Mod 4

Security Program

A company's security program designed to meet the requirements of the Safeguards Rule must include the following elements: A designated company representative to coordinate the program Identification of internal and external risks which affect the security of customer information Regular testing, monitoring, and adjustment of the security program Oversight of service providers who have access to customer information

Relationships with Consumers

A loan originator is likely the only individual with whom a consumer will have ongoing contact during the loan application process. A unique set of concerns arises when a loan originator works for a mortgage broker. Consumers have a tendency to assume that mortgage brokers represent their interests. This perception is supported by the representations that some mortgage brokers make of their ability to look at loan products that different creditors offer to find the most suitable loans for their customers. This can lead to ethical considerations when determining whether a mortgage broker or loan originator's statements and actions are truthful and ethical. For many years, industry experts, legislators, and consumer interest groups have debated the legal obligations that mortgage brokers - and their loan originator employees - have to consumers. Ethical considerations have played a large role in this debate and are the basis for state laws and professional standards which hold that mortgage brokers owe special duties to consumers who are shopping for a mortgage.

Deceptive Acts and Practices

A representation, omission, act, or practice is deceptive when it is: Likely to mislead a consumer The consumer's interpretation of the representation, omission, act, or practice is reasonable, and The misleading representation, omission, act, or practice is material The Manual clarifies that deception may exist even if a consumer is not actually misled. Deceptive information may be written, oral, expressed, or implied. Examiners will determine if a representation is likely to mislead based on a determination of whether the information is: Prominent enough for a consumer to notice it Presented in a format that is easy to understand and that is not contradicted by other information Placed in a location where consumers are expected to find it In close proximity to the claim that it qualifies Deceptive representations, omissions, acts, and practices include: Making misleading statements related to costs and pricing Offering products and services that are not actually available Using bait and switch techniques Omitting conditions and limitations from an offer These guidelines reflect the advertising rules found in Regulation Z, including its requirements to advertise only terms that are actually available, clearly and conspicuously state both benefits and risks of an offer, and present less-advantageous features of an advertised product with equal prominence and in close proximity to its favorable features (12 C.F.R. §§1026.16(a); 1026.24(a); Official Interpretations of 12 C.F.R. §§1026.16(2); 1026.24(b)(2)).

Handling Consumer Complaints

After receiving a complaint, the CFPB screens it to ensure that it has jurisdiction over the parties involved and the matter addressed. Then it determines whether the consumer that filed the complaint has a valid commercial relationship with the company. If there is no verifiable relationship between the consumer and the company that is named in the complaint, the CFPB will not file the complaint in the database. If a commercial relationship is verified, the CFPB forwards the complaint to the company, which will have an opportunity to communicate with the consumer to obtain additional information. Companies must respond to complaints within 15 calendar days of receipt. If a company misses the 15-day deadline for providing a response, it must respond within 30 calendar days in order to avoid the prioritizing of the complaint for investigation by the CFPB's Consumer Response team. Companies must submit responses through the company portal, and these responses must describe communication with the consumer, attempts to resolve the complaint, and follow-up actions, which may include resolutions such as the negotiation of a loan modification. The response must also indicate whether resolution of a complaint is still in progress or if it has been resolved with monetary relief, non-monetary relief, or with an explanation. Most mortgage-related complaints relate to the inability of consumers to make payments on their home loans. A smaller number relate to problems during the loan application process and to problems that arise when servicing for a mortgage is transferred to another loan servicer.

Example Agnes has applied for a mortgage loan to purchase her first home. She has saved some cash to cover costs related to the transaction, but her mortgage loan originator tells her that her earnings fall short of what is necessary to secure the requested loan amount. Agnes withdraws her application and submits a new one with a different lender. This time, she downloads a verification of employment form herself and asks her employer to complete and sign it. An HR representative emails the completed form back to Agnes, and she edits the document to show the amount of income needed to secure the loan. She also makes some changes to her tax documents, then prints all of the forms and sends them to the new lender using company stationery. When she receives a response from the lender, it is a letter explaining that verification of employment and income must come directly from the employer. A blank Form 1005 is attached to the notice. Once again, Agnes withdraws her application.

Agnes's actions are an example of schemes that consumers are willing to carry out in order to secure mortgage credit. It also shows how following protocols for obtaining reliable third-party records can prevent mortgage fraud. Consumers who use fraudulent tactics to secure a loan are likely to back out of a transaction if they suspect that they may be caught. This is the ideal outcome, since it protects both lenders and borrowers from dealing with the delinquencies and defaults that are likely to occur when a borrower obtains a loan that he or she cannot repay.

Unfair, Deceptive, or Abusive Acts or Practices

An unfair act or practice is one that: Causes or is likely to cause substantial injury to consumers Consumers cannot reasonably avoid, and Results in an injury that is not offset by consumer or competitive benefits Whether an act or practice causes substantial injury that consumers cannot reasonably avoid will depend on the unique circumstances of the situation and how enforcement authority interprets these facts. An act or practice is deceptive when: It is misleading or likely to mislead consumers A consumer's interpretation of the act or practice is reasonable "under the circumstances," and The representation, omission, act, or practice is material (i.e., likely to impact a consumer's choice of financial products and services) An act or practice is abusive if it: Materially interferes with the consumer's ability to understand a term or condition of a consumer financial product or service, or Takes unreasonable advantage of: The consumer's lack of understanding of the material risks, costs, or conditions of the product or service The consumer's inability to protect his or her own interests in selecting or using a consumer financial product or service, or The consumer's reasonable reliance on a covered person to act in the consumer's best interests

The TRID Rule and Collection of Fees

An unofficial estimate of loan costs does not qualify as providing a Loan Estimate, and thus, mortgage loan originators must be careful not to collect any fees or charges if such an estimate is given. The information included in the unofficial estimate must include a disclosure to the borrower that an official Loan Estimate should be obtained. Mortgage loan originators should also keep in mind the accuracy tolerances for disclosing certain rates, fees, and charges on the Loan Estimate, and ensure that amounts disclosed fall within those limitations.

Unfair Acts and Practices

As previously noted, an act or practice is unfair if it is likely to cause substantial injury to consumers that they cannot reasonably avoid and the injury is not outweighed by benefits or competition (12 U.S.C. §5531(c)). The specific injury resulting from an unfair act or practice is usually monetary harm. The CFPB's Supervision and Enforcement Manual provides the following guidelines for determining if an act or practice causes substantial injury: Small monetary losses may cause substantial injury if they impact a large number of consumers Instead of actual injuries, significant risk of "concrete harm" may be sufficient Speculative harm, such as emotional injuries, are not ordinarily regarded as a substantial; however, certain practices, such as harassment by a debt collector, may constitute a substantial injury In determining whether injury could have been reasonably avoided, the question is not whether the consumer could have made a better choice, but whether an act or practice hindered the consumer's decision-making. Consumers may only be expected to take reasonable actions to avoid injury. For example, expecting a consumer to hire experts for review or consult an attorney is not reasonable. Finally, a determination is made of whether the injury is outweighed by benefits to consumers or competition. For example: Lower prices for a financial product or service Wider availability of a financial product or service The costs that a financial institution would need to incur to make a financial product or service safer The costs to society in improving the safety of a financial product or service As general guideline that may help to determine whether there are countervailing benefits to an unfair act or practice, the Manual encourages the consideration of public policy. Public policy considerations do in fact play an important role in determining whether products are viewed as fair or unfair. However, they may not be the only, primary basis for deciding that an act or practice is or is not unfair.

Discovering Unethical Consumer Behavior

As previously stated, the importance of consumers accurately and honestly stating their income, assets, and other qualifications for a mortgage loan is absolutely vital. Today, many transactions take place online, but creditors and mortgage loan originators can take steps to ensure that consumers truthfully disclose their income by posting warnings on their websites emphasizing the penalties and consequences of pursuing a loan via fraudulent means. The fact that the FBI and the IRS are involved in investigating fraudulent transactions is sufficient to deter many consumers who might naively assume that embellishing a loan application is not a criminal offense. When bank statements, tax returns, and other documents reveal that a consumer has failed to complete a loan application accurately, the steps that a mortgage loan originator must take are likely to depend on other factors, such as the seriousness of the discrepancy/discrepancies and whether there are other indications that the transaction might be fraudulent. If documents used for verification purposes indicate that the consumer still has a legitimate interest in securing a loan and would be able to qualify for financing without artificially inflating income, it may be appropriate for the loan originator to offer a new application with instructions to complete it accurately. If there are still numerous discrepancies, including regarding the value of the property used to secure the loan and the identity/identities of the participant(s) in the transaction, notification of law enforcement representatives is critical.

Relationships with Consumers

As this sample of laws from different states shows, mortgage brokers and loan originators who work for mortgage brokers must look at the statutes in the states in which they do business to determine the full extent of their legal duties. All loan originators, including those employed by mortgage brokers and those employed by depository or non-depository lenders, should focus on advising consumers of the importance of providing truthful and accurate information on loan applications. Loan originators should explain to consumers that providing truthful information is a legal requirement and that having accurate facts regarding matters such as income and employment will expedite the lending process since it can help originators to identify suitable loan products.

Consumer Education Each year, in its Financial Literacy Annual Report, the CFPB lists the following tools and strategies that it is using to improve consumer literacy on mortgages:

Ask CFPB: this is an online tool that allows consumers to ask questions about financial transactions, including those for mortgages. Questions are posted with the CFPB's answers, and they help consumers to get quick information on matters such as, "What is a debt-to-income ratio?" and "What is the difference between an interest rate and an APR?" This tool may be accessed by visiting http://www.consumerfinance.gov/askcfpb/. Owning a Home: this CFPB website provides information on the home buying process, with guidelines that can help consumers understand interest rates, loan options, and the closing process. This information may be accessed by visiting http://www.consumerfinance.gov/owning-a-home. Find a Housing Counselor: when providing information booklets to consumers who are purchasing a home, creditors are required to include an updated list of certified counselors who are located in the same geographic area in which the consumer's lender is located (12 U.S.C. §2604(c)). Lenders may find HUD-certified counselors online at http://www.consumerfinance.gov/find-a-housing-counselor/. Remember that homeownership counseling is a legal requirement for all borrowers who are applying for high-cost mortgages, and this counseling must be verified by a certificate of counseling (12 C.F.R. §1026.34(a)(5)). Counseling is also mandatory for first-time borrowers who are applying for a mortgage with a payment program that may result in negative amortization (12 C.F.R. §1026.36(k)). Reverse Mortgage Information: the CFPB also offers special resources for older Americans, including an online pamphlet on reverse mortgages, which may be accessed by visiting http://files.consumerfinance.gov/f/201409_cfpb_guide_reverse_mortgage.pdf.

