Consumer Compliance Outlook > 2024 > Third Issue 2024

Consumer Compliance Outlook: Third Issue 2024

Consumer Compliance Requirements for Purchasers of Residential Mortgage Loans

By Kenneth Benton, Principal Consumer Regulations Specialist, and Katarina Liviana and Hailey Kozuchowski, Former Legal Interns, Federal Reserve Bank of Philadelphia

Residential mortgages are the largest consumer credit product market, with over $14 trillion in outstanding residential loans at the end of the first quarter of 2024.1 This market is attractive to financial institutions, which engage in a range of related activities depending on their business model: originating loans; purchasing loans; originating and purchasing loans; or employing an originate-to-distribute model. A financial institution may determine, for example, that the residential mortgage demand in the areas it serves is relatively low and would not justify the cost of maintaining a mortgage origination system, but it could increase revenues and enhance its Community Reinvestment Act (CRA) performance rating by purchasing loans.2

Although purchasing loans eliminates the complexities and expenses associated with residential mortgage origination, certain consumer compliance requirements still apply to loan purchasers. Federal consumer protection laws that can apply to purchased residential mortgage loans include the Truth in Lending Act (TILA), the Equal Credit Opportunity Act (ECOA), the Fair Housing Act (FHA), the Home Mortgage Disclosure Act (HMDA), and the privacy provisions of the Gramm‒Leach‒Bliley Act (GLBA).

To facilitate loan purchaser compliance, this article provides an overview of these laws and discusses compliance requirements that apply to the purchasers of residential mortgage loans and third-party risk management considerations. A companion article in this issue of Consumer Compliance Outlook (CCO) summarizes the laws and regulations that apply to servicers of residential mortgage loans.

TRUTH IN LENDING ACT

Assignee Liability

Under TILA, the purchaser (i.e., the assignee) of most consumer credit agreements secured by real property has liability only for voluntary assignments in which the violations are “apparent on the face of the disclosure statement.”3 The term disclosure statement refers to the TILA disclosures that must be provided in connection with the extension of credit, which will vary based on the type of mortgage, i.e., closed-end, open-end, reverse, or chattel-dwelling loans (such as loans secured by a mobile home not attached to real property).4 High-cost mortgages subject to the Home Ownership Equity Protection Act (HOEPA), however, are evaluated under a different standard of liability.5

For consumer credit transactions secured by real property, TILA clarifies that violations “apparent on the face of the disclosure statement” refer to:

For example, if the closing disclosure for a closed-end mortgage loan incorrectly understated the finance charge, in excess of the applicable tolerance, the assignee of the loan could be liable if it could have correctly calculated the finance charge from the itemization of the finance charges on the closing disclosure. But suppose instead the same borrower claims, after the loan was assigned, that the loan originator had orally promised to refund the loan origination fee but failed to do so, and the borrower now seeks a refund. That issue is not apparent on the face of the disclosure statement, and therefore the assignee would not be liable.

With respect to liability for not using the required term or format, model forms are available in the appendixes to Regulation Z for closed- and open-end mortgages, the use of which mitigates this risk under the safe harbor in TILA for using model forms.7 A loan purchaser can proactively discuss with the loan seller whether the model forms were used.

More generally, purchase agreements for mortgage loans typically contain a “representations and warranty” clause to address responsibility for complying with applicable laws, the full discussion of which is beyond the scope of this article.

Right of Rescission

TILA provides borrowers with the right to rescind certain open- and closed-end loans secured by the borrower’s principal dwelling.8 This right generally expires within three business days of loan consummation; however, the right to rescind is extended to three years if the creditor fails to provide accurate, material disclosures or fails to provide two copies of the notice of the right of rescission.9 Material disclosures include the annual percentage rate (APR), the finance charge, the amount financed, the total of payments, the payment schedule, and the disclosures and limitations in §§1026.32(c) and (d) and 1026.43(g).10

The right of rescission does not apply to certain principal dwelling-secured transactions, including most notably a “residential mortgage transaction,” which is a loan to purchase or construct a principal dwelling. For additional exemptions, see 12 C.F.R. §1026.23(f) (closed-end loans) and §1026.15(f) (open-end loans).

