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. 

Should You Reprocess Your Mortgage Loan File Before Submitting It to a Regulator for Review?

When it comes to regulatory reviews, presenting a meticulously organized and thoroughly vetted mortgage loan file is crucial. You might wonder if reprocessing your loan file before submission is worthwhile. The short answer is yes, especially if you are not already post-closing and organizing loans when they close. In this case, reprocessing your mortgage loan file could be the difference between a smooth review and a costly, time-consuming ordeal.

Why Reprocess? It’s All About Precision

Loan files are complex, containing numerous documents, verifications, and disclosures that must be accurate and complete. Even with the best intentions and processes, items can be missed. The reality is that we often discover missing or incorrect items when we take the time to reprocess files. These oversights might seem minor but can lead to significant issues during a regulatory review.

By reprocessing your loan file, you ensure that every document is where it should be, every calculation is correct, and every compliance box is checked. The attached FORM 1-4 QC PROC Closed File Pre-Audit Compliance Checklist is an excellent example of a comprehensive tool to guide this reprocessing. This checklist covers everything from verifying borrower information to ensuring all regulatory disclosures are accounted for. You might use the state required version of the file, such as that provided by North Carolina or Texas, for your review (even though the FORM 1-4 does contain all these items.)

The Benefits of Reprocessing

1. Reducing Findings and Penalties: Regulators are thorough, and they will catch mistakes. By reprocessing your file, you can correct errors before they become findings in an audit. This proactive step can save you from fines, penalties, or even more severe regulatory actions.

2. Cost Savings: When a file is well-organized and accurate, it takes less time for the examiner to review it. This not only makes the review process faster but can also reduce the overall cost of the examination. A clean file means fewer questions, less back-and-forth, and ultimately, less time spent by the examiner—time that you won’t be billed for.

3. Building Confidence: Presenting a thoroughly reprocessed file with a detailed checklist like the Post-Closing Audit Preparation/Regulatory Compliance Checklist gives the examiner confidence in your compliance processes. While it’s unlikely that an examiner will completely forego reviewing your files based on this alone, a well-organized submission can lead to a more favorable outcome, potentially reducing the depth of the review.

4. Streamlined Communication: A file that has been reprocessed is easier to navigate, not just for the examiner, but for anyone in your organization who might need to answer questions or provide additional documentation. Having a checklist attached that shows exactly what has been reviewed and included in the file simplifies communication and ensures everyone is on the same page.

What Happens If You Don’t Reprocess?

If you decide to submit your file without reprocessing, you’re taking a risk. Missing or incorrect items can lead to findings that will need to be corrected under the pressure of a regulatory deadline. This can be more stressful and costly than simply reprocessing the file upfront. Moreover, repeated findings can damage your company’s reputation with regulators and may lead to increased scrutiny in the future.

A Checklist to Guide Your Reprocessing

Consider using a tool like the FORM 1-4 QC PROC Closed File Pre-Audit Compliance Checklist as part of your reprocessing efforts. This checklist is comprehensive, covering all the necessary components of a loan file, including:

• Borrower and Loan Information: Ensuring all borrower details, loan amounts, and terms are correctly documented.
• Fee/Cost Reconciliation: Verifying that all fees are correctly calculated and documented, with copies of relevant checks and invoices attached.
• Record Retention: Confirming that all required documents are included and appropriately filed, from the initial loan application to the final promissory note.
• Post-Closing Audit: Preparing for a regulatory review by double-checking that all compliance requirements are met and that the file is ready for submission.

Conclusion

In conclusion, reprocessing your mortgage loan file before submitting it to a regulator for review is not just advisable—it’s essential. By taking the time to review and organize your file, using a comprehensive checklist, you can significantly reduce the likelihood of costly errors, streamline the review process, and potentially save your company both time and money. So, next time you’re preparing a file for submission, take that extra step to reprocess—it’s well worth the effort.

What items MUST a Broker retain independently in each loan file

Don't let your wholesaler tell you they've got everything you need. They don't. Important lessons in regulatory audits and examinations. 

"If you only do ONE THING - post close your loan files."

Brokers - ALWAYS Retain All Loan Documents

I cannot overstate the importance of meticulous record-keeping. Regulatory requirements and best practices require brokers to maintain comprehensive records of all loan transactions, including disclosure events and closing documents. 

I hear people saying, "I don't see anything in the regulations that says I have to keep certain documents..." but your regulator will require copies of all documents on all the loans you handle. In this article, we provide an explanation of what documents regulators hold brokers accountable for. 

I also hear people saying "My wholesaler will give me copies of everything if I ask for it. So I don't need to post-close my loan files..." While the wholesaler will retain copies, and may also provide a copy of a file a long time after loan closing, we see a lot of inconsistency in the condition of those document stacks from the lender. They can look like a jumble, which will require you to reprocess the file. Furthermore, what happens if the lender shuts down, gets merged or otherwise doesn't have the ability to provide what you need? 

Record Retention Requirements

As a broker, your record retention involves both the disclosures you issue and those provided by the lender. While federal and state regulations may not explicitly mandate the retention of all documents from the lender, best practices and regulatory expectations strongly advise maintaining a complete set of records. 

Also, your loans progress in stages and may not complete or get submitted to the lender. Our system suggests what you must retain at various stages of the process. 

