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Alligators in the Swamp

By Howard A. Lax, Esq.
Lipson, Neilson, Cole, Seltzer & Garin, P.C.
Troy, MI

Editor's Note: Due to all the indentations, you may want to read from the print-friendly version.

Federal and state lending regulations impose a quagmire of disclosure rules and substantive restrictions impeding the full authority of a Loan Officer to provide credit to the Bank?s customers. Each statute has its own particular quirks and requirements, and generalizations cannot be extended from one loan to another or from one law from other. Summarized below are the principal regulatory requirements found in traditional consumer protection laws that apply to business purpose loans and loans to commercial entities, that are secured by a residence.

I. Equal Credit Opportunity Act. The Equal Credit Opportunity Act (ECOA) is implemented by Federal Reserve Board Regulation B. Section B below applies to loans secured by a residence. The other features of this rule apply to all credit.

A. Discrimination is prohibited on the basis of race, color, religion, national origin, sex, marital status, age (provided that the applicant is old enough to enter into a contract), receipt of public assistance, or exercise of rights granted by federal laws. State laws and local ordinances may increase the number of protected >

B. Notice of the lender?s credit decision is required within 30 days of making a credit decision or having sufficient information to make a credit decision.

1. The lender may define the terms under which the borrower?s application for credit will be considered; however, consideration of the borrower?s financial circumstances in response to a generalized request for credit waives any application format that bank policies may require. For example, review and evaluation of a financial statement, or obtaining a credit report, in response to a general inquiry about the availability of credit is considered an application triggering the notification requirement.

2. The decision by lender that credit cannot be granted under any circumstances after receiving a generalized request for credit triggers the requirement to notify the applicant of the credit decision.

3. The 30 day notice rule implies that the lender has an obligation to request information needed to make a credit decision as soon as practicable, but no later than 30 days after a request for credit is received.

4. Each lender who participates in the credit evaluation process has an independent obligation to notify the applicant of that lender?s decision. One lender may issue a notice of credit denial on behalf of several lenders. A lender?s obligation to issue notice of a credit denial is waived if any lender offers the requested credit to the applicant and the credit is accepted.

C. The applicant must receive a notice of the right to receive a copy of the appraisal at or before the time that the credit decision is conveyed to the applicant. In the alternative, the lender may provide a copy of the appraisal to the applicant when credit is denied, when the offer of credit is not accepted, or at the closing. The appraisal report must include internal review documents reflecting that the lender?s property valuation is different than a third party appraisal report. Internal review documents used to confirm the valuation of a property do not need to be provided with the appraisal if they agree with the appraisal.

D. A lender cannot ask for information about the borrower?s or the principal?s spouse unless: the spouse will have access to the credit granted by the lender; or, the spouse volunteers to be contractually obligated to pay the debt; or, the applicant is relying upon the spouse?s income as a basis for repayment; or, the applicant resides in a community property state or the collateral is located in a community property state.

1. A lender cannot ask the principal?s spouse to sign a note or credit agreement simply because he or she is the spouse of the principle. Exceptions exist when the spouse is a director, officer or principal shareholder of the borrower business entity.

2. The same rules apply to requesting the spouse to sign a guarantee.

3. Do not confuse this rule with the rules for signing security agreements. Anyone with interest in the collateral for a loan can be required to sign a security agreement or mortgage to allow the lender to obtain a clear security interest in the collateral. A spouse of a homeowner can be required to sign a mortgage to convey his or her interest in the home or to waive homestead and dower rights.

F. Information about the race, ethnicity, sex, age and marital status of each borrower must be collected for home purchase, refinance and home improvement loans. The model Government Monitoring Questionnaire should be used for this purpose.

II. Home Mortgage Disclosure Act (HMDA) The Home Mortgage Disclosure Act (HMDA) requires lenders to report statistical information to the government regarding applications and loans to purchase or refinance a home, or to improve a residence. Application and loan information is collected for multifamily and single-family residential properties. Nonidentifying information from the lender?s report, and statistical compilations returned to the lender by the government, must be made available to the public. A notice of the availability of this information must be posted in each branch.

A. Each Loan Officer is responsible for providing information to the appropriate compliance officer or CRA officer about each loan and each loan application that may be reported under this law.

B. Applicants are not notified that information about their application or loan will be reported to the government.

III. Fair Credit Reporting Act The Fair Credit Reporting Act (FCRA) limits the purposes for which a person may obtain a consumer credit report. A credit report is any written, oral, or other communication of information bearing on an individual?s creditworthiness, credit standing, credit capacity, character, general reputation, personal characteristics, or mode of living, which is used, or expected to be used, or collected, in whole or in part for the purpose of serving as a factor in establishing a consumer?s eligibility for credit, insurance, employment, or other legitimate business purposes. The credit report may consist of public or private information. A Dunn & Bradstreet report concerning a business entity is not a consumer credit report.

A. In a commercial loan transaction, the individual?s consent is needed to obtain a credit report if the individual will not be obligated to repay the loan or provide a guarantee of payment.

