DODD-FRANK, CFPB & SELLER FINANCING

Most of the new rules pertaining to residential mortgage loans went into effect on January 10, 2014. These new rules were issued a year ago in January, 2013, by the Consumer Financial Protection Bureau which was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Despite the January 10, 2014, start date for the 2013 mortgage rules, lenders don’t have to use the new Loan Estimate (which replaces the Good Faith Estimate) for loan applications until August 1, 2015. Likewise, closings using the new Closing Disclosure Form (which replaces the HUD-1 Settlement Statement & the Truth-in-Lending) won’t go into effect until after lenders begin using the LE. (So if, for example, a loan app is taken in late July, 2015, the lender may use a GFE and the title or escrow company may close with a HUD-1.)

One of the new rules that went into effect on January 10, 2014, is the loan originator compensation/qualification rule. Under that rule, the definition of "loan originator" is very broad – so broad that seller financing transactions (i.e., seller carry-back loans, a/k/a purchase money mortgages, a/k/a conditional sales contracts) are included. This broad definition will affect any seller-financing transaction otherwise covered by the new rules unless the seller financer qualifies for one of two exemptions. These exemptions are paraphrased as follows:

a. The 3-Sale Rule [12 CFR Sec. 1026.36(a)(4)]:

(1) Seller has 3 or fewer sales in any 12-month period
(2) Seller didn't construct the building or act as general contractor
(3) Financing must be:

(a) Fully amortizing (no balloon)
(b) Seller determines Buyer has ability to pay (how this is to be done is unclear)
(c) Fixed rate or ARM after 5 yrs with changes subject to specific rules for rate increases

b. The 1-Sale Rule [12 CFR Sec. 1026.36(a)(5)]:

(1) Seller is a natural person, estate, or trust and has no more than 1 sale in any 12-month period
(2) Seller didn't construct the building or act as general contractor
(3) Financing must be:

(a) No negative amortization (apparently can be a balloon)
(b) Fixed rate or ARM after 5 yrs with changes subject to specific rules for rate increases

Because these seller financing rules are in effect now, sellers contemplating carry-back financing should seek legal counsel about the applicability of the new mortgage loan rules to them.

It is likely that settlement service providers such as TitlePlus! will issue notices and disclaimers regarding the obligations and qualifications of seller financers, as well as require seller financers to certify either that [i] they have complied with all requirements of a loan originator or [ii] are exempt from the requirements. In addition, settlement service providers may require seller financers and their borrowers to sign a disclaimer or release from liability pertaining to the seller-financing transaction.

* * *

NOTE: the above information does not and is not intended to constitute legal advice. Rather, it is intended to inform interested parties of current and upcoming changes to the mortgage lending and closing and settlement processes. As always, parties should consult their own legal advisors for advice specific to them.

- From TitlePlus!, January 24, 2014

The Offset Mortgage

The Offset Mortgage – Borrowing & saving at the same time

Suppose you’re borrowing $100,000 to buy a house and you have $40,000 in a savings account. Wouldn’t it be nice to pay interest only on $60,000 instead of $100,000?

You can do just that in the United Kingdom if the loan on your house is an offset mortgage.

Here’s how it works.

If the interest rate on your loan is 4.5%, you would be paying that rate on the full amount of your loan ($100,000) if you have a conventional mortgage. But if your bank offers an offset mortgage, you would pledge your savings account ($40,000) as additional security and pay interest on the difference ($60,000). So, not only would your savings account earn interest, you would also be “saving” 4.5% on $40,000.

Not bad these days of paltry interest on savings accounts.

But what if you need to use, say, $15,000 from savings? No problem. You simply withdraw the $15,000 and begin paying interest on $75,000 instead of $60,000.

Pretty slick. Makes you wonder why the offset mortgage isn’t offered here.

