by Timothy A. Raty
Higher-Risk Mortgages under the Truth-in-Lending Act
It’s not hard to find mortgage industry professionals who can tell you what a “high-cost mortgage” or “higher-priced mortgage loan” is, particularly if you mention them by one of their shorter designations (e.g. “HCL”, “HPML”, “Section 32 loan”, “Section 35 loan”, etc.). However, it is easy to stump or confuse them when you mention a “higher-risk mortgage.” Despite the fact that a “higher-risk mortgage” is one of the newer “kids on the Truth-in-Lending block,” the terminology we use to refer to them has not entered within the subconscious realm of automatic identification.
The term “higher-risk mortgage” came into being as a direct result of the Dodd-Frank Act (124 Stat. 1376 [2010]). Section 1471 of this Act modified 15 USCA § 1639h to impose certain requirements regarding appraisals on “higher-risk mortgages.” Ibid. § 1639h(f) defines a “higher-risk mortgage” as follows:
“For purposes of this section, the term ‘higher-risk mortgage’ means a residential mortgage loan [as defined under 15 USCA § 1602{cc}] , other than a reverse mortgage loan that is a qualified mortgage, as defined in section 1639c of this title, secured by a principal dwelling –
(1) that is not a qualified mortgage, as defined in section 1639c of this title; and
(2) with an annual percentage rate that exceeds the average prime offer rate for a comparable transaction, as defined in section 1639c of this title, as of the date the interest rate is set—
(A) by 1.5 or more percentage points, in the case of a first lien residential mortgage loan having an original principal obligation amount that does not exceed the amount of the maximum limitation on the original principal obligation of mortgage in effect for a residence of the applicable size, as of the date of such interest rate set, pursuant to the sixth sentence of section 1454(a)(2) of Title 12;
(B) by 2.5 or more percentage points, in the case of a first lien residential mortgage loan having an original principal obligation amount that exceeds the amount of the maximum limitation on the original principal obligation of mortgage in effect for a residence of the applicable size, as of the date of such interest rate set, pursuant to the sixth sentence of section 1454(a)(2) of Title 12; and
(C) by 3.5 or more percentage points for a subordinate lien residential mortgage loan.”
Sound familiar? For those who can read Legalese, this definition is very similar to the definition of a “higher-priced mortgage loan” set forth in 12 CFR § 1026.35(a). The CFPB noted as such when they formulated the regulations for implementing the provisions of Supra, but also noted how these two types of loans differ:
“TILA section 129H(f) defines the term ‘higher-risk mortgage’ in a similar manner to the existing Regulation Z definition of ‘higher-priced mortgage loan.’ 12 CFR 1026.35(a). However, the statutory definition of higher-risk mortgage differs from the existing regulatory definition of higher-priced mortgage loan in several important respects. First the statutory definition of higher-risk mortgage expressly excludes loans that meet the definition of a ‘qualified mortgage’ under TILA section 129C. In addition, the statutory definition of higher-risk mortgage includes an additional 2.5 percentage point threshold for first-lien jumbo mortgage loans, while the definition of higher-priced mortgage loan contains this threshold only for purposes of applying the requirement to establish escrow accounts for higher-priced mortgage loans. Compare TILA section 129H(f)(2), 15 U.S.C. 1639h(f)(2), with 12 CFR 1026.35(a)(1) and 1026.35(b)(3). “ (77 FR 54729 [2012])
Despite these differences, however, the Bureau decided to merge the requirements applicable to “higher-risk mortgages” and to “higher-priced mortgage loans” into the same section of Regulation Z – Section 35. The Bureau requested feedback in their proposed rules (Ibid. 54722 [2012]) as to whether using the two different terms within Section 35 would be confusing to the mortgage industry or consumers. Overall, feedback was critical of using the two different terms, thus the Bureau ultimately decided to use the term “higher-priced mortgage loan” in Section 35 to refer to both types of loans (see 78 FR 10371 [2013]), but structurally established the appraisal requirements to be applicable to only certain “higher-priced mortgage loans” – including “higher-risk mortgages.”
Conceptually, this established a simple logical structure for identifying the two types of loans: not all “higher-priced mortgage loans” are “higher-risk mortgages”; however, all “higher-risk mortgages” are “higher-priced mortgage loans.” While the term “higher-risk mortgage” cannot be found in Regulation Z, conceptually it exists as a special subset of “higher-priced mortgage loans,” to which the appraisal requirements set forth in 12 CFR § 1026.35(c) (which implement the statutory requirements of 15 USCA § 1639h) apply (almost exclusively).
It is for this reason that it is important to remember the statutory reference to “higher-risk mortgage.” Too often we hear that the appraisal requirements (e.g. providing copies of appraisals to consumers, as well as disclosures concerning their rights to receive copies of such appraisals, conducting two appraisals, etc.) apply to “higher-priced mortgage loans.” This can confuse mortgage industry professionals, who may mistakenly cause actions to be taken when they are not needed, such as ordering a second appraisal on a “higher-priced mortgage loan” pursuant to Supra § 1026.35(c)(4), even though this loan is also a “qualified mortgage” and, thus, exempt.
