By Ben Wu
Everyone is familiar with “Keep Calm And Carry On,” the motivational poster produced by the British government in 1939 to steady the morale of the British people during World War II. Today, it seems the mortgage industry needs to keep this advice in mind as we continue to await changes to TRID and prepare to comply with the new Home Mortgage Disclosure Act (HMDA) reporting rules.
While the new administration has called for fewer new regulations and reviews of existing rules, it is unclear, at least at the time of this writing, what this will mean for the mortgage industry. The new HMDA rule, the provisionsof which are mostly slated to take effect next year, would create new compliance and legal risks for lenders that are active in non-agency origination and home equity lending. This could be a significant problem since non-agency originations, particularly portfolio loans and HELOCs, have recently begun to rise as lenders look to replace the refinance volume that is falling in response to higher interest rates.
A Brief Look at the New HMDA Rule
When the HMDA rule was originally enacted in 1975, it required depository and non-depository institutions to collect and report data about mortgage originations. On October 15, 2015, the scope of the rule changed—expanding reporting coverage for non-depository institutions, increasing transactions covered, and increasing data elements to report. The new HMDA rule now requires 48 data points be collected, recorded and reported: 25 are new data points (including total loan costs or total point and fees, automated underwriting system, and open-end line of credit) and 14 are modified from the previous rule.
These new fields will allow regulators to better evaluate whether or not lenders have violated The Fair Housing Act and Equal Credit Opportunity Act (also known as Fair Lending laws). Some of the most common Fair Lending violations revolve around pricing and underwriting. For example, are minorities paying more on average than non-minorities for the same product or service? Are different standards and overlays having a discriminatory impact?
In addition, beginning January 1, 2018, covered loans under the HMDA rule will include not just closed-end mortgages, but also “open-end lines of credit secured by a dwelling” (i.e., HELOCs). That being said, not every financial institution will be subject to the rule. Institutions that originated at least 25 closed-end mortgages or 100 HELOCs in each of the two preceding calendar years will be required to collect, record, and report data under HMDA.
Reporting HELOCs for the First Time
For those lenders who have already been reporting closed-end mortgages, adding HELOCs to their HMDA Loan Application Register (LAR) isn’t a big deal. Many are already using a mortgage loan origination system (LOS) that collects the loan application data, verifies that the loan is consistent with underwriting guidelines, acts as a central system of record, and produces the proper reporting format to be uploaded directly to the Consumer Financial Protection Bureau’s (CFPB) site.
However, there are community banks and credit unions that don’t originate closed-end mortgages but do provide HELOCs. They offer HELOCs to better serve their customers who need to use home equity for various reasons: home improvement; debt consolidation; short-term investments in other real estate (i.e., rentals and second homes); and dealing with lifecycle events, such as college, weddings, caring for parents, etc. And these customers expect HELOCs to be fast and relatively hassle free.
These lenders will now need to report data that they’ve never had to report on. This presents several challenges for community banks and credit unions as they prepare to navigate the unchartered territory that is HMDA. Consistent underwriting and pricing policies will be key since the rule helps regulators determine if lenders are serving the housing needs of the public and communities, as well as identify possible discriminatory lending patterns and enforce anti-discrimination statutes.
Another challenge will be the origination technology used. Because these lenders consider HELOCs to be consumer lending, akin more to auto loans or credit cards than mortgages, they typically use a core banking system, like Jack Henry or Symitar, or a consumer lending system to originate their HELOCs. Unlike LOSs, those systems weren’t developed to be used for HMDA data collection and reporting. They do not track all 48 fields required by HMDA. So mechanically, these lenders will have a problem when the need to begin tracking and reporting this new data for their 100+ HELOCs at the end of the year.
In addition, many of these lenders are worried about all this data giving the CFPB greater visibility into their lending practices—making consistent lending practices critical.