- Morrie Erickson

Same-sex couples – Consequences of co-owning real estate in Indiana

In the May/June 2010 issue of the ABA’s Probate & Property publication, an article discusses the lack of legal benefits, protections, and recognitions experienced by same-sex couples compared to their opposite-sex married counterparts. In part, the differences are based on the so-called Defense of Marriage Act (“DOMA”) (1 U.S.C. Section 7, 28 U.S.C. Section 1738C). This federal statute has two components:
1. allowing states not to recognize same-sex marriages legally performed in other states; and,
2. allowing the federal government not to recognize any same-sex marriages, civil unions, or other relationship designations.
According to the article, the rights not enjoyed by same-sex couples are any of the 1,138 federal benefits of marriage (e.g., filing joint income tax returns, using the unlimited marital deduction for estate and gift taxes, enjoying benefits for employer-provided health insurance). While persons may agree or disagree with whether these distinctions ought to exist, it’s important for co-owners and prospective co-owners (regardless of sexual preference) who are not opposite-sex married couples to check with their legal counsel and/or tax preparer to avoid unintended consequences (such as taxation). But because of DOMA, there’s a special emphasis on same-sex couples, so let’s focus on that.
As of the end of 2010, six jurisdictions allowed same-sex marriages:
1. District of Columbia
2. Connecticut
3. Iowa
4. Massachusetts
5. New Hampshire
6. Vermont
Note: because of legislation passed in New York on June 24, 2011, same-sex couples will be able to be married in New York in late July, 2011, although New York already recognized same-sex marriages and civil unions performed in other states.

Also as of the end of 2010, twelve jurisdictions allowed civil unions or domestic partnerships:
1. Colorado
2. Hawaii
3. Maine
4. Maryland
5. Nevada
6. New Jersey
7. Oregon
8. Washington
9. Wisconsin
10. Illinois
11. California
12. Rhode Island

Note: approximately 18,000 same-sex couples are legally married in California, but Proposition 8 in 2009 repealed performing same-sex marriages after its passage.

For information about various states’ procedures, see www.lambdalegal.org/states-regions.
Indiana does not permit same-sex marriages, civil unions, or domestic partnerships and does not recognize same-sex marriages, civil unions, or domestic partnerships created in other states. See IC 31-11-1-1 et seq.
Therefore, because of DOMA, whatever legal relationship has been validated in any of the above jurisdictions has no effect in Indiana or at national level. While the article covers impacts beyond real estate transactions and does not mention Indiana specifically, it highlights issues same-sex couples may run into. For example, before asking an attorney to prepare a deed from one same-sex partner (or any other non-married partner) to the other after a closing (because only one qualified for the mortgage loan, perhaps), the couple should first check with their tax preparer to be sure they understand the potential consequences. (No one needs to presume a gay relationship between the persons; the consequences apply regardless.)
What consequences?
Usually, attorneys and title companies inquire whether title is to be held as tenants in common or as joint tenants with rights of survivorship. This is all the more important in a same-sex couple relationship, because if the couple was married in, say, Massachusetts the couple may presume putting both their names on the deed in Indiana will mean the survivor inherits upon the other’s death. But in Indiana, for unrelated co-owners, the default ownership is tenants in common rather than joint tenants with survivorship or tenants by the entireties. (For opposite-sex married couples in Indiana, the default is tenants by the entireties.)
Likewise, adding a same-sex partner’s name to a deed can cause an unintended tax consequence. Signing the deed creates a gift of half the fair market value of the property as of the date the deed is signed. Similarly, if one partner is employed (and makes the mortgage payments) and the other is not, half the payment may be considered a taxable gift to the other partner. For various tax consequences, see http://escholarship.org/uc/item/25c0n9rx.
The potential tax and non-tax consequences of same-sex relationships go on and on (e.g., not being allowed as beneficiaries under retirement plans, not being eligible for dependent coverage under health insurance plans).
While title companies are not in a position to advise same-sex couples (in part because title companies don’t represent any parties to a transaction), persons dealing with same-sex couples early-on would be wise to let them know they may wish to look into the situation further. For example, it would be prudent for real estate agents representing same-sex buyers and for lenders working on mortgage loans for same-sex borrowers to suggest a consultation with legal counsel and tax advisors.
- Morrie Erickson

Libor – How rate-setting works

Those of us who deal with real estate realize some loans have interest rates that vary or change. But did you ever wonder how and why the changes take place?

In the early 2000s adjustable rate mortgages were common in residential transactions. Interest rates were fixed usually for 1, 3 or 5 years then could change based on so many percentage points above an index, which often was the going rate for certain types of U.S. Treasury securities. In the commercial world, interest rates often varied as often as daily, based on fluctuations in the price of similar U.S. Government debt instruments.