Valuation Independence While the Rule strictly forbids interference with the independent judgment of an appraiser or other person who is preparing a valuation, it is not illegal to:

Ask the appraiser to consider additional and appropriate information, including information about comparables Request further substantiation or explanation for the conclusion that the appraiser reached regarding the value of the property Ask for the correction of errors in the valuation Obtain multiple valuations in order to secure the most reliable one Withhold compensation for the appraiser based on a breach of contract or substandard performance of services (12 C.F.R. §1026.42(c)(3)) In addition to the prohibited practices found in the Valuation Independence Rule, this regulation also includes a mandatory reporting requirement that applies to any covered person who reasonably believes that an appraiser has not complied with USPAP standards or with ethical or professional requirements for appraisers under state or federal law (12 C.F.R. §1026.42(g)(1)). The legal obligation to report misconduct arises when a failure to comply with appraisal standards and practices is "material." For purposes of determining if the mandatory reporting requirement applies, a compliance failure is material if it is likely to significantly affect the value of the consumer's principal dwelling (12 C.F.R. §1026.42(g)(1)).

Ethical Conduct in the Appraisal Process The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) established the Uniform Standards of Professional Appraisal Practice (USPAP) as the generally-accepted appraisal standards in the United States.

Compliance with the USPAP is mandatory for appraisers in any kind of federal loan transaction. State-level regulations for appraisers also require compliance with USPAP. Included in the USPAP standards are requirements for appraisers to: Perform assignments with impartiality, objectivity, and independence Refrain from accepting an assignment or a compensation arrangement that is contingent on delivering a predetermined result Protect the confidential nature of the appraiser-client relationship by guarding against the disclosure of information to anyone other than those persons who are specifically authorized to receive it Keep records on each assignment for five years after the completion of the assignment In addition to professional standards, state and federal laws also affect appraisal practice. During the most recent housing boom, unethical appraisal methods came to light in many instances of mortgage fraud. Falsely-inflated property values were used in fraudulent loan transactions which cost lenders billions.

Fair Housing Act

Congress adopted the Fair Housing Act to achieve three goals: To provide fair housing throughout the United States To prohibit discrimination in the sale and renting of housing, and To prohibit discrimination in mortgage lending transactions With regard to mortgage lending transactions, the scope of the Fair Housing Act is broad, and applies to transactions in the primary mortgage market, where loans are made, and to transactions in the secondary mortgage market, where loans are sold to investors. Since the adoption of the Fair Housing Act in 1968, the Department of Housing and Urban Development has been the federal agency with authority to implement and enforce it. Despite the many changes in regulatory authority brought by the Dodd-Frank Act, HUD continues to be the agency that promulgates regulations under the Fair Housing Act and that oversees compliance with the law.

Ethical Issues Related to Federal Lending Laws

Congress typically adopts legislation in response to a crisis, and the ethical basis for some laws can become less apparent as crises pass and economic and market realities change. For example, when federal legislators enacted HOEPA, predatory lending practices were increasing as the volume of subprime originations soared. Today, the subprime market is a fraction of the size that it was in 2006, and HOEPA has limited relevance. However, in order to understand the current market, it is critical to understand past events and practices that led to present legal and ethical restrictions. For this reason, seemingly irrelevant laws such as HOEPA remain in the curriculum for mortgage education.

Deceptive Acts and Practices

Disclosures are not sufficient to cure deceptive representations, omissions, acts or practices when consumers are discouraged from reading them, disclosures are made verbally or are in fine print, or are offered after the deceptive act or practice occurred. To determine whether a consumer's interpretation of a representation, omission, act, or practice is reasonable, the Manual instructs examiners to consider how a reasonable member of the target audience would interpret the representation. The Manual offers two general guidelines for determining whether an interpretation of a representation is reasonable. First, an interpretation is reasonable if a "significant minority" are misled by a representation. Second, if reasonable consumers determine that a representation has more than one meaning, and one of these interpretations is false, the representation is misleading. A representation, omission, act, or practice is material if it is likely to affect choices made by consumers. The following representations are presumed to be material: Express claims Knowingly false claims Omitted information that a consumer needs to evaluate a product or service Those related to the characteristics of a product, such as costs, benefits, or availability Implied claims that are intentionally made, even if there is no intent to deceive Even if not presumed to be material, a representation may be material if there is evidence that consumers are likely to consider it important.

Equal Credit Opportunity Act

ECOA prohibits the unethical practice of discriminating against loan applicants on the basis of race, color, religion, national origin, sex, marital status, age, the potential to have or raise children, the fact that the applicant receives income from a public assistance program, or the fact that the applicant has exercised his/her rights under the Consumer Credit Protection Act. More specifically, ECOA prohibits creditors from making inquiries about personal characteristics, such as gender, that are irrelevant to a borrower's creditworthiness. However, there are some exceptions to the law's prohibition on unlawful inquiries. These exceptions include, but are not limited to, the following: Inquiries regarding race, ethnicity, sex, marital status, and age are permitted for purposes of federal programs that monitor compliance with fair lending laws, including inquiries for the purpose of complying with the Home Mortgage Disclosure Act. Creditors may obtain information about an applicant's race, ethnicity, religion, sex, age, or other protected characteristics in order to determine the applicant's eligibility for special-purpose credit, such as a credit assistance program offered by a not-for-profit organization, or for a federal or state program to assist the economically disadvantaged.

Ethical Issues Related to Federal Lending Laws

Ethical considerations are the basis for most federal lending laws and have inspired the enactment of each of the federal laws discussed in this module: The Real Estate Settlement Procedures Act (RESPA) is intended to curb the unethical practice of charging consumers unearned fees for settlement services The Truth-in-Lending Act (TILA) and its initial goal of informing consumers about the cost of credit has expanded to address many ethical issues, including deceptive advertising practices, predatory lending, deceptive appraisal practices, and the origination of loans without considering a borrower's repayment ability The Homeownership and Equity Protection Act (HOEPA) is the component of TILA that addresses predatory lending practices by prohibiting particular acts and practices that were formerly associated with transactions for subprime loans The Gramm-Leach-Bliley (GLB) Act creates legal requirements for lenders to meet their ethical obligations to protect the privacy of personal information that consumers share during lending transactions The Equal Credit Opportunity Act (ECOA) prohibits the unethical practice of discriminating against loan applicants based on personal characteristics, such as gender, race, national origin, and marital status The Fair Housing Act also prohibits discriminatory lending practices

Ethical Conduct in the Appraisal Process

Even when overvaluation is not used for the purposes of mortgage fraud, it is a problem. Many appraisers report that they have been pressured by loan originators, loan applicants, and real estate professionals to arrive at a certain property value. While inaccurate appraisals often helped borrowers qualify for larger loans during the lending boom, the impact was devastating for the state of the housing and mortgage markets. The overvaluation of the fair market value of real estate is considered a violation of the Financial Institutions Reform, Recovery, and Enforcement Act, as well as several other federal regulations. In response to the problems that industry pressure on appraisers has created, the amendments to Regulation Z regarding valuation independence attempt to create strict boundaries between appraisers and mortgage professionals who rely on their services to close mortgage loans.

Discussion Scenario: Ethical Requirements of Federal Lending Laws

Eventually, Zack decides that he needs some help with his workload. He hires a young, newly-licensed mortgage loan originator, Megan. Megan believes that Zack's motives are altruistic, thinking that his efforts to make credit available to senior citizens and minorities are noble and kindhearted. Gradually, Megan assumes more responsibilities, and Zack begins to teach her more about how to "make loans happen," particularly with regard to his youngest clients, who frequently earned hourly wages (rather than annual salaries). "You know what they need to earn in order to get approved," Zack explains to Megan. "If they fall short, we can always make sure they have the proper documentation available to prove that they are eligible." Seeing how happy clients are when they get approved, Megan tries to disregard her growing concerns about the legality and ethical soundness of Zack's practices. Soon, she is as adept as he is at ensuring that her applicants secure approvals.

Loan Processors

Federal and state licensing laws often draw a distinction between mortgage loan originators, who offer and negotiate home loans, and loan processors, who perform purely administrative and/or clerical tasks under the supervision, and on behalf, of licensed mortgage professionals (12 U.S.C. §5102(4)). "Clerical and support duties" include communicating with consumers to gather information needed to process or underwrite a loan application, but do not include discussing, offering, or negotiating loan rates or terms, or providing loan counseling (12 U.S.C. §5102(5)(B)). These duties must be performed under the supervision and at the direction of licensed or registered loan originators. Loan processors are also prohibited from representing to the public, either through advertising or other means of communication, an ability to perform any of the activities of a mortgage loan originator (12 U.S.C. §5103(b)(1)). Overstepping the boundaries between licensed and unlicensed activities can have significant consequences for all those involved in a transaction. These limitations exist to ensure that mortgage professionals obtain the education they need to serve consumers, and to be sufficiently knowledgeable about loan products and eligibility requirements. Restrictions on offering or negotiating loans without a license apply in order to protect consumers - and the industry.

RESPA's Prohibitions against Markups and Up-Charges

Federal laws and regulations demonstrate the CFPB's intent to protect consumers against the collection of abusive or excessive fees connected to mortgage loan transactions. RESPA's prohibitions against fee-splitting, kickbacks, and markups, and requirements to clearly and accurately disclose the costs of a transaction, reinforce this commitment. Sham affiliated business arrangements, as discussed earlier, have historically been a focus of RESPA enforcement actions. However, another controversial compensation practice used by mortgage brokers is the use of unilateral markups and up-charges. Markups and up-charges occur when a mortgage licensee increases the charges of a settlement service provider and retains the difference; the markup of the charge is made for the purpose of collecting and retaining an additional fee. Amended provisions of the Truth-in-Lending Act and Regulation Z have sought to resolve this controversy, but courts have also used close readings of RESPA to determine the legality of markups. Regulation X expressly prohibits giving or receiving portions, splits, or percentages of charges made for rendering third-party services, other than those actually performed - a practice known as fee-splitting. Duplicative fees, as well as fees for "nominal services," are also considered to be unearned fees, and thus prohibited.

Ethical Issues Regarding the Compensation of Mortgage Brokers

For many years, the ability of mortgage brokers to accept yield spread premiums (YSPs) from lenders was a very controversial practice. YSPs were commissions that mortgage brokers obtained from lenders for originating a loan with an interest rate higher than the par rate. Consumer interest groups led efforts to eliminate YSPs, claiming that they were unethical because they gave mortgage brokers the incentive to steer borrowers away from loans with lower interest rates to place them in more expensive loans. Mortgage professionals pointed out that the ethical use of YSPs allowed them to help consumers obtain cash needed for closing, since they could pass the YSP on to the loan applicant as a credit against closing costs. It was instances where YSPs were not used for this purpose - and were instead pocketed by the broker for additional financial gain - that they became unethical. The issue of YSPs was addressed in many rounds of rulemaking, and ultimately resolved with some finality by revisions to the Truth-in-Lending Act. TILA prohibits any interpretation of its provisions permitting a YSP or similar compensation in any residential mortgage loan transaction that would permit compensation to vary based on the terms of the loan (12 U.S.C. §1639B(c)(4)). Today, the compensation of mortgage brokers is regulated by the CFPB's Loan Originator Compensation Rule. Yield spread premiums are now required to be "borrower credits," and may only be used as a credit to borrowers to help offset the out-of-pocket costs of closing.