If a mortgage loan subject to the right of rescission is sold, the borrower can exercise the right against the assignee — provided the loan is still eligible for rescission. As the right to rescind generally expires three business days after consummation, a loan purchased after this period would be subject to rescission only if the rescission right were extended to three years because the material disclosures were inaccurate or the borrower was not provided with two copies of the notice of the right to rescind. A determination of whether a disclosure is inaccurate includes considering any applicable Regulation Z tolerances, which provide a cushion for determining the accuracy of certain TILA disclosures. A full discussion of tolerances is beyond the scope of this article, but they are discussed in detail in the interagency examination procedures for Regulation Z.11

Notice of Change of Ownership: 12 C.F.R. §1026.39

In 2009, Congress amended TILA to require that, when ownership of a residential mortgage loan changes through a purchase, assignment, or other transfer, the new owner must notify the borrower within 30 days of the assignment or transfer.12 The notice must include the following information:

Thus, the purchaser must ensure it provides a timely notice to the borrower with the required information.

TILA Defenses

Correction of Errors: Civil Liability 15 U.S.C. §1640(b)

Section 1640(b) of TILA provides that, if within 60 days of discovering an error (and before receiving written notice from the borrower and before a lawsuit is filed), a creditor notifies the borrower of the error and the loan is adjusted so the borrower does not pay an amount in excess of the charge actually disclosed, or the dollar equivalent of the APR actually disclosed, whichever is lower, the creditor or assignee does not have civil liability for the violation.

Correction of Errors: Joint Statement of Policy on the Administrative Enforcement of the Truth in Lending Act—Restitution

The joint statement provides that, if within 60 days after discovering a disclosure error either through a final written examination report or through the creditor’s own procedures, the creditor notifies the borrower of the error and adjusts the account to ensure the borrower will not be required to pay a finance charge in excess of the finance charge actually disclosed or the dollar equivalent of the APR actually disclosed (whichever is lower), the creditor is not subject to restitution.13

Bona Fide Errors

Under TILA’s §130(c) (15 U.S.C. §1640(c)), a creditor or assignee is not liable for violating the requirements in Part B of TILA (15 U.S.C. §1631–1651) if the creditor or assignee can prove that the violation was unintentional and occurred because of a bona fide error despite taking reasonable steps to avoid such error. The Regulation Z examination procedures explain this defense:

A bona fide error may include a clerical, calculation, computer malfunction, programming, or printing error. It does not include an error of legal judgment. Showing that a violation occurred unintentionally could be difficult if the financial institution is unable to produce evidence that explicitly indicates it has an internal controls program designed to ensure compliance. The financial institution’s demonstrated commitment to compliance and its adoption of policies and procedures to detect errors before disclosures are furnished to consumers could strengthen its defense.14

The availability of this defense underscores the importance of maintaining appropriate policies, procedures, and controls.

FAIR LENDING

Equal Credit Opportunity Act

Assignee Liability

ECOA applies to a creditor, which Regulation B defines to include an assignee if it participates in the credit decision.15 The official staff commentary clarifies this requirement:

The term creditor includes all persons participating in the credit decision. This may include an assignee or a potential purchaser of the obligation who influences the credit decision by indicating whether or not it will purchase the obligation if the transaction is consummated.16

For example, if the purchaser specified the underwriting criteria for the loan originator to use, which were later determined to have a disparate impact on a prohibited basis, the purchaser could be liable because it participated in the credit decision. The purchaser could also have liability if it specified discriminatory purchasing requirements such as purchasing all of the loans in the seller’s assessment area, except for loans originated in majority-minority census tracts (MMCTs).

Fair Housing Act

The FHA implementing regulations specifically address the fair lending requirements for purchased loans. Under 24 C.F.R. §100.125, a person or entity involved in purchasing loans cannot refuse to purchase such loans or impose different conditions for purchases on the FHA prohibited bases of race, color, religion, sex, handicap, familial status, or national origin.17 To provide greater clarity, the regulation includes these examples:

For example, a purchaser could not tell the seller that it wished to purchase loans in the seller’s assessment area, except for loans in MMCTs.

