HMDA, ECOA and What's an Application?... again

Regulators do not understand Pre-Qualifications

Implications for NMLS Call Reporting and HMDA Reporting

Recent discussions make it apparent that regulators do not understand the concept of pre-qualification versus qualification or pre-approval. This is critical given the impending 2018 data recording season, when, with substantially lower reporting thresholds, even the smallest company becomes a potential HMDA reporter with its incumbent responsibilities and tasks.

Make sure you are armed with the facts when confronting a regulator who insists you are under-reporting your call volume or HMDA data.

What is Pre-Qualification?

"Pre"-Qualifying is a prior-to-application discussion of eligibility and rates, applied against published standard qualifying guidelines; ratios, down payment, loan type, and maybe even credit score. This analysis should result in a number; the maximum loan amount a customer could afford. It's not an application and the result states "THIS IS NOT AN UNDERWRITING DECISION", something that you must feature prominently on any correspondence. This is so consumers don't represent or think that they have been approved when they haven't.

If you Add a Property Address to a Pre-Qualification, the regulator will expect a Loan Estimate

Why Do Regulators Think Pre-Qualifications are Applications?

Buried in Reg B (ECOA/Fair Lending) commentary is a statement that has now become the lynchpin for the argument that pre-qualifications are applications. This opinion holds that pre-qualifications if failed, must be disposed of via Adverse Action and consequently are subject to activity reporting.

Comment for 1002.2(f)-3 When An Inquiry Or Prequalification Request Becomes An Application.
 3. When an inquiry or prequalification request becomes an application. A creditor is encouraged to provide consumers with information about loan terms. However, if in giving information to the consumer the creditor also evaluates information about the consumer, decides to decline the request, and communicates this to the consumer, the creditor has treated the inquiry or prequalification request as an application and must then comply with the notification requirements under § 1002.9. Whether the inquiry or prequalification request becomes an application depends on how the creditor responds to the consumer, not on what the consumer says or asks. (See comment 9-5 for further discussion of prequalification requests; see comment 2(f)-5 for a discussion of preapproval requests.) 

This comment illustrates the conundrum because, in this case, the consumer doesn't have to ask (apply) for credit but rather simply be ineligible for financing (according to the comment); the discussion must be treated as an application and denied. It also belies the intent of the pre-qualification which is, by its very nature, a positive discussion of what is possible. Even if the current scenario yields a $500 loan, it's positive, not negative. You CAN offer someone a loan if the income increases by a prospective amount, decrease debts by some prospective amount, save some prospective amount of money, and then identify what the pre-qualification yields. This is the purpose of the pre-qualification discussion - educating the consumer about how he or she should proceed if trying to obtain financing in the future.

This also shows the other flaw in the logic of considering a failed pre-qualification a reportable event; what's the number? It's ZERO! Where do you report that?

A "Failed Pre-Qualification" Doesn't Actually Exist

If we agree with the regulator that declining to issue a pre-qualification is a declined loan, you should consider this instance a "Failed Pre-Qualification." A "Failed Pre-Qualification" doesn't mean you issued a pre-qual that didn't meet the customer's expectations - such as one where the customer was looking at a 500,000 house but could only afford 125,000 - but merely should reflect the result of the qualification calculation, subject to underwriting.  So if they can afford a $500 loan, you should issue a pre-qual for $500 and call it a day - no reporting required. In theory, you should never have a failed pre-qualification under this structure.

Your pre-qualification process must show you are determining a maximum loan amount, not meeting a specific loan request criteria. Once you begin trying to meet a specific criteria, it's no longer a pre-qualification , but a qualification. 

Regulators are Correct About Pre-Approvals and Qualifying

Logically, the regulatory interpretation of pre-qualification activity WOULD be true if we called the process "qualification," eliminating the "pre-," instead. In a qualification exercise you start with a specific number - a desired property or particular loan amount - and work through the prospect's financial profile to determine whether the customer is eligible for that particular number. Results of this process identify, in binary form - YES/NO - whether the prospect can afford or is eligible for that number. In this case, if the borrower has too many debts, or has insufficient income or cash, or because of the limited profile, the credit score is insufficient for this particular instance, you now have a number that you are not eligible for. Either change the number (counter offer) or decline to proceed (adverse action).