Enforcement Actions by Federal Regulators

Fraud for housing and fraud for profit are both illegal, but federal enforcement agencies such as the FBI, the IRS, and the Department of Justice have largely focused efforts on fraud for profit. While fraud for housing is also a danger to the health of the industry, most who commit that type of activity fully intend to repay their mortgage debt. Conversely, those who commit fraud for profit generally do so with no intention whatsoever of honoring their mortgage loan agreements, leaving behind unpaid bills and increasing default and foreclosure rates. Too often, consumers who try to secure a mortgage with the use of false information are likely to take on more debt than they can repay. While prosecutors may be reluctant to file actions against delinquent homeowners, they will prosecute creditors that allow their loan originators to "coach" consumers by telling them the income levels and appraisal values that they need to show on loan applications in order to secure loans.

Fraud for Housing

Fraud for housing involves the use of falsified or otherwise inaccurate information to secure a home loan that the borrower intends to repay. Examples include the borrower misrepresenting his or her employment history, credit history, intention to occupy a property as a primary residence, or income in order to improve his or her chances of being able to secure a loan. In contrast to fraud for profit, in which the fraud is often motivated by a desire to obtain money without ever repaying a debt or (usually) occupying a property, fraud for housing is typically perpetrated by an individual who does intend to reside in the home and repay the debt, but is using fraudulent means to do so. Fraud for housing is most often carried out by consumers who genuinely want to purchase and pay for a property, but make false statements to secure approval. This might be a consumer who wants to occupy a primary residence but needs to "fudge" their income to get a debt-to-income ratio the lender will approve, or an amateur real estate investor who wants to buy a property to rent to others, but pretends they will live there themselves. Mortgage loan originators may even get involved, assuming they are committing a victimless crime and doing their client a favor by coaching them through the process of falsifying details. When these false statements are found out - or when the loan gets approved anyway and the borrower ultimately cannot afford the burden and enters default and foreclosure - the results are catastrophic. The consumer(s) and any mortgage loan originator involved in the scheme will be guilty of the mortgage fraud and could face civil and criminal liability to the tune of millions of dollars - not to mention the loss of the home. Even if someone means well, falsifying information cannot be tolerated. When fraud for housing is suspected, loan originators should advise consumers that they are violating federal laws and risking criminal penalties by including false and inaccurate information on a loan application. They should also keep in mind that assisting these consumers, however well-intentioned, is also a federal offense for the loan originator.

Fraud for Profit

Fraud for profit involves the conspiratorial involvement of unscrupulous individuals from all areas of the mortgage lending industry. Participants can include mortgage bankers, mortgage brokers, loan officers, underwriters, processors, real estate agents, appraisers, and lawyers. Using inflated appraisals, falsified loan documents, and straw buyers to secure fraudulent loans, these industry insiders are the source of an estimated 80% of all reported fraud losses.

Two Types of Mortgage Fraud

Fraudulent borrowing practices cost lenders billions of dollars each year, and these losses ultimately impact consumers who are likely to pay more for loans as lenders attempt to recoup lost funds with higher interest rates and loan fees. Other costs passed onto consumers include those for additional employee training and security systems so that lenders can detect mortgage fraud before it occurs. Prosecutors can rely on numerous federal laws to impose monetary penalties and prison terms on those who commit mortgage fraud. The Uniform Residential Loan Application refers to one such law, the Federal False Statements Act, which allows the federal government to prosecute those who willfully and knowingly make false statements on their loan applications (18 U.S.C. §1001). The FBI categorizes mortgage fraud into two types: fraud for profit and fraud for housing. The focus of most anti-fraud efforts is on fraud for profit, also sometimes known as industry insider fraud.

RESPA's Prohibitions against Markups and Up-Charges

HUD has argued that markups and up-charges that are made by and for the benefit of a single party are in violation of RESPA's prohibition against unearned fees. Some members of the regulated community argue that RESPA only prohibits fees that are split between parties, and does not apply to unilateral up-charges. The conflicting arguments regarding markups were presented to the Supreme Court in February 2012, and the Court wrote a decision confirming that markups are prohibited under RESPA only if the marked-up fee is actually split. The Supreme Court's decision to uphold the legality of markups creates a dilemma for loan originators who may legally mark up a service provider's charge despite the ethical implications of collecting an unearned fee. However, as a result of a provision that the CFPB added to Regulation Z, the use of markups is still a legally, as well as an ethically, perilous practice. Regulation Z states that the amount that a consumer is charged for a settlement service may not exceed the amount actually received by the settlement service provider for that service (12 C.F.R. §1026.19(f)(3)(i)). Allowances are made for average charges made for similar transactions in the same geographic area.

Managing Risk to Avoid UDAAP

Improving consumer information and service is critical to managing risk under UDAAP prohibitions. Some suggested steps to mitigate risk include: Ensuring that consumer materials are accurate and easy to read Avoiding the use of terms in marketing materials that a consumer may not understand. Examples include: "Pre-approved" "Lifetime rates" "Guaranteed" Providing clear disclosures when the terms of a contract may change Avoiding the promotion of favorable lending terms without noting those that are not advantageous, such as an introductory rate that may adjust and result in higher payments Reviewing all telemarketing scripts for deceptive claims

Example In order to determine whether affiliated businesses are properly limiting their financial gains to the return of an ownership interest, the CFPB will consider the following factors, including whether: Each owner in the new entity has made an investment of its own capital Each owner's interest in the business is based on the amount it invested The owners receive financial awards from the new entity based on the amount that they invested and not based on the number of business referrals Ownership interest is not adjusted based on the number of business referrals

In a previous module, students saw a scenario with an example of a lawfully-disclosed affiliated business arrangement. Unfortunately, here, the arrangement is not in compliance with the law. Bishop Homes and Red Eagle Mortgage Company are engaged in a fraudulent scheme to profit through their arrangement, taking advantage of the trust placed in them by unwitting homebuyers. Bishop may be disclosing the borrowers' right to choose another provider, but this does not make up for the company's choice to deliberately deceive customers with regard to their profitable relationship.

Sham Affiliated Business Arrangements

In order to determine whether affiliated businesses are properly limiting their financial gains to the return of an ownership interest, the CFPB will consider the following factors, including whether: Each owner in the new entity has made an investment of its own capital Each owner's interest in the business is based on the amount it invested The owners receive financial awards from the new entity based on the amount that they invested and not based on the number of business referrals Ownership interest is not adjusted based on the number of business referrals

Security Program

In order to ensure compliance with the Rule and the protection of personal information that is collected during a loan transaction, the FTC recommends the following practices: [1] Checking references and/or performing background checks before hiring employees who will have access to customer information Limiting access to customer information to only those employees who have a business reason to see it Using password-activated screen savers to lock employee computers after periods of inactivity Training employees to take basic steps for maintaining security, such as: Locking rooms and filing cabinets where records are stored Not sharing or openly posting passwords in work areas Encrypting sensitive customer information that is transmitted electronically via public networks Reporting suspicious attempts to obtain customer information Preventing terminated employees from accessing customer information by immediately deactivating usernames and passwords Ensuring proper disposal of customer information in accordance with the Disposal Rule Monitoring the websites of software vendors and reading relevant industry publications for news about emerging threats and available defenses against them

Changed Circumstances and Revised Loan Costs

In some cases, changed circumstances may affect settlement costs. A changed circumstance affects settlement charges if it causes an estimated charge to increase by more than the applicable tolerance under the TRID Rule or, for estimated charges that are subject to the Rule's 10% cumulative tolerance, causes the sum of those charges to increase by more than 10% (12 C.F.R. §1026.19(e)(3)(iv)(A)). The CFPB provides the following examples of changed circumstances that can affect settlement costs: A natural disaster, such as a hurricane or earthquake, that damages the property or otherwise results in added closing costs The creditor disclosed a charge for title insurance but the title insurer goes out of business before closing New information that was not relied upon when providing the charges is discovered [1]

Relationships with Consumers

In the debate over the duties that mortgage brokers and their loan originators owe to consumers, the opposing arguments are as follows: A fiduciary relationship exists: when a consumer uses a mortgage broker to find a loan, a principal and agent relationship arises, and the mortgage broker owes fiduciary duties to the borrower. Fiduciary duties include loyalty, good faith, and an obligation to put the interests of the principal (the consumer) ahead of the agent (mortgage broker/loan originator). There is no fiduciary relationship: mortgage brokers are intermediaries between consumers and lenders and owe no particular duty to borrowers who are ultimately responsible for understanding the terms of a lending agreement and deciding whether the loan is one that they can afford.

Example Drew Dorian is a mortgage loan originator for Swift Mortgage Loans. He is working on a transaction for Kevin and Lane Curry. Drew knows that in order for the loan to go through, the home needs to come in at an appraised value of about $275,000. Unfortunately, the appraiser returns a valuation that falls far short of this desired value. Knowing that this puts the transaction at risk, Drew is enraged at this news. He calls the appraiser and demands that the report be "corrected" to a higher value. To sweeten the deal, he tells the appraiser, Cal, that there is strong potential for a bonus out of the deal, and promises that it will result in referral of future business. Cal refuses, stating that he feels confident in his report and does not believe it would be appropriate or ethical to change the results. Drew persists, demanding that Cal produce an "amended" appraisal. Cal stays firm, further frustrating Drew. Finally, Drew snaps, stating that he will deny Cal compensation for the work until the report is changed.

In this scenario, Drew's actions toward the appraiser are seriously in violation of federal law, as well as basic industry ethics. The law specifically prohibits mortgage professionals from attempting to exercise improper influence over the independent judgment of an appraiser. Drew's demands that Cal change the results, attempts to bribe him, and threats to refuse payment unless he gets his desired valuation are all violations of appraisal laws.