The regulation contains a business necessity exception to its requirements:

This section does not prevent consideration, in the purchasing of loans, of factors justified by business necessity, including requirements of Federal law, relating to a transaction’s financial security or to protection against default or reduction of the value of the security. Thus, this provision would not preclude considerations employed in normal and prudent transactions, provided that no such factor may in any way relate to race, color, religion, sex, handicap, familial status or national origin.18

HOME MORTGAGE DISCLOSURE ACT

HMDA, as implemented by Regulation C, 12 C.F.R. part 1003, requires specified depository and nondepository financial institutions to collect, record, report, and disclose certain information on applications, originations, and purchases of covered loans.19

Institutional Coverage Tests

Depository Institutions

Depository institutions are subject to HMDA if they meet these five criteria:20

  1. Asset-Size Threshold: On December 31 of the previous year, the depository institution had assets above the annual asset-size threshold, which is at $56 million as of December 31, 2023, and is annually adjusted for inflation.
  2. Location Test: The institution had a home or branch office in a metropolitan statistical area on December 31 of the previous year.
  3. Loan Activity Test: During the previous calendar year, the depository institution originated a home purchase loan or refinancing of a home purchase loan secured by a first lien on a one- to four-unit dwelling.
  4. Federally Related Test: The depository institution meets one of the following criteria: (1) the institution is federally regulated or federally insured; or (2) in the preceding calendar year, the institution originated at least one home purchase loan or refinancing of a home purchase loan secured by a first lien on a one- to four-unit dwelling that was insured, guaranteed, or supplemented by a federal agency, or was intended to be sold to the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation.
  5. Loan-Volume Threshold: In each of the two previous calendar years, the depository institution originated at least 25 closed-end, dwelling-secured loans or at least 200 open-end, dwelling-secured lines of credit.

Nondepository Institutions

Nondepository institutions are subject to HMDA if they meet the Location Test and the Loan-Volume Threshold set forth above.

The Federal Financial Institutions Examination Council’s annual publication A Guide to HMDA Reporting: Getting It Right! further elaborates on these requirements.21

Regulation C Exemption for Reporting Certain Fields of Purchased Loans

Regulation C provides that certain data points of purchased loans do not have to be reported:

Depository Institution Partial Exemption for Certain Data Fields

In 2018, Congress amended HMDA to exempt insured depository institutions and insured credit unions from collecting certain data points set forth in 12 C.F.R. §1003.3(d)(1)(iii) if they originate fewer than 500 closed-end covered loans or fewer than 500 open-end covered loans in each of the two preceding calendar years and their CRA rating is not “needs to improve” or “substantial noncompliance.”30 If the purchaser of a covered loan meets the partial exemption requirements, it would not have to report the partially exempt data points.31

A full discussion of HMDA requirements is beyond the scope of this article. CCO has published several articles on HMDA compliance requirements that loan purchasers subject to HMDA may find helpful:

GRAMM‒LEACH‒BLILEY ACT

The privacy provisions of the GLBA, as implemented by Regulation P, 12 C.F.R. Part 1016, require financial institutions to provide consumers with a privacy notice disclosing that a consumer’s nonpublic personal information (NPI) is shared with nonaffiliated third parties, describing the consumer’s ability to opt out of sharing practices in certain circumstances, and explaining how to exercise the right to opt out. NPI is defined as “personally identifiable financial information and any list, description, or other grouping of consumers (and publicly available information pertaining to them) that is derived using any personally identifiable financial information that is not publicly available.”32

Unless an exception applies,33 Regulation P prohibits a financial institution from disclosing a consumer’s nonpublic personal information to a nonaffiliated third party unless the institution satisfies various notice requirements and the consumer does not elect to prevent, or opt out of, the disclosure. After the initial disclosure is provided, the institution must provide an annual notice unless:

See 12 C.F.R. §1016.5(e). For additional information, see Kenneth Benton, “Overview of Federal Consumer Privacy and Security Laws for Financial Services” (CCO, Third Issue 2021).

THIRD-PARTY RISK MANAGEMENT (TPRM)

When purchasing residential mortgage loans from a third party, financial institutions should apply TPRM principles, practices, controls, and tools to mitigate compliance, operational, reputational, and other risks. This is particularly important if the institution expects to have an ongoing relationship with the seller of the loans. A full discussion of TPRM is beyond the scope of this article. For additional information, see the 2024 interagency guidance “Third-Party Risk Management: A Guide for Community Banks.”