Similarly, a Pre-Approval is a loan commitment resulting from a customer's application for a specific amount of financing prior to property selection. A customer submits an application and all supporting documentation which the lender completely processes in the absence of a property - no sales contract and subject to appraisal, title and property conditions. All decisioning rules apply.  If the amount the borrower requests cannot be approved, then the underwriter may counter-offer for different terms, which the customer may accept. If not accepted, the loan must be declined and notices provided. Disclosures, except those which apply to a property, must also be provided.

You Can't Fight City Hall

Sadly, to this date, logic doesn't necessarily dissuade regulators from attempting to corral these innocuous discussions into a regulated process. According to several state regulators and the NMLS, while you don't count pre-qualifications in your call report, you must report declined pre-qualifications.

The golden rule applies. No amount of good reasoning will persuade a regulator, who has made a public determination about a policy, to admit that he or she is incorrect. So if you are in a state where the industry has allowed the regulator to control the definitions of what construes a credit inquiry, then you have to build policies around it, to ensure you comply.

Building a Compliant Pre-Qualification Process

Since this ECOA interpretation can open your business to regulatory scrutiny, you should build a process that inoculates you against under-reporting or fair lending findings. Simply, you could issue a pre-qualification certificate or letter for every single discussion, even if the result included a prospective versus current solution.

• Generate and retain a copy of all pre-qualification letters/certificates from every discussion.
•  Create a standard pre-qualification letter or certificate
• There may be multiple formats
• as is or
• prospective
• If you do not issue a pre-qualification (a failed pre-qualification) you should issue an adverse notice stating "we don't offer any program matching your requirements."  

A defined pre-qualification identifies a potential maximum, but does not state any basis for a declination. 

The Anti-Kickback Rule - Payment or Receipt of Non-Approved Fees

Background

With the recent spate of enforcement actions surrounding kickbacks, take the time to re-visit your explicit policies and procedures surrounding the anti-kickback rules.

12/23/2024 - CFPB Sues Real Estate Firm for Referral Fees

4/30/2015 - Updated filing shows actual money penalties by participants
1/22/2015 - Baltimore CFPB Action
St. Louis CFPB Action
Kentucky CFPB Action
Baltimore Referral Fee Lawsuit

Kickbacks are a problem because they tend to inflate the cost of a transaction.

Kickbacks tend to inflate the cost to the consumer due to the fact that someone else has to get paid for the referral. 

Prohibited - Kickbacks and Referral Fees

Section 8(a) of RESPA prohibits anyone from giving or receiving a fee, kickback, or “anything of value” pursuant to an “agreement or understanding” for the referral of business related to the purchase or financing process. The purpose of the prohibition is to protect consumers from the payment of fees when no additional work is actually performed. Kickbacks tend to increase the cost of the transaction, since the borrower will have to be charged more in order to cover the cost of the referral fee.

All personnel should avoid even the appearance of accepting or paying for non-approved services.

An “Agreement or Understanding” does not have to be a formal agreement, but can be a verbal agreement or even an agreement established through a practice, pattern, or course of conduct.

Prohibited Payment – “Anything of Value”

Payments include, but are not limited to

A “Thing of Value” Money Discounts Commissions Salaries Stock Opportunities to participate in a money-making program Special or unusual banking terms Tickets to theater or sporting events Services of all types at special rates Trips and payments of another’s expenses

Prohibited - Fee Splitting 

Fee splitting is when a service provider inflates charges and splits the excess funds with another service provider in exchange for the referral of business.  This is tantamount to a kickback and is a prohibited practice.  Service providers may attempt to circumvent this prohibition by establishing joint ventures or entering into business arrangements that allow referrals between organizations and conceal the fee splitting arrangement.