The good news in both instances is interest rates followed the market.

But as the residential and commercial lending arenas expanded, new loan products were developed to appeal to different tastes. Or, said another way, to take advantage of different appetites for risk.

Enter Libor – London Interbank Offered Rates – the rates lending institutions charge when lending to each other. Although Libor got its start in 1986, it didn’t catch on in residential transactions until a couple of decades later. But as an index for residential mortgages, use of Libor – a bank-to-bank lending product – was probably misplaced. Still, variable rate mortgages began to appear using Libor as an index because bank-to-bank lending rates tended to be low.

How does Libor work? Each day, the British Bankers’ Association publishes rates in 10 currencies for loans between banks for terms ranging from overnight to one year. The rates are set in the London time zone, so don’t account for market conditions developing later in, say, New York and Asia.

A cynic might say Libor emanates from a smoke-filled room, because it’s calculated by a daily morning survey of 20 big banks (the number used to be 16) to determine the rate each bank thinks it would have to pay to borrow money from the others. The BBA throws out the 5 highest and 5 lowest rates and averages the remaining 10 to come up with its rates.

According to the Financial Times, more than $350 trillion in financial products are based on Libor. The FT also reported recently that UBS, the Swiss bank, has been subpoenaed by U.S. regulators “…over whether it had made ‘improper attempts’ to manipulate those rates.” If, for example, during the 2008 economic meltdown, a weakened bank predicted a high rate for borrowing, would a competing bank resist lending to it, worried about a Lehman Brothers-style default? Possibly. Which might tempt the weakened bank to misstate its borrowing rate, thereby skewing the Libor rate-setting process.

There’s no question the meltdown caused sharp bank-to-bank interest rate spikes as stronger banks grew suspicious of their sister institutions, which meant Libor-based variable rates in turn elevated dramatically. As a result, monthly installments of Libor-indexed residential mortgages shot off the charts, sometimes quadrupling the initial monthly payment. Not only were borrowers shocked; many began to default.

Yet another instance of borrowers having no inkling of what they were getting into.

- Morrie Erickson

Judgment Liens – Does bankruptcy wipe them out?

Suppose you’ve been sued for unpaid medical bills. The court enters judgment against you for $5,000. You own your house but because you’ve lost your job, as more and more bills pile up you throw up your hands and file for bankruptcy relief. The bankruptcy court orders an automatic stay, meaning the judgment creditor, your mortgage holder, and any other lien creditor can’t sue you to take away your property – at least, not until your bankruptcy case is over.

So you breathe a sigh of relief because, now, you’re protected and the $5,000 debt will be history, right? Well, not quite.

Most people think a bankruptcy discharge wipes the debtor's slate clean. While a bankruptcy discharge DOES cancel the debtor’s personal obligation to pay it, the discharge doesn’t terminate the judgment lien which attached to the house when the judgment was entered – unless the lien is removed by the bankruptcy court.

Until the bankruptcy court actually removes the lien (and it’s been my experience that in most cases it doesn’t), the lien sticks to the house like flypaper, regardless of the debtor not being personally responsible for paying it. As a result, the holder of the judgment can foreclose its lien against the house as soon as the bankruptcy case is closed and the automatic stay lifted.

When that happens, the creditor is free to enforce its lien through a court-enforced sale of the property. While on the one hand, the debtor has no obligation to pay, if the debtor doesn’t, the property will be auctioned off, the creditor being paid from the proceeds. It’s a case of the creditor forcing the debtor to cough up the money…or else.

The lesson? Debtors should ask their bankruptcy attorneys (during the bankruptcy, not afterwards) to petition the bankruptcy court to have the liens released. Whether they can be depends on several factors, but high loan-to-value personal residences are likely to qualify.

What about property acquired AFTER bankruptcy? In Indiana, debts which become judgment liens BEFORE bankruptcy do not attach to property acquired AFTER bankruptcy. Why? The rationale is the old debt ceased to exist before it could attach to the new property. Title underwriters refer to this doctrine as the “fresh start” rule.

- Morrie Erickson

Residential Mortgages – A lesson from Canada

Thanks to the recent economic meltdown, the U.S. mortgage industry – and its lax standards in residential lending – has been the subject of intense scrutiny. The debate has led to the question: where do we go from here?