We provide a checklist of this here:

Key Practices and Checklists

1. Retain All Broker-Issued Disclosures:

   • Initial Loan Application Form (1003): Ensure that the signed initial application is on file.
   • Loan Estimate and Required Providers Disclosure: These should be issued within three days of application.
   • Notice of Intent to Proceed: Must be signed by all borrowers.
   • Changed Circumstances Re-issued: Include any tolerance adjustments.
   • E-SIGN Acceptance/Agreement and Delivery Transcript: Keep records of acceptance and delivery audit trails.
   • Signed Initial and Final Broker Fee Agreement: Must match the closing disclosure or settlement statement.

2. Obtain and Retain Lender-Issued Documents:

   • Final Loan Application (1003) and Transmittal Summary (1008): Essential for compliance.
   • Executed Closing Disclosure (CD): Include all attachments.
   • Final Mortgage Loan Lock-in/Financing Agreement: Required at least five days prior to closing.
   • Appraisal and Related Notices: Keep copies of the appraisal order, the appraisal itself, and the right to appraisal notice.
   • Final Sales Contract and Earnest Money Deposit: Ensure these are part of your records.
   • Loan Commitment/Approval Notification: Document the lender's commitment to the loan.

3. Comprehensive Documentation:

   • Fee/Cost Reconciliation: Maintain copies of all application fees, appraisal fees, credit report fees, and other relevant costs.
   • Affiliated Business Arrangement Disclosure: If applicable, retain this disclosure.
   • Compliance Disclosures: Include ARM disclosures, CHARM Booklet Notice, Anti-Steering Notice, ECOA Rights, Fair Credit Reporting Act Notice, and others.
   • State-Specific Disclosures: Ensure all state-required disclosures are documented and retained.

Why Complete Record Retention Matters

State regulators, such as those in Washington and Texas, expect brokers to maintain records similar to those required from lenders. During examinations, brokers are often asked to produce detailed records of all disclosure events, closing documents, and other pertinent paperwork.

Texas, North Carolina, and Maryland Loan File Checklists

Adhering to the checklists from different states can help ensure comprehensive compliance:

• Texas Checklist: Includes initial and final disclosures, funding checks, appraisal reports, and title insurance.
• North Carolina Loan File Checklist: Similar to the Texas checklist, emphasizing the importance of complete documentation.
• Maryland Loan File Checklist: Focuses on detailed retention of all application and closing documents.

Updated Practices and Client Advice

In light of experiences and state examinations, brokers should update their practices to require copies of all signed disclosures and final closing packages from the lender. This proactive approach not only ensures compliance but also protects brokers in the event of an audit. You do not want to have to stop producing and getting new business to have to reprocess loan files to submit to a regulator. 

Advice for Broker Clients: Always obtain a complete disclosure package from the lender, and ensure you send out the required broker disclosures independently. This comprehensive approach to record retention is crucial for compliance and to avoid citations for missing lender documents. If the lender does not cooperate, document your efforts to obtain the necessary records.

QC Requirements for Non-Delegated Correspondents

UWM, and many other wholesale lenders, comply with the Fannie Mae requirement that all third parties have a quality control plan that meets their guidelines. Among other things, this means that 

• you need to have periodic reviews, dependent on your volume, at least quarterly (See #1)
• you report those results to management (See #1)
• you certify that your plan meets all federal regulatory requirements (See #4)
• your plan requires reviewers to have independence from the production process or that you use a 3rd party (See #3)
• your scope includes the documents you are involved in producing (e.g.; origination, closing) (See #2)

This means that non-delegated correspondents who are table funders must thread the needle on quality control procedures to avoid expensive and redundant reviews. So we structure the non-delegated QC plan to ensure that you meet these requirements without assuming lender responsibilities. 

Avoiding redundancy

We call it redundant because a requirement for a full forensic review of a loan file for a non-delegated correspondent means YOU review your LENDER'S work! The lender is already reviewing the documents that you provide. And the lender includes these loans in their own QC reviews. What is gained by conducting ANOTHER review? While there 

While there is nothing wrong with another set of eyes looking for fraud in a loan file. The review is better spent reviewing critical items within your loan files - specifically compliance. Did you retain everything you needed? 

Independence - Internal or Third-Party Quality Control Reviews

In our products, independence is created by the use of checklists. However, not every lender or regulator believes that you can create independence this way. If you have a very small company, it's unlikely that personnel tasked with reviews will not have involvement in the process they review. In that circumstance, you have to hire a 3rd party reviewer.

When hiring a 3rd party reviewer, remember that YOU define the scope of the review. Do not just request a quality control review. Create a specific scope of work. For non-delegated correspondents, those requirements generally fall within the scope of the regulatory compliance review we provide in Section 6 - Post-closing Financial, Compliance, and Document Retention Review. 

These reviews cost between $100-$200 per loan, depending on the company and your volume. If you need a referral to a good provider for these needs, please let us know, and we can make a recommendation based on your profile. 

Full Scope QC Reviews or Not?

If your near future plans include applying for Fannie Mae, Freddie Mac or HUD approval, you should consider upgrading your Quality Control Reviews to a "full-scope" investor/agency-level quality control review. These reviews give you insight into what the lenders are looking for, and the depth and scope of reviews at a more intense level. This review is a full forensic re-underwriting of the loan file, including re-ordering verifications, appraisals, credit, etc. 

Then you can start self-reporting and compiling the monthly reports to document your preparedness for lender-level quality control reporting responsibilities.