An increasing number of nonbank financial participants are considering an entry or reentry into the mortgage finance market as the financial crisis, which commenced a decade ago, starts to recede from view.
This turnabout results from more than short-term memories. The economic conditions necessary to support a normalized residential mortgage finance market have improved significantly. Housing prices have stabilized throughout the United States. Some markets even show signs of newly formed housing bubbles. This positive home price appreciation has created refinancing opportunities for mortgagors who were previously underwater on their mortgage loans and ineligible for special refinancing programs through government programs. Substantial improvement in the U.S. economy has produced low unemployment, resulting in more steady jobs. This allows potential borrowers to save the down payment necessary to finance the purchase of a new home or to refinance an existing mortgage. More importantly, jobs produce the sustainable income and stable employment history needed to satisfy today’s more stringent mortgage underwriting criteria. Interest rates seem poised to rise, creating compelling opportunities for writing long-dated financial instruments, such as mortgages. Finally, technology has created highly scalable ways to originate new mortgage loans, thus increasing competition and decreasing the cost of running a large mortgage loan origination network.
Each mortgage finance participant faces a different regulatory framework that governs and impacts their activities. Although there are similarities, the regulatory framework governing and impacting each of these activities varies significantly. Each participant considering entering or reentering the market should have a strong understanding of the regulatory risks it faces in order to design a program that achieves regulatory compliance.
In the United States, there are significant differences among the regulatory frameworks governing consumer residential mortgage loans for origination, servicing, ownership and financing. Each regulatory regime is distinct, with materially less regulatory oversight governing financing and ownership than for the origination and servicing of consumer residential mortgage loans.
The type of residential mortgage loan determines applicable requirements. For example, one relevant factor is whether the loans are originated to be insured or guaranteed by the federal government or to be pooled or sold with or to federal government or federal government-related entities. Loans may be insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs or the Rural Development branch of the Department of Agriculture. Those insured or guaranteed loans may be eligible to be pooled into securities guaranteed by the Government National Mortgage Association. Conventional loans—that is, loans that are not government insured or guaranteed—may, in turn, be pooled with or sold to the government-sponsored enterprises known as Fannie Mae or Freddie Mac. Conforming conventional is the term used for conventional loans that meet the purchase criteria of Fannie Mae or Freddie Mac, while non-conforming conventional is the term for those conventional loans not meeting such purchase criteria. The eligibility and other criteria pertaining to these categories of loans are not in all cases regulatory in nature; rather, they are often grounded in contract, but they drive the manner in which such loans are originated, serviced, purchased and sold and financed.
Regardless of a loan category, there may be unique regulatory requirements based on the features, terms and characteristics of the loans. Examples include adjustable rate versus fixed rate loans, regularly amortizing versus balloon loans, and closed-end versus open-end credit. The original purpose of the loan—such as owner occupancy, second home or investment—is another factor that impacts the applicability of certain laws and regulations. Similarly, the applicable regulatory requirements depend on payment status, such as current versus in default. The point is that there is not a single, monolithic regulatory framework that applies to all aspects of the origination, servicing, ownership or financing of consumer residential mortgage loans. Instead, the profile of the loan will inform the applicable regulatory requirements. For purposes of this article, however, we are highlighting differences among the regulatory frameworks at a high level.
Consumer Residential Mortgage Loan Origination and Serving Activities
Generally speaking, financing the purchase of a home is the largest consumer credit transaction in which the average consumer engages. Since the consequence of defaulting on a home loan is the loss of the consumer’s home, there’s little wonder that the home finance industry is highly regulated. In the U.S., the origination and servicing of consumer residential mortgage loans is regulated at both the state and federal levels, including such areas as advertising, required disclosures, anti-discrimination, underwriting, closing and default servicing. At the state level, every state in the U.S. regulates some aspect of originating and servicing consumer residential mortgage loans in that state. Not all of the origination and servicing state laws on the books, however, apply across the board to all entities. Most do not apply to depository institutions. Some may only apply to nonbank state-chartered entities that are required to be licensed in that state. And some state laws may apply without regard to the type of entity.
At the federal level, most consumer financial protection laws are interpreted and enforced by the Consumer Financial Protection Bureau, which Congress created by the Dodd-Frank legislation that followed the U.S. credit crisis. The CFPB has sweeping authority across most consumer residential mortgage loan origination and servicing activities, regardless of the state in which they are conducted. Other federal regulators and government authorities, including the Department of Housing and Urban Development, the Federal Trade Commission, the Department of Justice, the Federal Deposit Insurance Corporation, the Federal Reserve Board and the Office of the Comptroller of the Currency have authority to enforce certain laws affecting consumer residential mortgage loans.
Licensing is required in most states for state-chartered entities to originate and service mortgage loans. Licensing approval requires significant background information on the officers, directors and other control parties that will control a licensed entity, as well as the continuing legal education of the employees of the entity performing the loan servicing and origination activities. Licensing is also required of mortgage loan officers originating consumer residential mortgage loans. State regulators have rights to periodically audit the origination and servicing activities of the licensed entity. Licensed lenders generally are subject to substantive requirements, limitations and prohibitions pertaining to the origination and servicing of consumer residential mortgage loans to which only such licensees are subject.
At the federal level, no licenses are required for state-chartered entities, but the CFPB has significant authority to supervise the activities of state-chartered non-depositories and audit compliance with, and address violations of, federal consumer financial protection laws related to consumer mortgage loan origination and servicing. Entities that own licensed mortgage originators and servicers, commonly known as control persons, may also be subject to disclosure and enforcement at the state and federal levels. Violations of law may result in, among other remedies, restitution, fines and penalties assessed against the licensed entity or control person and, in certain circumstances, disqualification from participation.