CONCLUSION

Purchasing residential mortgage loans may allow a financial institution to generate additional revenue and income while avoiding the complexities and costs associated with mortgage loan origination. However, as discussed in this article, the purchaser has corresponding compliance obligations as the new owner of the loan. Financial institutions should raise specific issues and questions with their primary regulators.

ENDNOTES

1 Financial Accounts of the United States, Quarterly Total Mortgages, Q1 2024, available at Federal Reserve Bank of St. Louis, FRED Economic Data.

2 Purchased loans may qualify for CRA credit under the CRA lending test. See 12 C.F.R. §228.22(a)(1).

3 15 U.S.C. §1641(e)(1).

4 “What Is a Truth-in-Lending Disclosure for Certain Mortgage Loans?” Consumer Financial Protection Bureau, accessed October 4, 2024. https://www.consumerfinance.gov/ask-cfpb/what-is-a-truth-in-lending-disclosure-for-certain-mortgage-loans-en-180/.

5 Purchasers of HOEPA loans are “subject to all claims and defenses with respect to that mortgage that the consumer could assert against the creditor of the mortgage, unless the purchaser or assignee demonstrates, by a preponderance of the evidence, that a reasonable person exercising ordinary due diligence, could not determine, based on the documentation required by this subchapter, the itemization of the amount financed, and other disclosure of disbursements that the mortgage was a mortgage referred to in section 1602(aa) of this title.” 15 U.S.C. §1641(d)(1).

6 15 U.S.C. §1641(e)(2).

7 15 U.S.C. §1640(f).

8 15 U.S.C. §1635; 12 C.F.R. §§1026.15 (open-end) and 1026.23 (closed-end).

9 12 C.F.R. §§1026.15(b)(1) and 1026.23(b)(1).

10 The material disclosures are defined in 12 C.F.R. §1026.23(a)(3)(ii) and Comment 23(a)(3)-2 for closed-end loans secured by the consumer’s principal dwelling and in 12 C.F.R. §1026.23(a)(3)(i) for open-end loans secured by the consumer’s principal dwelling.

11 See Revised Interagency Examination Procedures for Regulation Z at pp. 19–21, 41–42, and 70–74.

12 15 U.S.C §1641(g)(1) and 12 C.F.R. §1026.39(b).

13 63 FR 47495 (September 8, 1998). The policy statement also states that the creditor is not subject to administrative enforcement if it follows this procedure to make the consumer whole. 63 FR 47498.

14 See Revised Interagency Examination Procedures for Regulation Z at p. 165.

15 12 C.F.R. §1002.2(l).

16 Comment 2(l)-1 (emphasis added).

17 24 C.F.R. §100.125.

18 24 C.F.R. §100.125(c).

19 “Covered loan” is “a closed-end mortgage loan or an open-end line of credit that is not an excluded transaction under §1003.3(c)” 12 C.F.R. §1003.2(e).

20 12 C.F.R. §1003.2(g)(1) and (2)

21 A Guide to HMDA Reporting: Getting It Right! (2024) at pp. 2–3.

22 12 C.F.R. §1003.4(a)(1)(ii).

23 12 C.F.R. §1003.4(a)(12)(i), Comment 4(a)(12)-7.

24 12 C.F.R. §1003.4(a)(15)(i).

25 Comment 4(a)(17)(ii)-1.

26 12 C.F.R. §1003.4(a)(23).

27 12 C.F.R. §1003.4(a)(24).

28 12 C.F.R. §1003.4(a)(35)(i).

29 12 C.F.R. §1003.4(b). Although an institution is not required to report these data points, it is allowed to report them if it so chooses.

30 12 C.F.R. §1003.3(d)(6).

31 Comment 3(d)(2)-1 and 3(d)(3)-1 clarify that the partial exemption applies to purchased closed-end loans and open-end loans, respectively, if the purchaser meets the requirements for the partial exemption.

32 12 C.F.R. §1016.3(p)(1).

33 See 12 C.F.R. §§1016.13, 14, and 15.