B. A customer must be provided the right to opt out of sharing of credit reports between affiliated entities. Hence, loan officers must determine whether the bank?s financial privacy disclosure informed the consumer of the opportunity to share information with affiliates, and the consumer was allowed 30 days after receiving the disclosure to opt out, before the loan officer, may obtain a credit report from, or provide a credit report to, an affiliated financial institution.

IV. Financial Privacy Rules (Article V of the Gramm-Leach-Bliley Act) The GLB Act requires each financial institution to provide a financial privacy disclosure to customers at the time that each customer relationship is established. This rule applies to consumer purpose transactions involving individual borrowers.

V. Real Estate Settlement Procedures Act The Real Estate Settlement Procedures Act (RESPA) only applies to consumer purpose transactions. Disclosure forms such as the Good Faith Estimate of Settlement Costs, HUD ? 1 Settlement Statement, Special Information Booklet (Buying Your Home), Servicing Disclosure Statement, Notice of Transfer of Servicing, Escrow Disclosure, and Affiliated Business Arrangement Disclosure, are not required for commercial transactions.

VI. Truth in Lending Act The Truth in Lending Act (TILA) only applies to consumer purpose transactions. Disclosure forms such as the Federal TILA box disclosure, Itemization of the Amount Financed, CHARM Booklet and ARM Program Disclosure, Section 32 Disclosure, Reverse Mortgage Disclosure, and the Notice of Right to Cancel, are not required for commercial transactions.

A. There is no bright line between a consumer purpose transaction and a commercial purpose transaction. The greater the contribution of the proceeds of the loan to the borrower?s ability to earn a livelihood, the more likely it is to be a commercial transaction.

B. Loans to purchase or improve nonowner occupied rental property are, by definition, business purpose loans. Loans to a commercial entity are, by definition, business purpose loans.

C. A business purpose affidavit does not necessarily prove that a loan is for business purposes. The converse is also true. A determination that a loan is for business purposes does not mean that you can ignore the requirement that you obtain a business purpose affidavit to avoid usury problems.

VII. Usury and Federal Preemption Under DIDMCA Loans principally secured by a first lien on a single family residence are not subject to civil or criminal usury limits on finance charges (a finance charge is defined in TILA). As a general rule, if the collateral includes more than a home and an acre of land, you should consult your legal counsel regarding any loan with interest and other loan charges at or above 25% (weighted over the life of the loan). This becomes an issue with short term swing loans and construction loans. If a lender relies on federal usury preemption to charge finance charges, a fifteen (15) day grace period is required before a late payment fee may be imposed.

VIII. Due on Sale Rules Due on sale clauses are enforceable except for the following events involving owner occupied secured homes:

  • The creation of a junior lien or other junior encumbrance that does not relate to a transfer of rights of occupancy in the property (i.e. the due on sale clause is enforceable if the property is encumbered by a land contract, but not if the encumbrance is a second or third mortgage);
  • The creation of a purchase money security interest for household appliances;
  • Transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety (inheritance does not trigger the due on sale clause);
  • The granting of a leasehold interest which has a term of three years or less and which does not contain an option to purchase (either a lease of more than three years or a lease with an option to purchase will allow the exercise of a due on sale clause);
  • A transfer, in which the transferee is a person who occupies or will occupy the property, which is: (A) A transfer to a relative resulting from the death of the borrower; (B) A transfer where the spouse or child(ren) becomes an owner of the property; or (C) A transfer resulting from a decree of dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement by which the spouse becomes an owner of the property;
  • A transfer into an inter vivos trust in which the borrower is and remains the beneficiary and occupant of the property, unless, as a condition precedent to such transfer, the borrower refuses to provide the lender with reasonable means acceptable to the lender by which the lender will be assured of timely notice of any subsequent transfer of the beneficial interest or change in occupancy.
  • Other restrictions: A prepayment penalty should not be collected when a home is sold.
  • IX. Alternative Mortgage Transaction Parity Act Savings associations have broad authority to charge prepayment fees and late charges. Mortgage companies have the same authority when originating a balloon loan or an adjustable rate loan. Banks do not have the same broad authority. In general, a bank may charge a reasonable prepayment fee for a commercial transaction if the prepayment fee cannot exceed the state usury limit. In Michigan, state usury laws limit prepayment fees to 1% of the prepayment during the first three years of the loan.

    Copyright, Howard A. Lax. First published on 6/9/02

    Lending Compliance Matrices
    Six indispensable quick reference guides help you keep the lending regulations straight. These popular compliance aids, originally developed by Mary Beth Guard in 1995, are used by thousands of bankers nationwide. They include:
    • Everyone's favorite, the Real Estate Lending Matrix, which shows which regulations apply to 26 different types of extensions of credit;
    • the Lending Regulation Coverage Chart, which shows you at a glance the basic coverage rules for nine major federal lending requirements;
    • the Right of Rescission Decision Chart, which gently guides you through the analysis of whether a right of rescission must be given;
    • the Lending Disclosures Timing Chart, a quick guide to what disclosures must be given and when;
    • the Insider Loan Limitations Chart, a tool for ensuring you're in compliance with Regulation O;
    • a Monitoring Information Matrix, a handy reference for determining whether a particular loan application type is one on which monitoring information must be requested.

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    First published on 06/09/2002

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