The CFPB has communicated its expectations through its announcements and enforcement actions. In its Supervisory Highlights (Winter 2016), the CFPB said:
“The loan originator rule under Regulation Z requires depository institutions to establish and maintain written policies and procedures for loan originator activities, which specifically cover prohibited payments, steering, qualification requirements, and identification requirements. In one or more examinations, depository institutions violated this provision by failing to maintain such written policies and procedures. In most of these cases, examiners found violations of one or more related substantive provisions of the rule. For example, one or more institutions did not provide written policies and procedures – a violation itself – and violated the rule by failing to comply with the requirement to include the loan originator’s name and Nationwide Multistate Licensing System and Registry identification on loan documents.”
The report added:
“At one or more institutions, examiners concluded that a weak compliance management system allowed violations of Regulations X and Z to occur. For example, one or more supervised entities failed to allocate sufficient resources to ensure compliance with Federal consumer financial law. As a result, these entities were unable to institute timely corrective-action measures, failed to maintain adequate systems, and had insufficient preventive controls to ensure compliance and the correct implementation of established policies and procedures.”
This means all lenders, whether they originate closed-end mortgages or HELOCs, must develop and maintain compliance management systems (CMSs) that not only have comprehensive policies and procedures, but also perform regular, internal pre-submission audits. Their CMSs must also include reviews of regulatory changes, training, and corrective action, as well as a responsible individual or group who manages oversight.
Ensuring Consistent Lending Practices Through Technology
A community bank or credit union only using a core banking or consumer lending system will not be able to say that their loan approvals and rate/price given to borrowers is indeed consistent and fair. Many banks and credit unions use “underwriter discretion” on loan approvals, which are essentially undocumented exceptions to their stated credit policy. In addition, there is “loan officer discretion” on price concessions to help borrowers on a case-by-case basis, which may lead to rate/price discrepancies with a disparate impact. When loan decisioning/pricing is done manually like this, ensuring consistency is a challenge.
Automated technology can help ensure consistency at the starting point. Exceptions can then be seen, documented, and properly managed, based on valid compensating factors on the loan, rather than an individual’s “discretion.” Automated technology can also help collect, record, and report their data. Of course, the time to make these technology changes is now in order to take year-end 2017 applications that close starting January 1, 2018, and properly report them in 2019.
Whether a lender is using a core banking or consumer lending system or an LOS, having an automated underwriting system (AUS) in place helps demonstrate that a consistent, quality underwriting process is being used to manufacture assets. Many lenders already use Fannie Mae’s Desktop Underwriter or Freddie Mac’s Loan Prospector, but in the case of portfolio loans or HELOCs, they will need to turn to an alternative AUS engine to yield the appropriate response for their institution, to be reported with confidence to the CFPB.
A good portfolio AUS can capture any set of underwriting guidelines within its engine to help deliver a consistent, rules-based underwriting decision. It should also be able to deliver an assessment report that includes a breakdown of every rule applied to that loan and whether it passed or failed that particular guideline—creating an audit trail for underwriting and ability-to-repay decisions and helping to ensure consistent, transparent credit policy application to support Fair Lending.
In addition, lenders should have a HMDA reporting solution that can not only import the records from their loan origination technology and electronically submit their encrypted HMDA LAR to the CFPB, but also detect and list validity and quality error conditions. A good HMDA reporting solution can reduce processing and submission time, correct common data entry errors, and automatically re-verify census tracts for accuracy.
With the new HMDA expanded coverage and data collection requirements right around the corner, lenders will need to take steps to analyze and explain their lending decisions and data. Regulators, advocacy groups, and plaintiff’s attorneys will be using this information to draw their own conclusions as to whether discriminatory lending patterns exists. While that may sound a bit scary, our industry has already survived a wealth of other regulations. We just need to prepare, keep calm, and compliance on.
Ben Wu is executive director of LoanScorecard, a leading provider of automated pricing, underwriting and compliance solutions. Wu can be reached at firstname.lastname@example.org.