Are We Headed For A New Compliance World?

Imagine a world in which banks must give disclosures about their costs and third party costs before the applicant signs or pays anything. Imagine a world in which the bank must guarantee those early disclosure costs or face the risk of criminal prosecution. Imagine a world in which the finance charge and the APR contain every cost the consumer chooses to pay, even if they might have paid for a similar service in a cash transaction. Imagine a world in which compliance managers are never allowed to retire. If HUD has its way, that world is coming.

Just before the end of July, the Federal Reserve Board and the Department of Housing and Urban Development sent a joint report and recommendation to Congress on ways to revise RESPA and TILA. This report is the result of a mandate given to the two agencies by congress in the EGRPRA 1996. When the banking associations lobbied for this provision, they envisioned a simplified set of disclosures that would contain the concepts of both RESPA and TILA but in simpler form. Instead of using their authority to issue regulations to make refinements to the existing disclosure requirements, the agencies chose to report to Congress that the job could not be done without legislative changes.

Unfortunately for the industry, HUD seems to be using this opportunity to ask for significant increases in consumer protection that were not actually contemplated in the original RESPA. The proposal contains several recommendations that would provide consumers with new protections and remedies. Needless to say, they would be provided at the expense of creditors even if the creditor was not necessarily the malfeasor.

HUD's agenda does not seem to include genuine simplification. Nothing in the proposal would make RESPA compliance easier. In fact, the proposal includes all of the requirements that are currently problematic and adds more. It appears that HUD is using this opportunity to lobby for changes to the law that HUD has failed to incorporate effectively into its own regulation.

The FRB, on the other hand, seems to have worked with a genuine commitment to making improvements in both the information given to customers and the ability of creditors to comply.

Recommendations for change
The recommendations fall into several areas:
Improving the cost disclosures of Truth in Lending; Improving the settlement cost disclosures of RESPA; Timing and delivery of disclosures; The consumer's right of rescission; and Additional consumer protections.

In carrying out this review, the agencies faced several systemic problems in the form of fundamental differences between the two laws. Truth in Lending addresses the cost of credit - and only credit - and places the responsibility for disclosure and compliance on the creditor. RESPA applies to all settlement services, the costs for those services, and all of the service providers.

Improving the cost disclosures of Truth in Lending
One of the FRB's findings is that consumers don't adequately understand what the APR is and how to use it. To remedy this, the FRB proposes making changes to the APR. This editor notes that the consumer world has had 30 years to come to grips with the APR and the fact that it has not done so should tell us something about the basic concept: it doesn't work. Therefore, changing the APR is not going to deal with the problem - it will simply change it a little.

The FRB accurately identifies the APR and the Total Finance Charge as being at the heart of the problem. They are both the source of the most common violations of Regulation Z. Clearly, something needs to be fixed. However, the FRB immediately concludes that the APR is a useful benchmark that is of value to consumers and that it deters charging hidden fees that would be included in the calculations. The APR was intended to be a shopping tool, not a deterrent. Most participants in the debate agree that it does not function as a shopping tool. Presumably, then, the focus of this study should be on identifying effective shopping tools rather than preserving brontosaurian deterrents. Instead, however, the FRB focused on ways to make the APR more meaningful.

The best approach to making the APR more meaningful, according to the FRB, is to load more information into it, i.e., include more fees so that it is a larger number. The problem with this approach is twofold. First, it still wouldn't provide the customer with any more information than it currently does. However, it would invite unscrupulous lenders to skim off numbers to reduce their APR.

To its credit, the FRB recommends dropping the "amount financed". This calculation is not only a source of common violations, it is terribly confusing to the consumer. Consumers simply do not understand the technical distinctions between the amount of money they are borrowing and the amount financed - the amount of money of which they have the use.

Improving RESPA's settlement cost disclosures
HUD apparently began its analysis with the concept that customers cannot use the GFE to compare settlement costs if they could not rely on the costs initially disclosed. [We cannot help noting that RESPA was not originally designed to be a shopping tool. It was designed to prevent "settlement shock" - the consumer's surprise at closing for fees that must be paid. Shopping was not the motivator for RESPA.]

One of RESPA's weaknesses is that the requirements for good faith estimates and settlement cost disclosures are not supported with penalties for non-compliance. HUD is using this opportunity to seek enforcement powers and penalties for non-compliance with these provisions. To establish a measurable standard, HUD proposes that creditors use one of two methods: guarantee closing costs, or be subject to a tolerance.

A creditor offering guaranteed closing costs would be responsible for providing mortgage credit at a fixed settlement cost. In effect, the creditor would serve as the settlement service shopper and would take on the consequences of price increases - the creditor would pay any increases or differences.