It might be helpful to look north, given that our Canadian neighbor’s residential mortgage lending industry didn’t get out of whack like ours did here in the U.S.

According to an article in the Financial Times on January 19, 2011, Canada’s home-finance system is more conservative than the one in the U.S. For starters, most residential mortgage lending is handled by large domestic banks. When loans are made in purchase and sale transactions, the banks are required to buy government insurance if less than 20% of the purchase price is put down. The result? Subprime and other high-risk mortgages amounted to a small part of the Canadian housing market.

Also, the impetus for Canadian homeowners to borrow as much as possible isn’t as great as in the U.S. because interest paid on residential mortgages in Canada is not tax deductible. Although suggesting that kind of revamp in the U.S. might cause an outcry in several quarters, some members of the U.S. Congress have suggested taking away the interest deduction would be a welcome double-whammy by curbing U.S. borrowers’ appetite for debt and reducing the U.S. deficit.

Because during the downturn Canada’s economy remained much more robust than the U.S.’s, housing prices have continued to rise despite Canada’s mortgage lending controls. But as of January 17, 2011, the controls were deemed not tight enough. So the Canadian government imposed even stricter lending standards, reducing the maximum amortization term to 30 years.

As a further protection to homeowners, home equity loans (which typically have variable interest rates that can spiral upwards) are now capped at 85% of loan-to-value (down from 90%). What’s more, the Canadian government will no longer insure home equity loans, meaning banks are now on their own if they expect to be repaid by borrowers.

And that lack of insurance protection, according to the Canadian finance minister, will place risk evaluation squarely on the shoulders of lenders instead of taxpayers.

Food for thought.

- Morrie Erickson

RREAL IN – The form only title agents see

As most people involved in real estate are aware, the past few years have seen the State of Indiana and the federal government focus on mortgage fraud.

As a part of those efforts, since January 1, 2010, Indiana has required closing agents to fill out an electronic form for every closing involving single-family residential first lien mortgage loans whether purchases or refinances (practically all mortgages). The form was developed through the Indiana Department of Insurance (IDOI) which regulates and licenses title insurance and closing agents and is known as RREAL IN, which stands for Residential Real Estate Acquisition of Licensee Information and Numbers Database for Indiana, and is mandated by Indiana Code 27-7-3-15.5. The purpose is to develop an electronic system for collection and storage of information about persons participating in or assisting with applicable transactions.

Some of the information the RREAL IN form calls for must be provided by persons or companies closing agents don’t deal with, which makes filling out the form problematic. For example, closers rarely see appraisals but must report the appraiser’s name and license number, the appraisal company’s name and license number, the amount the property appraised for, and the appraisal completion date.

Here’s a list of other information the closer must enter:

1. Name & license number of each:
a. salesperson or broker;
b. principal broker;
c. mortgage loan originator;
d. mortgage brokerage company;
e. mortgage loan originator company;
f. title agent (closer); and,
g. title agency;
2. Name of each seller;
3. Name of each buyer;
4. Purchase price;
5. Property description by tax parcel number & street address;
6. Date closing instructions received; and
7. Date of closing.

As mentioned previously, the RREAL IN form is electronic. It’s accessible only online. Unfortunately, it can’t be filled out partially and saved. Long pauses between entries void the form, meaning closers have to start over again if, say, they take a phone call during data entry. Closers chuckle when IDOI says it takes only 2 or 3 minutes to fill out the form; in reality 20 minutes is more likely. Much of the information on RREAL IN is already on the Sales Disclosure Form (another “simple” form title agents have been required to fill out for years), which leads me to wonder whether anyone at state-level considered combining the forms into one. My cynical side says probably not. Of course, double entry adds to the workload and drives up costs. Maybe no one thought of that either.

While we title agents and closers are doing our part in exposing mortgage fraud (we have strict rules on funding, disbursing, anti-flipping, etc.), we hope agencies tasked with combating the problem are looking at data we’re submitting. But if the targets of RREAL IN are fraudsters, why is House Bill 1273 making its way through the 2011 Indiana General Assembly? Curiously, HB 1273 makes RREAL IN applicable to cash transactions. Which raises the question: What is the actual purpose of RREAL IN?

- Morrie Erickson