If anything, it is beneficial to remember that the Subsection 35(c) appraisal requirements apply almost exclusively to a “higher-risk mortgage,” which is a “higher-priced mortgage loan” without the following features, as set forth as exemptions under 12 CFR § 1026.35(c)(2):
- Features which satisfy the criteria of a qualified mortgage as defined pursuant to 15 U.S.C. 1639c;
- Secured by a mobile home, boat, or trailer;
- Structured as a reverse-mortgage transaction subject to 12 CFR 1026.33(a); and
- Secured solely by a manufactured home, if certain conditions are met (see § 1026.35[c][2][viii][B] for details).
Other exemptions set forth in Ibid. § 1026.35[c][2] were added separate from the definition of “higher-risk mortgage” (see 78 FR 10378 – 10384 [2013] for details). However, identifying loans subject to the Subsection 35(c) requirements as “higher-risk mortgages” may help to distinguish the applicability of these requirements from those requirements applicable to all “higher-priced mortgage loans.”
Higher-Risk Mortgages under the Homeowner’s Protection Act
The term “higher-risk mortgage” or “higher-risk loan” is also used within the context of the Homeowner’s Protection Act (“HPA”). Not to be mistaken with loans of the same name under the Truth-in-Lending Act, a “higher-risk” loan under the HPA is loosely defined as follows:
“. . . [a] residential mortgage transaction that, at the time at which the residential mortgage transaction is consummated, has high risks associated with the extension of the loan –
(A) as determined in accordance with guidelines published by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, in the case of a mortgage loan with an original principal balance that does not exceed the applicable annual conforming loan limit for the secondary market established pursuant to section 1454(a)(2) of this title, so as to require the imposition or continuation of a private mortgage insurance requirement beyond the terms specified in subsection (a) or (b) of this section; or
(B) as determined by the mortgagee in the case of any other mortgage . . .” (12 USCA § 4902[g])
The thing that makes “higher-risk” loans under the HPA special (or would make them special) is the fact that, unlike other “residential mortgage transactions” (defined under 12 USCA § 4901[15]), mortgage insurance:
- Cannot be cancelled solely upon the request of the mortgagor (borrower) when certain conditions are met; and
- Is automatically terminated when the principal balance of the mortgage is first scheduled to reach 77% of the original value of the property (rather than 78%).
However, the reason why the special rules applicable to “higher-risk” loans are not so special is because when the HPA was passed, it required the Comptroller General of the United States to submit to Congress (by July 29, 2000) a report describing the volume and characteristics of such loans. The Comptroller General did this and found the following:
“Fannie Mae and Freddie Mac have not defined ‘high risk.’ Instead, they have decided to treat all conforming mortgages the same way and not apply the act’s high-risk provisions for canceling or terminating private mortgage insurance to specific mortgages. For conforming mortgages, therefore, the act’s exception for high-risk loans has had no effect. With respect to nonconforming loans, two trade associations – the Mortgage Bankers Association of America and America’s Community Bankers – have published a guide on implementing the act’s cancellation and termination provisions. These organizations have chosen, as Fannie Mae and Freddie Mac have done, not to define high-risk mortgages in this guide.
We believe that a mortgage lender would gain little by invoking the high-risk provisions for a mortgage of more than $240,000 because these provisions do not explicitly stipulate that the borrower have a good payment history or be current on the loan. According to the Mortgage Bankers Association and America’s Community Bankers, the benefit a lender might derive by terminating the private mortgage insurance on a lender-designated high-risk loan at 77 percent – compared with 78 percent for a non-high-risk loan – may be outweighed by the apparent lack of a requirement in the act for the borrower to be current on his or her mortgage payments. As a result, we believe there is a disincentive for lenders to invoke the high-risk exception.
We believe that attempting to determine the number and characteristics of high-risk mortgages would not, in all likelihood, produce information helpful to congressional decision makers for two reasons. First, Fannie Mae and Freddie Mac have decided to treat all mortgages the same way and not apply the act’s high-risk provisions for canceling or terminating private mortgage insurance to specific mortgages. Second, the number of lenders who would define some mortgage loans of more than $240,000 as high risk would, in our view, likely be small because of the disincentive in the act for lenders to define such loans as high risk. If it becomes apparent that Fannie Mae and Freddie Mac are planning to change their position or that private lenders have decided to ivoke the high-risk exception, we would certainly revisit the issue.” (http://www.gao.gov/assets/90/89408.pdf)
This report was submitted on December 10, 1999. To this date, nothing has changed. Thus, while there is a legal structure created for “high-risk” loans under the HPA, such loans do not currently exist in reality – much in the same way that a pizza does not exist, even though a cook has the pepperoni, flour, cheese, and tomato sauce in his kitchen. All the ingredients are there to create one, but currently there is no motivation or initiative to do so.