Fraud Detection, Reporting, and Prevention The FBI takes mortgage fraud very seriously, and the focus of its efforts is on "industry insider fraud." Following is a description of some of the tactics that are employed in fraudulent schemes carried out by industry insiders:

Inflated appraisals: inflated appraisals are one of the most common elements of fraudulent lending transactions. In some cases, the values of properties used to secure mortgages are inflated by unscrupulous appraisers for as much as 100% of their true market values. Property flipping: property flipping occurs when a property is bought and resold within a very short period of time. Some property flips occur within the same week, and even on the same day. The resale usually involves the use of an inflated appraisal of the property's value even though no improvements to the home have taken place. Straw buyers: a straw buyer is an individual who accepts a fee, ranging from $500 to several thousand dollars, to provide his/her name, Social Security Number, and other personal information for use on a mortgage application. Although it appears that the straw buyer is applying for a purchase money mortgage and although the mortgage application may indicate that the buyer intends to reside in the home, the straw buyer does not intend to own or possess the property used to secure the loan. Straw buyers walk away from these transactions, often unaware that they are liable for fraud and for making false statements to the government. The parties to the scheme pocket most of the money obtained through the loan, the property used to secure the loan lies vacant, and the loan typically goes into foreclosure. Straw sellers: a straw seller is an individual who accepts a fee to falsely claim ownership to a property. Falsified or fabricated title documents, including sham warranty deeds, are created to support the fraudulent claim that the straw seller is the owner and occupier of the property securing the loan. Straw sellers may appear at closings where the property, which they claim to own, is transferred to straw buyers. Air loans: when a fictitious borrower obtains a mortgage loan and "secures" it with fictitious property, the loan is known as an air loan. Fraudsters may even use fictitious employers, appraisers, and credit agencies in order to obtain verifications necessary to process the loan application. Identity theft: identity theft occurs when a fraudster uses another individual's name, Social Security Number, driver's license number, and other personal information to secure credit or make purchases. The use of the information is made without the knowledge of the individual whose personal information is included in fraudulent loan applications or other documents. Sale or assignment of a sales contract: instead of flipping a property by reselling it, some fraudulent real estate investors may obtain a contract on a property with an inflated value and offer to sell the sales contract or assign it to an unwitting buyer for a fee. The "investor" walks away from the transaction with several thousand dollars in his/her pocket, and the new buyer closes on a property that has an inflated price and only a fraction of the value that the buyer anticipated. These transactions can also create a transfer of ownership that is not on public record, making it difficult for consumers, appraisers, or title searches to detect. Cursory inspections: fraudulent real estate brokers or investors may try to unload property with an inflated value and questionable title history on an unsuspecting buyer. When these buyers ask to inspect the property, the seller may discourage an inspection or rush the potential buyer through the home. A hasty inspection is most likely to occur when a faulty appraisal has inflated and grossly misrepresented the value of the property.

Investors

Investors play a critical role in the strength of the mortgage market. The overall soundness of the industry depends on the interplay of primary lenders with mortgage insurers and secondary market investors. Private investment banks participate in the secondary market, but government-sponsored enterprises (GSEs) - i.e., Fannie Mae and Freddie Mac for conventional loans, and Ginnie Mae for non-conventional - have been the biggest buyers of home mortgages. Fannie Mae and Freddie Mac hold and guarantee half of the country's mortgage debt. If these investors collapsed, the mortgage market and other credit markets could potentially become paralyzed. The Housing and Economic Recovery Act of 2008 transferred the oversight of Fannie Mae and Freddie Mac from HUD and the Office of Federal Housing Enterprise Oversight to the Federal Housing Finance Agency (FHFA). FHFA has much more involvement with Fannie Mae and Freddie Mac than the former regulatory agencies had.

Discussion Analysis

Is it illegal for Zack to direct his advertisements and high-cost products to a particular demographic? By targeting specific populations based on their protected characteristics and employing focused, deceptive advertising tactics to lure them into financially onerous transactions, Zack is violating fair lending laws. Zack is using the illegal and discriminatory practice of reverse redlining to offer loans with unfavorable terms to vulnerable consumers. His actions violate ECOA and the Fair Housing Act . Are the communities that Zack targets protected by fair lending laws? Yes. Both ECOA and the Fair Housing Act provide that national origin is a protected class. Each time that Zack targets these consumers with offers for expensive adjustable-rate mortgages, he is illegally basing lending decisions on a protected personal characteristic (national origin), and is failing to offer mortgages on the basis of creditworthiness. Does Zack and Joe's arrangement of soliciting and referring elderly clientele violate any federal fair lending laws? The practice of targeting elderly homeowners with offers for home repairs financed by expensive mortgages with risky adjustable-rate features is yet another version of reverse redlining, and another violation of ECOA. Zack and Joe's business arrangement itself is also a violation of RESPA; the 10% kickback that Zack hands over to Joe for each referral violates RESPA's prohibitions against paying and receiving unearned fees.

Discussion Questions

Is it illegal for Zack to direct his advertisements to a particular demographic? Are the communities that Zack targets protected by fair lending laws? Does Zack and Joe's arrangement of soliciting and referring elderly clientele violate any federal fair lending laws? Since Zack's mortgages typically offer fixed rates for the first two years, is he violating any laws when he advertises them as fixed-rate products? If Zack is making mortgage credit available to consumers who are often otherwise excluded from the market, why are his practices questionable? If Megan encourages her clients to inflate income on loan applications, and does so solely for the purpose of helping them qualify for a loan they intend to repay, is she acting illegally?

Appraisers

It cannot be stressed enough that ethical behavior with regard to appraiser relationships is critical for both legal and ethical compliance. Appraisers are well-trained and highly regulated professionals who must be permitted to make an independent, objective decision on the value of a property. It is the responsibility of appraisers, prior to accepting an appraisal assignment, to review the assignment and determine if they have the knowledge and experience to complete it competently. Appraisers operate under a number of professional and ethical expectations, including those of their state regulators and those of the Appraisal Standards Board at the national level. More information about appraisers, their role in mortgage loan transactions, and the importance of ethical conduct with regard to appraisals will be discussed in a later section.

Expanding Anti-Discrimination Measures

It is important for mortgage professionals to understand that federal law does not preempt state laws, which may have a broader scope and stricter requirements. Mortgage loan originators should familiarize themselves with the fair lending laws of the states in which they practice and to be mindful of any actions that may be construed as discriminatory in states in which the protected classes include more categories. Recent revisions to HMDA to expand demographic data collection is another example of a federal commitment to prioritizing fair lending. By collecting information regarding the ethnicity, race, and sex of loan applicants and monitoring credit decisions that lenders make on loan applications, HMDA allows regulators to monitor compliance with ECOA and the Fair Housing Act, and to identify areas where access to mortgage credit is limited. Loan originators should be aware that the CFPB and the Department of Justice have made fair lending a top priority. The CFPB has an office devoted to fair lending that is known as the Office of Fair Lending and Equal Opportunity. Actions for violations of fair lending laws, such as ECOA and the Fair Housing Act, are handled by the Department of Justice in its Fair Lending Unit of the Civil Enforcement Division.

Mortgage Loan Originators, Lenders, and Brokers

Loan originators act as a liaison between potential borrowers and lenders. It is essential that these individuals are properly educated and licensed or registered to act in mortgage loan transactions with consumers. It is important for mortgage professionals working in multiple locations to remember that requirements vary from state to state. For example, in some states, originators are required to be employed by a mortgage broker, banker, or lender, and may not operate independently. The duty of care that an originator owes to a borrower also differs from one state to the other. In most, they are expected to act as a consultant to the potential borrower, but in others they may also be required to serve as the loan applicant's fiduciary. Acting as a fiduciary to the borrower is the highest ethical standard, as it requires the mortgage loan originator to always prioritize the borrower's best interest before that of any other party involved - including him or herself, the employer, and the lender. While acting according to the standard of a fiduciary is not required by law in every state, it is the ideal way to ensure that transactions are carried out in accordance with high ethical principles and that consumers are protected. Mortgage brokers establish ongoing relationships with lenders such as mortgage bankers or banking institutions. They stay up to date with available lending programs and use their knowledge to help borrowers choose programs to fit their needs. They also ensure that potential borrowers are applying for loans that suit their income level and future financial plans. Mortgage lenders may specialize in specific types of loans, such as conventional loans or FHA programs. Each lender is unique in how they handle policies, procedures, underwriting, broker and borrower support, fees, and schedules.

General Business Ethics

Many professional organizations, such as the Maryland Association of Mortgage Professionals, the Florida Association of Mortgage Brokers, and the National Association of Professional Mortgage Women, require their members to agree to maintain ethical and professional standards. These standards are set forth in Codes of Ethics, Best Business Practices, or in Standards of Professional Practice. Mortgage industry Codes of Ethics vary by organization, however, the essence of each code is very similar. Although exact provisions will differ, general ethical requirements include: Conducting business with honesty and integrity Using advertisements and solicitations that contain accurate information Providing full disclosure of the costs associated with a lending transaction Charging reasonable fees Maintaining the confidentiality of personal information Acting in accordance with all applicable laws and regulations A Code of Ethics does not have the force and effect of federal and state laws and regulations. However, mortgage lending laws provide a legal basis for the enforcement of the principles addressed in Ethics Codes and in Statements of Professional Standards.

Example Steven calls himself a real estate investor who buys and flips properties, but he is actually a thief and a conspirator who makes his living stealing loan funds from mortgage lenders. Steven has paid numerous individuals for the use of their Social Security numbers and other personal information on loan applications to finance home purchases. With the help of a former mortgage broker, Steven assembles fraudulent documents to verify the straw buyer's employment, income, and assets, which he submits to a lender. When the loan application is approved and the fraudulent purchase is complete, Steven pays the straw buyer an additional fee to list the property for sale. He works with several appraisers that provide inflated valuations for the newly purchased home. When the valuations are too high to lure a genuine buyer, Steven brings in another straw buyer. As soon as a lender wires funds to the account of the straw seller, Steven pays commissions to his straw buyer and straw seller and to the appraisers and former mortgage broker. As the leader of this mortgage fraud ring, Steven pays the largest commission to himself.

Mortgage lenders have lost billions of dollars to schemes that are similar to Steven's. In addition to straw buyers, straw sellers, and forgers, participants in mortgage fraud rings include individuals who pose as human resource managers to "verify" a fraudulent loan applicant's employment history and income. If caught, individuals who work together to steal funds from lenders are subject to prosecution for conspiracy and bank fraud. Since Steven and his co-conspirators probably used the Internet and the mail to forward loan applications, supporting documentation, and appraisals to lenders, a prosecutor could bring additional charges against them for wire fraud and mail fraud. Individuals who commit these crimes may face prison terms of up to 30 years and penalties for as much as $1 million. Since most mortgages are either insured or guaranteed by the government, funded by an institution that is insured by the government, or purchased by a government-sponsored enterprise, any false statement on a loan application constitutes a false statement to the government, which is also an illegal act that can result in imprisonment and monetary penalties.

Real Estate Licensees

Mortgage professionals often have a close working relationship with real estate professionals. In fact, some states permit an individual to act or hold licenses as both a loan originator and a real estate agent. In cases in which an individual fills a dual role, it is always a legal requirement to appropriately advise consumers due to the potential conflict of interest. In the absence of dual licensure, mortgage professionals must remain vigilant in their interactions with real estate agents. One primary area of concern involves referrals and compliance with RESPA. Real estate agents are often in a position to refer business to loan originators and vice versa, and it is a violation of RESPA for there to be any compensation given or accepted in exchange. Privacy is another area of concern when dealing with real estate professionals. In many cases, real estate licensees clearly establish an agency relationship with their customers. During the purchase or sale of a property, the real estate licensee is understandably concerned with the status of his/her customer's interest in the transaction. However, it is a violation of the customer's privacy to share personal protected information with the real estate agent. Such information may only be discussed with the borrower directly.

