages.87 This requirement meant that creditors were prohibited from making these loans “based on the value of the consumer’s collateral without regard to the consumer’s repayment ability as of consummation, including the consumer’s current and reasonably expected income, employment, assets other than the collateral,

Mortgage Lending: 7.2.3.2 State Laws

About half the states have high-cost loan laws, designed to address predatory mortgage lending.105 Usually these statutes are, like HOEPA, limited to a defined class of loans that carry particularly high interest rates or points and fees.

Mortgage Lending: 7.2.3.3.1 Overview

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) amended the Truth in Lending Act (TILA)112 by imposing significant restrictions on lending without regard to the borrower’s ability to repay.113 These restrictions apply to “residential mortgage loans”—a defined term that includes most closed-end, dwelling-secured loans.114 The statute prohibits lenders from originating a covered loan without making a reaso

Mortgage Lending: 7.2.3.3.2 Minimum ability-to-repay standards

In January 2013, the CFPB issued rules codifying minimum standards for determining affordability.122 These rules are effective for applications received on or after January 10, 2014 but, as with other federal guidance, they may be useful for establishing what existing industry standards require.123 This is particularly true for these rules, which the Bureau described as establishing “minimum requirements.”124

Mortgage Lending: 7.2.3.3.3.2 Presumption of compliance for qualified mortgages

Qualified mortgages are presumed to comply with the minimum standards of affordability applicable to all residential mortgages.149 The presumption of compliance creates a safe harbor that protects lenders from liability under the ability-to-pay rules. For certain loans the presumption of compliance is rebuttable, while for other loans it is not.

Mortgage Lending: 7.2.3.3.3.3 Presumption of compliance and state law claims

Qualified-mortgage status should not foreclose an inquiry into whether, under state law, the loan was foreseeably affordable or otherwise abusive.159 Practitioners should remember that the Dodd-Frank Act merely requires an assessment of ability to repay; it does not require that loans actually be affordable. It is entirely possible that a creditor could know that a mortgage was foreseeably unaffordable and make the loan anyway.

Mortgage Lending: 7.2.3.3.4 Qualified residential mortgages and credit risk retention

Among other provisions designed to reduce reckless lending, the Dodd-Frank Act also requires sponsors of mortgage-backed securities to retain five percent of the risk that a mortgagor will default—unless the mortgage loan meets the definition of a “qualified residential mortgage.”160 Six federal agencies jointly issued the Credit Risk Retention rule in December 2014 to implement this requirement, effective February 2015.161

Mortgage Lending: 7.2.3.5 Other Sources of Industry Standards

In addition to the statutes, regulations, and guidance promulgated by legislatures and banking agencies, there are other basic industry standards applicable to consumer mortgage loans.181 Some examples of these standards can be found on the websites of major participants in the mortgage marketplace, such as Fannie Mae,182 Freddie Mac,183 the FHA,184 and the VA

Mortgage Lending: 7.2.4.2 Measuring Income; Grossing Up

As a general rule, creditors look to pre-tax, or gross, income when measuring affordability. The question then arises how to account for non-taxable income, such as Social Security income or Supplemental Nutrition Assistance Program (SNAP) benefits. If one compares two homeowners with the same dollar amount of income—one with only taxable employment income and the other with only non-taxable public benefits income—the one with only non-taxable public benefits income will have more dollars to spend because that homeowner will not have to also pay taxes.

Mortgage Lending: 7.2.5.1 Verification of Income and Expenses

Verification of income has always been a standard and essential part of underwriting.241 The amount, source, and reliability of the income should all be verified.242 But, in the years leading up to the subprime mortgage meltdown, the prevalence of loans without documentation, or with only limited documentation, undermined this essential element of underwriting.243 Even when creditors claimed to be verifying income, they often cut corners, rel

Mortgage Lending: 7.2.5.2 Special Considerations for Stated-Income Loans

Stated-income loans, or “no-doc loans,” are loans made without documentation or verification of the borrowers’ income. Even if borrowers submit documentation of income, it will be ignored.256 These loans are sometimes referred to as “liars’ loans” because of the opportunity they afford for dishonest behavior.257 Related to stated-income loans are reduced documentation loans, for which lenders require only limited documentation of income, such as bank statements or tax returns.

Mortgage Lending: 7.2.6.1 The Nature of Risk in Nontraditional Mortgage Products

A common feature among the complex, risky mortgage products that drove the subprime mortgage collapse in 2007 was an adjustable interest rate. By 2006, adjustable rate mortgages (ARMs) accounted for eighty percent of all subprime mortgage originations.278 Many of these ARMs had interest rates that could only adjust upward from their initial rate. That is, the contract established the initial rate as a floor below which the interest rate could never fall.

Mortgage Lending: 7.2.6.2.1 Problems of measuring affordability in non-standard mortgages

Adjustable rate mortgages (ARMs) and non-standard products present particular problems for measuring ability to repay. An ARM can start out as affordable, only to double in cost in a few years when the rate resets. Many courts have been skeptical of the affordability of ARMs, particularly when combined with initial “teaser” rates and prepayment penalties that prevent affordable refinancing.288

Mortgage Lending: 7.2.6.2.2 Banking agency guidance on standards of affordability for ARMs and nontraditional mortgages

As early as 1997, the Office of the Comptroller of the Currency (OCC) recognized that adjustable rate mortgages lead to high rates of default.293 The OCC recommended that lenders consider the credit risk of ARMs: “At a minimum, the impact should be weighed in terms of both annual and lifetime caps.”294 In other words, when underwriting loans, lenders were to pay attention to the maximum possible payment.

Mortgage Lending: 7.2.6.2.4 Dodd-Frank standards of affordability for nontraditional mortgages

Interest-only and negatively amortizing loans are not generally eligible for any presumption of affordability under the Dodd-Frank Act ability-to-repay rules.303 The CFPB underlined its basic skepticism about the affordability of these nontraditional mortgage loans by allowing eased requirements for measuring a borrower’s ability to repay when a new creditor is refinancing an adjustable rate, interest-only, or negatively amortizing loan into a fixed rate, fully amortizing mortgage.304 In oth

Mortgage Lending: 7.2.7.1 Overview

Courts have recognized that the practice of lending without regard to the borrower’s ability to repay is a per se unfair and deceptive act or practice.308 This may be the case even when the loan was a refinancing of an earlier loan that was, itself, unaffordable.309 Failure to follow the basic precepts of underwriting for affordability and sustainability can subject the originating creditor, the assignee,310 or even the investment banks who f