Permitted – Approved Affiliated and Controlled Business Arrangements

In some cases, there can be fee splitting or referral fees paid under what is known as an “affiliated business arrangement”.  An affiliated business arrangement is where a person who refers settlement services has an “affiliate relationship” or “an ownership interest of more than one percent in a provider of settlement services.”

The payment of reasonable fees is acceptable as long as the relationship is disclosed to the borrower and the referrer actually performs a service – or somehow adds value.  The referral service provider may NOT be a REQUIRED provider of services, such as an appraiser or credit bureau that the lender must select.  An affiliate relationship structured simply to legitimize the payment of a fee is referred to as a “sham”. Affiliates must be a “Bona Fide Provider of Services” to receive a referral fee legally.

Approval Required - Desk Rental Arrangements

Because of the level of oversight, and the potential for the payment of desk rental to masquerade as payment for a referral, all Desk Rental Arrangements must be approved in advance. Provide the following:

·         Copy of the lease/rental agreement

·         Document market value of desk rental services through Craig’s list, square footage analysis or other verifiable source

Approval Required – Joint Marketing Arrangements

Similar to a Desk Rental, partnering with referral sources to advertise or market must also be evaluated for potential conflicts and approved by management. Particularly when this relates to commercial communication, the material must also be reviewed against the Provide:

·         Any advertising agreement

·         Copy of publication or proposed media

Approval Required - Marketing Vendors

Payments to marketing vendors, such as lead generation companies, may create problems if we base the payments on anything but the lead itself.  If there is a payment conditioned upon a certain criteria or threshold, such as confirmed application, underwriting approval or closing, the arrangement may be considered illegal.  For approval provide:

• Marketing Agreement
• Fee Schedule for Leads

In addition, the agreement and vendor must be approved to ensure the vendor complies with Fair Lending, Information Security, Customer Privacy and other consumer-facing regulation.

Approval Required - Payments to Counseling Agencies

Payment for services to a non-profit agencies for counseling services performed are permitted.  Provide:

• memorandum of understanding between the lender and the non-profit agency 
• establish how payments to vendor are not based on referrals .

Required Disclosures

·         Affiliated Business Arrangement Disclosure (AfBA) – if Applicable

·         Required Provider Disclosure – From LOS

·         Approved Settlement Services Provider List

Operating Areas Affected

·         Origination - Production

·         Compliance

Penalties for Non-Compliance

Penalties for violations of the anti-kickback provision include fines of up to $10,000 and up to one year in prison.

Unethical or Illegal? Dual Agency/Dual Capacity, Double Compensation in Loan Origination

Updated 1/6/2025

It seems obvious, but the fact that an originator might represent someone else's interests in a transaction creates an inherent conflict of interest. The real estate agent works for the seller, and the loan officer owes his fiduciary responsibility to the borrower. Conflict occurs when the loan originator can receive compensation elsewhere in a transaction besides the mortgage, such as:

• real estate commission
• insurance sale
• title/closing/escrow transaction
• appraisal/valuation
• financial services
• accounting

The question at issue: whether it's merely unethical to "double-dip" or illegal and prohibited? The answer lies in the location of the property. If your state prohibits dual agency or has rules against dual compensation, then it's illegal. 

Since acting as a real estate agent (where you represent the seller) and a loan officer (where you represent the buyer) is a conflict, you should not allow both. However, it may be acceptable for you to have a business where you actively sell real estate as a licensed real estate agent and separately originate loans as a licensed mortgage loan originator. There is no conflict if you recuse yourself from participating in the transaction. 

Loan Originator Compensation Rules

In a conundrum for "true" buyer brokerage (where the buyer pays the agent's commission), dual agency cannot exist due to the requirement that the borrower cannot pay the loan originator anything outside of the commission on the loan. If you recuses yourself from the fee, it appears this would be acceptable. 

Is it acceptable to Have a Real Estate License?