Roles and Responsibilities of Mortgage Professionals

Mortgage transactions require the participation of many people besides the borrower and the mortgage loan originator. No mortgage transaction is complete without the involvement of third-party service providers, such as credit reporting agencies, appraisers, title insurers, escrow agents, and attorneys. Mortgage professionals have a responsibility to ensure not only their own ethical and legal compliance, but also that of industry partners with whom they engage. Unfortunately, it is often industry partners acting in concert who carry out fraudulent mortgage lending transactions. False appraisals and title reports are commonly linked to fraudulent transactions, and participants have also frequently included attorneys and lenders. More information about fraud will be discussed in a later section of this course.

Ethical Issues Regarding Referrals

One of the ethical problems that RESPA addresses is the ability of mortgage professionals to pocket fees that they have not earned, secured by the simple act of referring consumers to particular settlement service providers. Naturally, loan applicants rely on referrals to secure the services needed to complete the processing of a loan. Most consumers take part in very few real estate closings over the course of their lives and do not have contacts with the appraisers, insurers, inspectors, attorneys, and closing agents who can help them to close on a home. However, consumers should not have to pay for these referrals, which is exactly what happens when the cost of paying a referral fee is inevitably passed on to the consumer.

Handling Consumer Complaints

One of the many directives that Congress issued to the CFPB was a requirement to establish "reasonable procedures" to respond to consumer complaints against providers of consumer financial products and services (12 U.S.C. §5534(a)). Since December 2011, the CFPB has been accepting consumer complaints related to consumer financial products and services, including mortgage products and services. After receipt and initial processing of a complaint, the CFPB enters the information in its consumer complaint database. The CFPB's receipt of consumer complaints takes place through a "consumer portal," and the CFPB also accepts complaints by phone, fax, or mail. The CFPB forwards complaints to the company that is named in a complaint, and the CFPB's receipt of company responses is carried out through a secure system that it refers to as the "company portal." The CFPB's Company Portal Manual outlines the process that companies, including mortgage companies, must follow when signing up as a user of the portal, and the manual provides information on viewing and responding to consumer complaints.

Gramm-Leach-Bliley Act, Title V

One of the most important ethical considerations during transactions for home loans is the obligation to protect the privacy and confidentiality of the personal information that consumers provide to mortgage professionals in order to secure a mortgage. The unauthorized sale and use of personal information, and other failures to protect personal information, are ethical challenges that the Gramm-Leach-Bliley Act (GLB Act) is intended to address. The GLB Act aims to protect the privacy of consumers and customers in a number of ways, including requiring privacy notices, opportunities to opt out of the sharing of personal information, and more. Many of these requirements are discussed in Module 1 of this course. The Gramm-Leach-Bliley Act also protects consumer information by requiring compliance with the Safeguards Rule.

Sales & Marketing and TILA

One of the principal ethical problems that TILA addresses is the use of deceptive and misleading advertising to solicit mortgage business. Typical violations of the law include an advertisement's use of trigger terms, such as "low monthly payments," without stating the less advantageous terms of repayment. The annual percentage rate (APR) is the most frequently required information when trigger terms are present. Another common violation involves the advertisement of mortgage products that are not actually available.

Sham Affiliated Business Arrangements

RESPA establishes three conditions that an affiliated business must meet in order to satisfy the exception for referrals: Disclosure of the relationship: the person making the referral must provide the consumer with a written notice of the nature of the relationship. Regulation X includes a sample disclosure form with the required format. No required use of the referred entity: the person making the referral cannot require the use of a particular settlement service provider. There are some limited exceptions when a creditor may require use of a particular attorney, appraiser, or credit reporting agency. Limitations on the "things of value" resulting from the arrangement: the only benefit allowed is a return of an ownership interest or franchise relationship.

Real Estate Settlement Procedures Act

RESPA was established with a number of ethical goals, including the protection of consumers from excessive costs and fees in mortgage loan transactions. Section 8(a) of RESPA prohibits any person from giving or accepting unearned fees, including kickbacks, referral fees, or other things of value, unless a commensurate amount of work is performed. Section 8(b) of RESPA concerns fee splitting, prohibiting the practice in situations where fees are received but services are not actually performed. Violations of RESPA can result in hefty fines and even imprisonment. Regulation X cautions that high prices may prompt an investigation to determine if they have resulted from referrals or split fees. The rules state that high prices alone are not proof of a violation; however, payment of a thing of value that does not bear a reasonable relationship to the market value of goods or services provided may be used as evidence of a RESPA violation (12 C.F.R. §1024.14(g)(2)). The following sections will detail prohibited compensation practices under RESPA, and the related ethical issues that mortgage professionals can face in mortgage transactions.

Redlining

Redlining is a particular discriminatory practice that violates ECOA. The term "redlining" came from the practice of using red lines on a map to designate areas that lenders regarded as an unsafe credit risk. Redlining restricts lending funds for entire communities, preventing access to credit and harming entire neighborhoods based on the discriminatory, baseless assumption that residents belonging to certain racial groups, tax brackets, or immigration status groups were credit risks.

Sales & Marketing and TILA

Regulation Z addresses a number of the deceptive and unethical practices that lure consumers to mortgage products which do not live up to the promises made in advertisements. These practices, which are expressly prohibited in closed-end transactions secured by a dwelling, include: Misleading advertising of "fixed" rates and payments: the use of the word "fixed" in advertisements for loans that have variable rates, or combined fixed and variable rates, is prohibited unless there is conspicuous and equally prominent information about variable rates and increasing payments. Misleading comparisons in advertisements: comparisons between an advertised mortgage for closed-end credit and a hypothetical loan that a consumer may have are prohibited unless the ad includes the requisite disclosures regarding APRs and payments. An advertisement to "save $300 per month on a $300,000 loan" is an implied and prohibited comparison between the payment due on the advertised loan and a consumer's current loan payments. Misrepresentations about government endorsement: statements that lead consumers to the incorrect assumption that a mortgage product is endorsed or sponsored by the government are illegal. Misleading use of the current lender's name: some lenders and mortgage brokers have made direct solicitations that lead consumers to the incorrect assumption that their own lender is contacting them with information on mortgage products. Misleading claims of debt elimination: this prohibition addresses the practice of suggesting, in an advertisement, that a borrower can obtain the elimination, forgiveness, or waiver of his/her obligations to another creditor. Examples of these types of misleading statements include "Refinance today and wipe your debt clean!" and "Pre-payment penalty waiver." Misleading use of the term counselor: an advertisement cannot refer to a for-profit lender, mortgage broker, or its employees as a "counselor." Misleading foreign-language advertisements: some advertisements target consumers who lack fluency in English by advertising favorable lending terms, such as a low introductory rate, in their first language, while providing information on the additional and less favorable lending terms in English. (12 C.F.R. §1026.24(i))

Sales & Marketing and TILA

Regulation Z also prohibits the use of misleading terms in advertisements for open-end mortgages, such as home equity loans (12 C.F.R. §1026.16(d)(5)). Another prohibition related to open-end credit is the use of misleading statements regarding tax deductions for interest paid on home equity loans (12 C.F.R. §1026.16(d)(4)). Mortgage brokers, mortgage bankers, and loan originators that violate TILA's advertising restrictions and prohibitions are subject to enforcement actions by the FTC and the CFPB. The FTC has also set up a web page to help consumers understand mortgage ads, encouraging them to ask the following when seeking mortgage financing: What are the monthly payment amounts and how often can they increase? Does the monthly payment include an amount that is set aside to cover taxes and insurance? What is the loan term and is a balloon payment due at the end of the term? Does the loan include prepayment penalties? If the loan has a teaser rate, is it possible to refinance the loan without paying a penalty before the rate resets?

Reverse Redlining

Reverse redlining occurs when certain neighborhoods are profiled and actually targeted, rather than avoided, by predatory lenders. The perpetrators will take advantage of the perceived or actual lack of homebuyer education, experience, knowledge, or English-language skills to bilk residents into onerous mortgage loans they do not understand. These practices are prohibited through ECOA and HOEPA, but some unscrupulous and discriminatory industry players today still attempt to exploit protected classes through these tactics.

Valuation Independence The Federal Reserve Board wrote the Rule to include the following two "safe harbors" for compliance:

Safe harbor for creditors with more than $250 million: if a creditor had assets of more than $250 million for the past two calendar years (as of December 31 for each year), then there is no conflict of interest based on employment by, or affiliation with, the creditor if: The compensation of the appraiser or other person performing valuation management functions is not based on that value produced by the appraisal The appraiser or other person performing valuation management functions reports to a person who is not involved in generating or approving mortgage loans The compensation of the appraiser or other person performing valuation management functions is not based on closing the transaction for which the appraisal is performed, and No employee, officer, or director who is involved in generating or approving mortgage loans is directly or indirectly involved in selecting, retaining, or influencing the selection of an appraiser or in preparing an approved list of appraisers Safe harbor for creditors with $250 million or less: if a creditor had assets of less than $250 million for the past two calendar years (as of December 31 for each year), then there is no conflict of interest based on employment by, or affiliation with, the creditor if: The compensation of the appraiser or other person performing valuation management functions is not based on the value produced by the appraisal, and The creditor requires that any employee, officer, or director who orders, performs, or reviews a valuation must abstain from any decision to approve, not approve, or set the terms of the transaction

Discussion Analysis

Since Zack's mortgages typically offer fixed rates for the first two years, is he violating any laws when he advertises them as fixed-rate products? The advertising provisions of TILA state that it is illegal to advertise loans with combined fixed- and adjustable-rate features as fixed-rate products unless the advertisement includes equally conspicuous and prominent information about adjustable rates and payment changes. If Zack is making mortgage credit available to consumers who are often otherwise excluded from the market, why are his practices questionable? Zack's practices are unethical because he is taking advantage of two vulnerable groups of consumers in his community. He is deliberately targeting specific individuals based on their personal characteristics, and then placing them with expensive, onerous loan terms when they might qualify for other loans that would be much less costly. He also informs Megan that he inflates income to help applicants get approved - an unlawful practice that constitutes fraud. If Megan encourages her clients to inflate income on loan applications, and does so solely for the purpose of helping them qualify for a loan they intend to repay, is she acting illegally? Megan's actions are illegal, as are those of the loan applicants who misrepresent their income on loan applications. These actions violate anti-fraud laws, and can lead to fines and imprisonment. These practices are known as fraud for housing, and even though the borrowers may intend to repay the loan as it is offered, the act of falsely inflating income interferes with a lender's ability to make sound credit decisions, and is unlawful.