The theory behind guaranteed costs is that the creditor would be motivated to shop for discount packages, and would use its specialized knowledge to obtain favorable prices for the consumer. The report contains a fairly long discussion of how creditors would or could identify and guarantee costs.

For those of us with long memories, it is this very packaging approach, and the abuses that it concealed, that led to RESPA in the first place. But of even more concern is the burden of responsibility that this places on the lender. Because RESPA covers all settlement service fees, and all service providers, this approach would make the mortgage lenders responsible for the actions of third parties. Banks and other mortgage lenders would become active players - if not enforcers - in the settlement service market. Will small lenders even be able to offer this approach?

A final concern with this approach is that it would require lenders to guarantee the very types of fees that generally lead to differences between the GFE and the HUD-1. The solution is blissfully simple - make the lender pay.

Even with guaranteed closing costs, HUD is recommending that lenders itemize what is included. Thus, the disclosure burden would not be reduced. Moreover, HUD is not proposing to roll back Section 8, but to provide instead that appropriate settlement packages be qualified for an exemption from Section 8. Creditors using this approach would have no guarantee of immunity from prosecution under Section 8. As an alternative to guaranteed closing costs, HUD recommends another method to make the GFE more reliable: establish tolerances that could not be exceeded. This tolerance would apply to all closing costs, including points and fees charged to lock in or obtain a rate. Thus, the cost of the loan would be established at the time of application.

HUD makes additional recommendations relative to the early cost disclosures. These recommendations include disclosures about required escrow accounts, servicing transfers, and information about required private mortgage insurance.

To make these disclosure concepts work, HUD proposes "new and simplified" remedies for consumers, including strengthened criminal sanctions, new civil remedies, and private causes of action.

This all began with the goal of making loan shopping easier. By offering two different and incompatible methods of disclosure, HUD proposes making comparative shopping impossible. Somewhere, the agency made a U-turn.

Timing and delivery of disclosures
The agencies note that the disclosure process would be "simplified" if the timing requirements for different disclosures were made more consistent. The process would be "improved" for consumers if disclosures were given when they were most useful. Note that this set of assumptions allows the agencies to recommend that disclosures be given at the same time, on the basis that joint timing is "simplified", even if the timing requirement is more rigorous or more difficult to meet.

Because of these assumptions, the agencies are generally recommending that disclosures be given earlier in the process. For example, the HUD booklet should be given as soon as possible, perhaps by realtors or other settlement service providers.

Banks should have serious concerns about these ideas. The problem for banks, especially during examinations, will be to prove that the disclosures were given by third parties. Other participants in the sale and settlement process will not be regularly examined. The compliance problems now in evidence - such as realtors and mortgage brokers failing to give GFEs - will continue but be magnified.

The agencies presume that earlier disclosures will be facilitated by growth in technology, making it easier to generate early disclosures. This assumption does not take bank size and cost of technology into account. This assumption may seriously cripple the ability of small banks to offer mortgage loans.

Consumer's right of rescission
The FRB proposes using the earlier cost disclosure requirement to adjust the time period for the consumer's right to rescind. When the creditor provides accurate closing cost disclosures three days prior to closing, the consumer's three day right of rescission would run from the date of the final disclosures to the date of closing.

The FRB also proposes eliminating the right of rescission in certain types of transactions, such as when the consumer is refinancing to obtain a lower interest rate. In addition, the recommendations would provide for relaxing the circumstances allowing a consumer to waive the right to rescind. However, other situations, such as high-priced home improvement loans, would have strong protections. In addition, consumer advocates argue that any material errors in disclosures or failure to provide disclosures should lead to an extended three-year right to rescind that would not be subject to waiver by the consumer.

While the reasoning behind these proposals is fair and sound, the implementation is complex and unclear. Consumer advocates have openly admitted that Truth in Lending is the most important litigation tool in relieving consumers from foreclosure and other debt enforcement proceedings. Any rule that allows the evaluation to be made after the fact will contain serious compliance problems for lenders.

ACTION STEPS

Follow this joint agency report. It may take us places and if the process is fast, you will need to be ready.
Get familiar with the report and study the reasoning the agencies give. The reasoning behind the recommendations will help you understand what happens and even predict it.
Encourage your lending staff to talk with customers and find out what they really want. Use this information in lobbying and comment letters.
Review your lending process. Think about how the process works, who does what, and what resources they have to do it with. How will the proposed changes affect that? Are they even do-able? Share this information with trade associations.
Many pieces of the report contain good explanations of Regulation Z and RESPA. Consider using these in training or your compliance manuals.