Ownership of Consumer Residential Mortgage Laws
Entities that solely own consumer residential mortgage loans and do not participate in the origination or servicing of those loans have more limited licensing requirements at the state level and are probably not subject to supervisory oversight by the CFPB. Additionally, provided the loans are not considered to be high-cost loans under federal or state laws and do not finance the purchase of retail goods or services, such as loans to purchase a new roof or siding sold by a dealer, the legal authority of a borrower to raise or pursue claims related to violations of law committed by the originator generally is limited.
A purchaser of residential mortgage loans is, however, directly subject to a limited number of federal consumer regulatory laws. For example, when a person becomes the owner of an existing mortgage loan by acquiring legal title to the debt obligation, that person must provide a written transfer of ownership notice to the borrower within 30 days of the date of transfer. Purchasers of loans and owners of servicing rights are also subject to antidiscrimination laws and certain privacy and information security laws.
In contrast, the holder could be subject to certain state and federal consumer credit laws if it participated in the initial credit decision of the originator, such as loans purchased on a prior approval basis before the originator elects to make the loan, or provided the funds with which the originator made the loan. In these cases, the line between origination and purchase may be blurred, and, in some cases, the law treats the purchaser as an indirect lender. Many secondary market mortgage loan purchase programs are structured so that these laws are not triggered.
An entity that purchases a non-defaulted residential mortgage loan in good faith without knowledge of the violation of law is not legally subject to claims and defenses that may be asserted against the originator. There are, however, a few exceptions to this rule.
For example, affirmative and defensive claims may be brought against an owner of a loan for certain violations of the Federal Truth in Lending Act committed by the originator that are apparent on the face of the documents being assigned to the purchaser. Purchasers generally protect themselves from this risk by performing due diligence on the mortgage loans they purchase. In addition, a holder could be subject to defensive claims by the borrower in a foreclosure action that the lender failed to satisfy the ability to repay or loan originator compensation requirements under TILA.
At the state level, there are also a limited number of broadly drafted consumer residential mortgage loan origination statutes that appear to also apply to the mere ownership of consumer residential mortgage loan. In these situations, it is prudent for an owner of consumer residential mortgage loans to either own those loans through a licensed entity or to use an alternative holding vehicle that is not subject to state licensing. That vehicle is commonly a trust where title to the mortgage loans is held by a national bank or federal savings bank trustee exempt from the underlying licensing statute because of its status as a federally chartered banking institution.
This is why so many nonbank-sponsored secondary market buyers of consumer residential mortgage loans have opted to own their loans through trusts as opposed to other legal entities. In the highly developed RMBS market that existed prior to the credit crisis, securitization trusts holding consumer residential mortgage loans in the name of the trustee were the most common issuers of RMBS securities.
In addition to the risks noted above, a consumer residential mortgage loan purchaser should consider certain derivative legal risks. For example, under the Dodd-Frank Act, the CFPB may seek to hold a person liable for knowingly or recklessly providing substantial assistance to a covered person who engaged in unfair, deceptive or abusive acts or practices. This generally is analogous to aiding and abetting prohibitions under common law, which are discussed below, although there is no private right of action under the Dodd-Frank Act for such substantial assistance.
Financing Consumer Residential Mortgage Loans
Financing pools of consumer residential mortgage loans is the least regulated of all the various activities from a consumer credit law perspective. Financing arrangements, whether a repurchase transaction or a regular-way loan agreement, sidestep most of the regulatory requirements mentioned above, because they are wholly commercial transactions. If appropriately structured, the regulation generally is not implicated, because the loan is extended against a pool of consumer residential mortgage loans. There are two caveats to this general principle. First, should the lender be so embedded in the approval process for the origination of consumer residential mortgage loans that ultimately will be financed through a lending arrangement, it is possible that the lender could be implicated as an aider and abettor in a regulatory violation brought by a state or federal regulator against the mortgage loan originator. The Dodd-Frank Act includes a provision regarding aiding and abetting. However, aiding and abetting claims require knowingly or recklessly providing substantial assistance in the violation of law, and the facts and circumstances surrounding this type of extension of regulation would be at the extreme margins of ordinary consumer residential mortgage loan origination and finance activities and could easily be prevented by proper protocols established by a lender for funding a consumer residential mortgage loan origination program.
The second caveat is that the exercise of remedies by the lender may require the temporary ownership by the lender of consumer residential mortgage loans prior to arranging for the disposition of those loans. In this situation, the regulations mentioned above relating to the origination, servicing and ownership of consumer residential mortgage loans could apply. If the lending entity is a bank, then the lender could easily own loans without further concern about the reach of state licensing statutes to its loan ownership activities. If the lending entity is not a bank, it could form a loan ownership trust with a national bank trustee similar to what we have described above in order to facilitate the disposition of repossessed mortgage loans. Mortgage loan servicing could be handled by a licensed third-party servicer to the extent that servicing on the repossessed loans was moved away from the original servicer.
There are significant differences between the regulations governing originating and servicing, owning and financing pools of consumer residential mortgage loans. This article offers a very simple and high-level overview of those differences. Nonbank financial participants considering an entry or reentry into the residential mortgage finance market should be mindful of these differences and how the varying regulatory frameworks will impact their activities.
Click here to read part one.