Ethical Issues Related to Federal Lending Laws

Some lending laws are less urgently needed than they were at the time of their enactment, but retain relevance since the unethical practices that they address are less blatant, but still persist. For example, when Congress adopted ECOA, women faced prejudicial lending practices that are unimaginable today. These practices included outright denials of mortgage credit to women who were unable to rely on a spouse or a male relative as a co-applicant, and the "discounting" of income earned by women when young married couples tried to use both of their salaries to qualify for a home loan. While these particular acts of discrimination may no longer occur, others have arisen, including lenders' refusals to complete lending transactions while women are on maternity leave. Today, a primary focus of fair lending efforts is addressing racial gaps in housing access, particularly for Black, Hispanic, and Latino Americans. These groups tend to face greater gaps in homeownership rates than white Americans, and industry stakeholders are stepping up to attempt to secure a more equitable housing market. Civil rights and consumer advocacy groups are also participating in these efforts, working to dismantle systemic barriers to access and secure equitable, affordable access to homeownership for all. These efforts are also aimed at identifying subtle discriminatory effects in the market, primarily resulting from disparate impact. ECOA continues to offer a legal basis for challenging these discriminatory practices, and HMDA helps use lenders' demographic data to reinforce fair lending efforts. Regardless of the characteristics of the current lending market, federal lending laws help to define the nation's minimum ethical values. Laws that prohibit discrimination and that protect privacy and fairness represent a collective commitment to creating an ethical market for consumer financial products and services. At the same time, determining what constitutes ethical and unethical behavior can be a subjective matter. For example, certain state statutes contain laws against usury. However, since Congress adopted legislation in the 1980s to preempt certain state usury laws, there have been no legal limits on the amount of interest charged, and interest rates are determined not by ethical considerations, but by market forces. Another notable difference between the ethical approach of state and federal statutes is apparent in their contrasting approaches to the obligations that mortgage brokers and loan originators owe to consumers. As discussed in a subsequent section on "Roles and Responsibilities of Mortgage Professionals," some state laws require brokers and originators to guide consumers through lending transactions while serving as their fiduciaries. Federal laws have taken a different approach, relying on the use of disclosures to prepare consumers to make their own choices related to loan products.

Handling Consumer Complaints

Specific topics addressed in the manual include: Technical matters related to use of the company portal, such as identifying supported browsers and providing guidance on the establishment of a company's username and password The procedure for responding to consumer complaints Requirements that companies must meet for maintaining the privacy of personal information that they receive in consumer complaints Mortgage companies, including creditors and mortgage brokers, should download the manual and refer to it when questions arise about use of the company portal and when dealing with consumer complaints. The manual is accessible online. [1]

Company Compliance

State-licensed loan originators are often employed by mortgage companies that hold state licenses to operate as mortgage brokers or mortgage bankers. Most state licensing laws for these entities include provisions which require them to provide careful employee oversight. Even without these provisions in licensing laws, other state and federal laws that address the legal relationship between employers and employees create duties for mortgage brokers and mortgage bankers to adequately oversee loan originator employees and to ensure that they are conducting business in full compliance with the law. Comprehensive oversight of employees is important because a mortgage company may be held responsible for the actions of its employees. The employer is expected to maintain policies and procedures to encourage ethical and legal lending practices and to take steps to ensure that employees receive adequate training to meet the prescribed policies and procedures. The establishment and maintenance of a compliance management system (CMS) is the most effective measure that a mortgage company can take to demonstrate commitment to ethical lending practices and intent to comply with the law.

Company Compliance

The CFPB has stated, "A sound and robust compliance management system is essential to ensuring compliance with Federal consumer financial law and preventing associated risks of harm to consumers." [1] The CFPB describes a sound system as one that includes: Policies and procedures Training for board members and employees System monitoring Procedures for implementing corrective actions An auditing program to identify gaps in the compliance system and to ensure that it is functioning properly The CFPB has stated that having an effective compliance management system in place may help a company to establish a basis for claiming that a compliance failure was the result of a bona fide error. Without one, "Showing that a violation occurred unintentionally could be difficult..." The CFPB has also noted that violations of lending laws most commonly occur in companies that have a weak compliance system or no compliance system.

Handling Consumer Complaints

The CFPB's Mortgage Servicing Rules, which have been effective since January 2014, should help to resolve loan servicing issues, including the problems that consumers encounter when they are struggling to make mortgage payments. These rules, which are found in RESPA's Regulation X, include provisions for "Error Resolution" and provisions for "Early Intervention Requirements." The Early Intervention Requirements are intended to resolve delinquencies and defaults and to prevent foreclosures. These servicing rules are reviewed in a separate module of this course. While loan originators are unlikely to find themselves dealing with issues that may arise during the years that a mortgage is repaid, they should be prepared to explain to loan applicants that resources continue to be available throughout the loan term to resolve future problems such as those that arise when payments are not properly applied to a loan balance, or those that arise when borrowers are delinquent. Loan originators are in a unique position to educate consumers by letting them know that there are some regulations that can facilitate the resolution of complaints and others that can help borrowers to avoid foreclosure if they face circumstances that make it difficult to honor their obligations under a lending agreement.

UDAAP Penalties and Enforcement Actions

The Dodd-Frank Act has created three penalty tiers for violations of consumer financial protection laws, including the UDAAP law. These include civil penalties of: $5,000 for each day that a violation continues if the violation is neither a reckless nor a knowing violation $25,000 for each day that a reckless violation continues, and $1,000,000 for each day that a knowing violation continues (12 U.S.C. §5565(c)(2)) Penalty amounts are subject to numerous mitigating factors, which include: The size, financial resources, and good faith of the entity charged with violations Compliance history of the entity charged with violations The severity of risks to consumers or losses sustained by them (12 U.S.C. §5565(c)(3)) The CFPB frequently includes allegations of UDAAP in its enforcement actions, and in most circumstances, facts that serve as a basis for alleging violations of other federal lending laws will also serve as a basis for alleging that unfair, deceptive, and abusive acts and practices have occurred. For example, if a lender violates TILA's requirements for truthful advertising, it has also committed a deceptive act, and if a lender violates fair lending laws, it has likely also engaged in unfair and abusive lending practices.

Proper Appraisal Conduct

The Dodd-Frank Act's provisions on appraisals are found in 15 U.S.C. §1639e, and they are intended to protect appraiser independence by prohibiting: Coercion, bribery, and any other actions intended to influence the judgment of an appraiser Appraisers and appraisal management companies from having a financial or other interest in the property Extension of credit by a creditor that knows there has been a violation of the prohibition on coercion or of the prohibition against conflicts of interest The law also mandates: Reporting appraiser misconduct to state appraiser licensing authorities (15 U.S.C. §1639e(e)) Paying reasonable and customary fees to fee appraisers (appraisers that are not employees of creditors or of appraisal management companies hired by creditors) (15 U.S.C. §1639e(i))

Institutions Covered by the Safeguards Rule

The FTC's Safeguards Rule covers all the "financial institutions" (as defined under the GLB Act) that are within its jurisdiction. Financial institutions within the jurisdiction of the FTC include mortgage brokers and non-bank mortgage lenders.

Equity-Based Lending

The Home Ownership and Equity Protection Act (HOEPA) was enacted as an amendment to TILA. Being one of the first federal anti-predatory lending laws, HOEPA has the principal goal of curbing unethical practices such as equity-based lending and abusive or fraudulent loan flipping. Equity-based lending involves the offering of mortgage credit exclusively on the basis of the equity that a consumer has in his or her home, without consideration of repayment ability. This practice is commonly used in reverse redlining schemes, targeting vulnerable consumers who fail to realize that they are accepting loans that are likely beyond their means. Congress also addressed equity-based lending by amending TILA to prohibit the making of a residential mortgage loan without a reasonable, good faith determination of ability to repay (15 U.S.C. §1639C(a)(1)).

Integrated Disclosures

The Loan Estimate and Closing Disclosure were drafted by the CFPB to enhance consumer understanding. Loan originators should urge loan applicants to read their disclosures. Consumers are generally overwhelmed and confused by the details related to their transactions, and may be embarrassed to ask about details that they do not understand. If a loan originator explains the importance of disclosures and emphasizes their educational component, then consumers may be more inclined to use them for their intended purpose. Loan originators should also direct consumers to the online educational tools that the CFPB provides and encourage them to take advantage of these resources.

Ethical Issues Regarding the Compensation of Loan Originators

The Loan Originator Compensation Rule applies to closed-end consumer credit transactions secured by a dwelling (12 C.F.R. §1026.36(b)). It is applicable even if the home securing a loan is not the borrower's principal residence, and applies to first and subordinate lien mortgages. Violations of this rule have led to numerous enforcement actions by the CFPB. Enforcement actions have included those based on: A mortgage banker's practice of paying compensation to branch managers that was based in part on the interest rates of the loans closed The payment of bonuses and commission to loan originators who steered borrowers towards more expensive mortgages The Rule establishes prohibitions against: Steering borrowers toward loans that do not suit their needs but will result in higher compensation for the loan originator Receiving dual compensation on a loan transaction Compensation that is based on the terms of a loan A review of the Loan Originator Compensation Rule is included in a previous module of the course.

Valuation Independence

The Official Interpretations of the Rule offer further insight as to the prohibition addressing conflicts of interest. Generally, the Rule does not prohibit a lender's use of staff appraisers, as long as there are "firewalls" between its loan originators and its appraisers. The Official Interpretations state that whether the use of employees or affiliates in the preparation of a valuation is prohibited will depend on the circumstances of each particular case, including the nature and structure of the employee/affiliate relationship (Official Interpretations of 12 C.F.R. §1026.42(d)(1)(ii)(1)).

Valuation Independence Instead of referring to appraisals, the Valuation Independence Rule uses the term "valuation," which is defined as "...an estimate of the value of the consumer's principal dwelling in written or electronic form, other than one produced by an automated model or system" (12 C.F.R. §1026.42(a)(3)).

The Rule refers to valuation management functions, which include the functions of persons who: Are involved in selecting, contracting with, or employing a person to prepare a valuation Manage, oversee, or administer the receipt of orders for valuations, the processing and preparing of valuations, the submission of valuations to creditors, and the receipt of fees for the valuations, and Review or verify the work of those who prepare valuations (12 C.F.R. §1026.42(a)(4)) Under this broad definition, valuation management functions are not limited to the actions of appraisers; they also include the acts of creditors, mortgage brokers, or loan originators who order appraisals.

The TRID Rule and Collection of Fees

The TRID Rule addresses an ethical issue that Congress initially sought to resolve with the enactment of RESPA in 1974; RESPA was intended to protect borrowers from arriving at the closing table and learning that loan costs were more than those quoted by their lenders. The law sought to put these protections in place without adopting rate-setting rules that would limit charges for loans and settlement services. When Congress issued a decree for the CFPB to combine RESPA and TILA disclosures into single integrated disclosures of estimated and actual costs, the CFPB created the Loan Estimate and Closing Disclosure. These disclosures, like the GFE and HUD-1 Settlement Statement that preceded them, strike a balance between controlling loan costs and allowing the market to determine the cost of mortgage credit. This balance is achieved by limiting the amount of change that is permitted between estimated and actual loan costs and by limiting the circumstances in which estimates can change. As noted in previous modules of this course, the TRID Rule tightly restricts the collection of fees before a Loan Estimate is provided and the customer indicates intent to proceed. A creditor, or any other person, is prohibited from collecting any fees from a loan applicant before that time, other than a bona fide, reasonable fee for obtaining a credit report.