Mortgage originators with a real estate license sometimes find it easier to generate business because their experience in real estate adds professional credibility to real estate agent referral sources. However, this does not mean the mortgage company or bank finds this acceptable. The POTENTIAL for conflict creates enough possible risk to lead the mortgage company to create a hiring policy that prohibits this arrangement unless the license is affirmatively inactive. 

This stems from the fact many secondary market contracts and loan purchase eligibility warranties often cite the requirement for no conflict of interest in the loans sold or purchased. The mere existence of a conflict can require a lender to repurchase a loan, regardless of whether there was a negative outcome. 

FHA Allows it - USDA Does NOT

Recently, FHA clarified that it WOULD allow non-credit (not underwriters, valuations, quality control, etc.) related parties to act as both agents and loan originators. However, on 3/31/23, USDA clarified this was a conflict of interest and specifically DISALLOWED this. 

Dual agency in Real Estate Transactions Prohibited

Eight states have made dual agency in real estate illegal: Alaska, Colorado (although dual capacity for LO is allowed), Florida, Kansas (allowed for broker), Maryland (Prohibited from receiving finder's fee -aka broker fee), Texas (Dual Capacity For LO allowed), Wyoming, and Vermont. Dual Agency refers to the real estate agent representing both the seller AND the buyer. This is one indicator that, regardless of role, a loan originator who is also a real estate agent could run afoul of this. Some states allow what is known as "Dual Capacity."

Real Estate Rules Where Undisclosed Dual Capacity is a Violation

Massachusetts, Massachusetts, also does not allow acting as a real estate attorney and a broker on the same transaction. 

States that may specifically disallow Dual Capacity

North Dakota	Not Allowed	Examiner - Ownership okay, but cannot be agent and MLO on same transaction
Illinois	Not Allowed (must be separate)	https://idfpr.illinois.gov/faq/bre/mlofaq.html#faq-5caniholdamlolicenseandrealestatesalespersonlicensesimultaneously-faq
Louisiana	Not Allowed	La. Rev. Stat. §6:1090(I)
Utah	Not Allowed	Prohibited per 61-2c-301 (1)(i)
RI	Not Allowed	Commentor

Maryland - No "double dipping"

States that do not specifically disallow Real Estate Agents and Originators to Receive Commissions on Both Transactions - known as "Dual Capacity."

Arizona (Mortgage Broker License)

California (DRE Licensed)

Colorado - With Proper Disclosure

Connecticut

District of Columbia - With Proper Disclosure

Kansas - If properly disclosed

Michigan (MI DFI) - Must use AfBA disclosure

Nebraska

Nevada

New York

North Carolina (maybe) - Strong advisory against it because of possible RESPA/TILA violations

Ohio - with proper disclosure as of 6/24 

Texas - With proper disclosure

Virginia

Washington - Required Language in Disclosure 

We will add it to this list, or you can send your citations as we collect more information.

Regulatory Guidance - Appraiser Independence Rule (AIR) Violation Minefield

The most frequently overlooked problem with this arrangement is the possible influence of the appraiser. The real estate agent (particularly the listing agent) meets the appraiser at the inspection of the property and has a vested interest in obtaining the highest possible value to support the sales price. The company could be liable for undue appraiser influence if the agent is also a loan originator. The lending company can put guardrails in place, but there is no such fail-safe for real estate agents. 

Affiliated Business Arrangement Disclosure

Many states have their own language for Dual Authority, but RESPA rules require that the relationship be disclosed using the Affiliated Business Arrangement Disclosure (AfBA). Further, there should be a prominent disclosure that the customer receives services and pays fees to the same individuals for multiple services. 

This is also true if the agency owns a part of the lender, or any related settlement service. 

Unless it's Specifically Codified - Best Practices Dictate "Don't Do It."

Sources

“Required Disclosures by State - American Mortgage Network.” American Mortgage Network - Funding The American Dream, 22 Nov. 2022, https://www.amnetmtg.com/required-disclosures-by-state.