Valuation Independence

The Valuation Independence Rule applies to the following persons and transactions: Covered persons: the term "covered person" is defined to include creditors and persons that provide settlement services in connection with a covered transaction (12 C.F.R. §1026.42(a)(1)). "Settlement services" is very broadly defined under 12 U.S.C. §2602(3) to include the origination of mortgages and all of the other services associated with loan origination, such as title searches, appraisals, obtaining credit reports, and inspection services. Therefore, a "covered person" includes a loan originator. Covered transactions: the term "covered transaction" is very broadly defined to include an extension of consumer credit that is or will be secured by the consumer's principal dwelling (12 C.F.R. §1026.42(a)(2)). Under such a broad definition, covered transactions include those for open-end and closed-end loans, purchase money mortgages, and reverse mortgages.

Ethical Conduct in the Appraisal Process

The appraisal of real estate used as collateral for a mortgage loan is one of the most critical components of the entire transaction, as the loan amount is directly tied to the value of the property. Appraisals are also the component of mortgage lending transactions with which unethical actions are most commonly associated. Appraisers are often faced with pressure to return a specific property value to meet a borrower's financing needs. During the lending boom, originators as well as borrowers were tempted to pressure appraisers to deliver the numbers needed to close a transaction.

Valuation Independence

The appraisal rules prohibit: Coercion: no creditor and no person who provides settlement services may cause or attempt to cause the value of a consumer's principal dwelling to be based on anything other than the appraiser's independent judgment (12 C.F.R. §1026.42(c)(1)). The rules list the following examples of actions that would constitute coercion: Influencing a person preparing a valuation to report a minimum or maximum value Withholding or threatening to withhold timely payment unless the consumer's dwelling is valued at or above a certain amount Suggesting that current or future use of the services of the person preparing the valuation will depend on the result of the valuation Excluding a person from consideration for future valuations if the value reported does not meet or exceed a predetermined threshold Conditioning compensation paid to the person preparing the valuation on the closing of the loan Misrepresentation: no person preparing valuations may materially misrepresent the value of the consumer's principal dwelling in a valuation. A misrepresentation is "material" if it is "...likely to significantly affect the value assigned to the consumer's principal dwelling" (12 C.F.R. §1026.42(c)(2)). Extension of credit when a knowing violation has occurred: if a creditor knows at or before consummation that a violation of the Valuation Independence Rule has occurred, then it must not extend credit based on the valuation, unless it documents that it acted with reasonable diligence in determining that the valuation does not materially misstate or misrepresent the value of the dwelling (12 C.F.R. §1026.42(e)). Conflict of interest: a person who prepares valuations may not have a direct or indirect interest, whether that interest is financial or otherwise, in the property or transaction for which a valuation is or will be performed (12 C.F.R. §1026.42(d)).

Financial Responsibility

The concept of financial responsibility as it relates to mortgage origination refers to both the individual loan originator's qualifications and his or her handling of loan transactions. The Secure and Fair Enforcement for Mortgage Licensing Act (S.A.F.E. Act) established requirements for individuals trying to become state-licensed loan originators to meet certain standards for financial background and responsibility. Financial responsibility can also refer to the loan originator's compliance with regulations such as the ATR Rule and the Loan Originator Compensation Rule. Showing regard for the consumer's ability to afford a mortgage loan, and ensuring loan suitability, also demonstrate the loan originator's ability to make sound financial judgments.

Participants in the Loan Process

The following will briefly describe the roles that mortgage professionals and other industry partners play in lending transactions and of the opportunities that these individuals and entities have to identify unethical and illegal activities that may take place during a transaction.

Fraud Detection, Reporting, and Prevention

The moral and ethical incorrectness of mortgage fraud is never contested. The Federal Bureau of Investigation (FBI) defines mortgage fraud as "the intentional perversion of the truth for the purpose of inducing another person or other entity in reliance upon it to part with something of value or to surrender a legal right." [1] Mortgage fraud takes many forms, including: Liar loans: when lenders were willing to fund low-documentation and no-documentation loans, borrowers took advantage of these products by inflating their stated income and enhancing their other qualifications. These actions are illegal under state and federal lending laws, and consumers who use these tactics to secure a mortgage may face criminal charges. Occupancy fraud: obtaining loan approval and a lower interest rate is easier when the home that will secure a mortgage is to be occupied by the borrower as his/her principal residence. Borrowers that falsely state on a loan application that they will reside in a home are committing occupancy fraud and could be subject to criminal prosecution. Predatory lending: when real estate agents and mortgage loan originators encourage a consumer to purchase a home based on an inflated appraisal or steer him/her towards high-cost mortgage products with unfavorable lending terms, they are committing fraudulent acts against consumers and are subject to criminal action. Industry insider fraud: this type of fraud involves the conspiratorial actions of members of the mortgage industry who use lending transactions as a means of securing funds from lenders. With their knowledge of the mortgage lending process, unscrupulous mortgage bankers, mortgage brokers, loan officers, underwriters, processors, real estate agents, appraisers, and lawyers have worked together to close fraudulent loans and pocket the loan funds.

Example Gene and Frances McCann are a retired couple living in a small town in Maine. Gene and Frances both still work from time to time; Gene is a sculptor and Frances writes and self-publishes cookbooks. They plan to take out a reverse mortgage loan to pay for some modifications that will make their home more accessible for Gene, who uses a walker to get around. They also wish to use a portion of the loan proceeds to give a significant wedding gift to their great niece. The McCanns receive a flyer in the mail from ReverseAdvise, a local mortgage company specializing in lending to seniors. The flyer promises competitive reverse mortgage options and dispels many of the couple's fears: the company states that borrowers can remain in their homes for as long as they wish, will not have to make any payments related to the loan, and could not possibly lose their home. Gene and Frances immediately make an appointment at the company and meet with an employee named Wendy. The process moves quickly, and the McCanns soon have their loan. However, several years later, tragedy strikes and Gene passes away suddenly. Since he took out the loan in his name (the couple did not apply jointly), Frances learns that because her husband has died, she must repay the entire loan balance or face the loss of her home. Having no idea that this was a possibility, Frances is unprepared for the burden, and she is ultimately forced to give up her home and move in with her great niece.

The practices carried out by ReverseAdvise are a clear example of unfair, deceptive, or abusive acts or practices. The advertisement deliberately causes consumers to believe that there are essentially no risks to taking on a reverse mortgage loan, which is untrue. Unfortunately, this ultimately results in Frances losing her home - something the advertisement promised her would never happen.

Fraud Detection, Reporting, and Prevention

The precipitous decline in home values and the distress of homeowners facing foreclosure has given rise to new fraudulent schemes, and one that is currently on the rise is a scheme known as "flopping." Unlike property flipping, which uses an inflated appraisal to secure a loan for more than a property is worth, property flopping is executed by forcing the sale of a home for less than it is worth and reselling it at its true value. Flopping schemes can be very elaborate and can involve a number of co-conspirators. It often involves the false promise of foreclosure relief to a beleaguered homeowner who signs over his/her rights of homeownership to a foreclosure specialist who resells the home after claiming that attempts to refinance the home or modify the loan were not workable. It can also involve erroneously convincing a lender to permit a short sale based on the property's "decreased" value and absorb the loss, leaving the property to then be resold at market value by parties who split the fraudulent profits. In 2009, Congress took action to step up enforcement against those who commit mortgage fraud with the adoption of the Fraud Enforcement and Recovery Act (FERA). This law is intended to facilitate the prosecution of those who commit mortgage fraud and to increase the financial resources that are available to investigate and prosecute fraud cases. FERA revised the federal criminal code by specifically providing that the law against defrauding a financial institution includes actions related to the "mortgage lending business." FERA defines "mortgage lending business" as "...an organization which finances or refinances any debt secured by an interest in real estate, including private mortgage companies and any subsidiaries of such organizations, and whose activities affect interstate or foreign commerce" (18 U.S.C. §27).

Ethical Issues Related to Federal Lending Laws

The primary focus of this module is on the use of ethical and legal constraints used to protect consumers, but there are also transactions in which lenders need protection from the unethical actions of borrowers. These transactions are those involving mortgage fraud. While some lending matters may present ethical dilemmas, there are no gray areas when it comes to fraud. Under any set of values, the use of deceptive and misleading information to secure loan funds is unethical and results in losses that extend beyond those sustained by lenders. As discussed in the following section, mortgage fraud takes the form of fraud for profit and fraud for housing. Both forms are unethical and illegal, and bring harm to the mortgage industry and to consumers who rely on the mortgage market for financial products and services.

Sham Affiliated Business Arrangements

The purpose of these conditions is to allow one service provider, such as a lender, to refer consumers to its affiliates in order to obtain other services necessary for the completion of a lending transaction. By limiting any benefit from such referrals to "return of an ownership interest," Congress sought to ensure that affiliated businesses did not reward each other for referrals among themselves using unearned fees. The ten factors that the CFPB will consider when assessing the legitimacy of an affiliated business arrangement include: Sufficient capital to operate Its own employees Control of its own business affairs A separate office Assumption of the risks and rewards of a comparable enterprise Performance of the services it purports to offer, instead of contracting out the work Performance of its own work instead of contracting out work to an independent third party Proof that it pays an amount that reflects the reasonable value of services performed by a third party Evidence that it competes in the market for business Business interaction with members of the lending industry other than its affiliate

Sales & Marketing and TILA In 2011, the FTC adopted its own set of prohibitions for unfair and deceptive acts and practices in the advertising of mortgages, called the Mortgage Acts and Practices (MAP) Rule. The CFPB is now the agency that has primary authority to implement and enforce the MAP Rule.

The regulations issued pursuant to the MAP Rule are known as Regulation N (12 C.F.R. §1014 et seq.). The Rule prohibits "...any material misrepresentation, expressly or by implication, in any commercial communication, regarding any term of any mortgage credit product..." (12 C.F.R. §1014.3). Specific provisions of the MAP Rule are discussed in a previous module of the course.

Expanding Anti-Discrimination Measures

There have been ongoing efforts for the past several years to create additional protections under ECOA and the Fair Housing Act by prohibiting discrimination based on sexual orientation and gender identity. The Housing Opportunities Made Equal Act of 2013 is an example of one such law, which would amend ECOA to add these protections. A number of state legislatures have already successfully implemented bills making it illegal to discriminate on the basis of sexual orientation or gender identity. In fact, 20 states, the District of Columbia, and a number of localities have already enacted full protections on these bases; an additional two states offer protections based on sexual orientation, but not gender identity. [1] In addition, HUD has announced its intention to enforce the Fair Housing Act to prohibit discrimination on the basis of sexual orientation and/or gender identity as it relates to FHA loans and programs. This decision was made based on HUD's evidence that "...same-sex couples and transgender persons in communities across the country experience demonstrably less favorable treatment..." when seeking housing access. [2] The CFPB has also clarified its position, announcing that it views gender identity and sexual orientation as part of the protected characteristic of sex under ECOA and will enforce the law accordingly. In other words, discriminating against a person based on their actual or perceived gender identity, sexual orientation, or gender/sex nonconformity is prohibited and will be punishable under ECOA as discrimination on the basis of sex.

Relationships with Consumers

There is another important consideration that is related to customer relationships, and that is the importance of treating all loan applicants equally. Fair lending laws make it illegal to: Discourage particular consumers from applying for mortgages, or Base lending decisions on personal characteristics such as race, gender, country of national origin, or religion Loan originators should be familiar with the "protected classes" under ECOA and the Fair Housing Act and trained to avoid the ethical and legal problems that arise when they treat loan applicants differently. For example, it is a violation of fair lending laws to ask a female or minority loan applicant for more documentation than is required from a male applicant or to set higher credit score requirements for women or minorities. Loan originators should have uniform methods for determining the creditworthiness of each loan applicant and remain mindful that creditworthiness is the ethical and legal basis for credit decisions.

Relationships with Consumers

There is no federal law stating that mortgage lenders, loan originators, or mortgage brokers are obligated to consumers to serve as their agent or fiduciary. Congress had the opportunity to address this issue in 2008 when it adopted the S.A.F.E. Act, but limited the "standards" for loan originators to licensing and registration requirements. Despite the absence of federal requirements, many state laws have addressed the issue directly and have added provisions to their licensing laws that expressly state that an agency or a fiduciary relationship exists between mortgage brokers and borrowers. These states include, but are not limited to, California, Illinois, Minnesota, Nevada, New Mexico, South Carolina, Washington, and Wisconsin. For example, in the state of Washington, the law leaves no doubt about the role of mortgage brokers, stating that "A mortgage broker has a fiduciary relationship with the borrower" (RCW 19.146.095(1)). The law clarifies that fiduciary duties include acting in the borrower's best interests, carrying out the borrower's lawful instructions, disclosing all material facts to the borrower, using reasonable care in the performance of duties, and accounting for all money and property received from the borrower. Minnesota is a state that refers to the relationship between mortgage brokers and borrowers as an agency relationship, imposing a duty on brokers to exercise "utmost good faith" towards borrowers and to make decisions that are in the best interests of borrowers without ever compromising their rights or interests (Minn. Stat. §58.161, sub. 1). Other states have laws that address the relationship between mortgage brokers and borrowers, but without making an express declaration that an agency or fiduciary relationship exists. Colorado, Maryland, North Carolina, and Virginia are examples of states that have taken this approach by adopting laws that require mortgage brokers to exercise good faith and fair dealing when working with borrowers in mortgage lending transactions.

Learning Objectives

This chapter was created based on the Ethics section of the NMLS National Test Content Outline. The topics found in this chapter could likely appear on the NMLS national test in multiple choice question format. By the end of this module, course participants should be able to: Discuss ethical goals of some of the federal mortgage lending laws including: Real Estate Settlement Procedures Act (RESPA) Truth-in-Lending Act (TILA) Gramm-Leach-Bliley (GLB) Act Equal Credit Opportunity Act (ECOA)Fair Housing Act Identify the key elements of mortgage fraud and learn how to prevent it Interpret ethical dilemmas faced by consumers, originators, brokers, lenders, appraisers, and settlement service providers during mortgage lending transactions Describe the ethical conflicts that arise during the appraisal of property used to secure a home loan Describe ethical implications related to financial prohibitions Identify unfair, deceptive, or abusive acts or practices Discuss implications related to the ethical behavior of consumers Interpret mortgage fraud rules, including the various types of mortgage fraud and techniques in identifying fraud Analyze two Discussion Scenarios based on concepts presented in this module

Example Jude is shopping for his first house. When he finds a recently updated split-level in a neighborhood close to his office, he decides to do whatever he must to get the loan needed. Jude only has enough cash for closing and nothing to put toward a down payment; fortunately, the seller has extended an offer, through the realtor, to provide cash for the down payment. The realtor warns Jude that this will give the seller a subordinate lien on the home, and that missed payments can lead to foreclosure. The realtor also advises Jude to disclose this arrangement to his loan originator. Jude, who has already told Daisy, his loan originator, that he is short on cash, simply tells her that a distant relative just passed away and left him a generous inheritance. The "inheritance" just so happens to be exactly enough for a 15% down payment. Concerned that Jude was suddenly able to produce these funds, Daisy decides to investigate this further. She asks Jude for paperwork to verify this inheritance, which he is unable to produce. In discussing the transaction with Jude's realtor, Daisy learns about the seller financing that he was offered. Having detected Jude's attempt at concealing a subordinate lien, she grows concerned about moving forward with the transaction, and decides to discuss the matter with her compliance manager before things progress any further.

This scenario describes a case in which a consumer commits fraud in order to secure a loan for which he is not actually eligible. Jude may fully intend to reside in the home and make his loan payments, but he has still concealed vital information that would affect his eligibility - constituting fraud. It is important for financial institutions to have a full and accurate picture of the borrower's cash investment, in order to ensure that the homeowner has sufficient interest in the transaction to avoid default. Daisy's instinct to verify the funds and pause the transaction after detecting the deception was a good one. As a licensed mortgage professional, looking the other way in a case like this would make her liable for the fraud as well, and it would put her license at risk. She would also face criminal liability as a participant in the fraud.

Example Colebrook Mortgage Company recently opened a branch in an area largely populated by immigrant and minority families. Many of these families are bilingual or have entirely non-English-speaking family members. Though most people in the area live in rented condominiums or apartments, new construction and turnover of older homes have led to an uptick in home sales. Colebrook decides to take advantage of this boom by offering its products to local consumers hoping to become homeowners. Colebrook distributes a number of advertisements in the area, many of which are in Korean or Spanish, two of the languages commonly spoken in surrounding neighborhoods. These advertisements also feature information in English, typically the "fine print" for advertised products. Don, an employee of the company, frequently meets with potential loan applicants to offer financing. Most of the loans that Don offers to his clients qualify as high-cost loans under HOEPA. Burdened by the expenses associated with the loans, many of these borrowers later return to Colebrook in an attempt to refinance their mortgages. Some loans are refinanced more than once. Don is happy to oblige, as the company is already familiar with the borrowers' qualifications and profits tidily from the fees collected on the refinances.

This scenario is a prime example of the discriminatory practice of reverse redlining. Don's actions show his intent to take advantage of a language barrier in order to capitalize on unwitting consumers who are simply trying to become homeowners. By saddling them with high-cost loans, Don ensures that these individuals will be faced with a steep financial obligation. He then profits further when they return to Colebrook for refinances and he is able to collect fees from those transactions.

Example Ben is troubled by a loan application that he received through his mortgage company's website. The applicant stated on the application that her annual income was $150,000. However, her bank statements and other documents used for verification purposes indicate that she only earns $120,000 per year. When Ben calls to ask for clarification of the applicant's income, the call goes to a number that has been disconnected. Taking a closer look at the application, Ben is unable to verify her current address. When he calls to speak with the woman's employer, the first person who answers the call appears flustered and confused, then passes the call to another person. After alerting his lending manager, further investigation shows that not only are the applicant and her personal information fictitious, but the home she is attempting to buy also does not exist. Ben's employer immediately files a SAR with FinCEN.

This transaction appears to be an instance of a consumer falsifying information in order to profit from loan proceeds. This particular tactic of falsifying an identity, employer, and property is known as an "air loan."

Ethical Behavior Related to Loan Origination Activities

Today's mortgage loan originators are operating in a mortgage market overseen by a regulator that is focused on consumer protection. Ethical practices have been codified into federal and state laws and regulations, strengthening professional standards for the industry. Mortgage professionals must familiarize themselves with the standards and responsibilities that they must meet, the expectations of consumers, and the requirements put forth by the CFPB. This section will review subjects related to ethics in the mortgage origination process.

Fair Housing Act

Under the Fair Housing Act, the protected classes include: Race Color National origin Religion Sex Familial status Handicap Any lending or housing decisions that discriminate against persons based on a protected class are in violation of the law.

Underwriters

Underwriters are responsible for ensuring that loan applicants meet the requirements established by lenders and investors for loan programs. For example, if a borrower applies for a conventional conforming loan, the underwriter will make the following determinations: Does the loan amount meet lending limits for conforming loans? Is the loan applicant's debt-to-income ratio equal to or less than the 43% limitation for qualified mortgages? Will points and fees for the mortgage meet the 3% limitation for qualified mortgages? If a consumer is applying for non-conventional credit, such as a VA or FHA loan, does he/she meet the program requirements? Does the borrower have a credit score that meets lender and investor guidelines? Does the LTV ratio meet lender and investor guidelines? If the loan applicant does not have enough cash for a down payment that meets lender and investor guidelines, is private mortgage insurance available? Has the loan applicant provided reasonably reliable third-party documents to verify income, assets, and employment? The responsibilities of the underwriter provide a layer of checks and balances between loan origination and loan funding. A loan originator's attention to detail prior to submitting a loan file for underwriting can dramatically increase successful loan approval and make the underwriter's job much easier. In addition to ensuring potential borrowers meet loan program standards, underwriters are also charged with spotting missing or questionable items in order to verify the accuracy of application materials. While performing these responsibilities, underwriters are in a position to be able to see any evidence of unethical or fraudulent activity that is related to a loan application.

Example: Hoping to gain traction for his newly-established mortgage business, Saul Wight prepares a couple of advertisements to run in local newspapers and online. He includes on the advertisement the company's name and contact information, and because he just got word of approval for licensure, adds the logos of the state regulator, the CFPB, and HUD. He advertises a couple of loan products that "might" be available to applicants with the right qualifications. Finally, Saul adds a statement that the company has a trained and licensed staff of counselors ready to help consumers learn about their mortgage options and complete loan applications. The staff that he is referring to includes Chad and Renee, two licensed mortgage brokers he recently hired.

Unfortunately, Saul's advertisement falls far short of the standards and requirements set forth by law. TILA specifically prohibits misrepresentations about government endorsements, and Saul's inclusion of government logos (his state regulator, the CFPB, and HUD) certainly constitutes that type of violation. Further, his advertisement of "trained counselors" is a violation, and his failure to add qualifying details about advertised products is also problematic.

Ethical Issues Regarding Referrals

Violations of RESPA and Regulation X occur when a referral results in giving or accepting an unearned fee or any other thing of value. Things of value can include non-monetary compensation, such as meals, sporting event tickets, and other forms of entertainment, as well as items such as office equipment or expense reimbursements. It has been a common misconception in the mortgage industry that a thing of value is acceptable as long as its value is nominal - such as less than $25. This is simply not the case. As stated in Regulation X, any referral of a settlement service "...is not a compensable service" (12 C.F.R. §1024.14(b)). Kickbacks are also a violation of the law that the CFPB takes seriously. As recently as early 2017, a mortgage company was fined after the CFPB determined that it provided cash incentives to brokers and other mortgage professionals who steered their clients to apply for loans with that lender. This is just one example of a kickback, and presents a serious compromise to the integrity of the industry and to the public's ability to trust mortgage professionals. The most certain way to avoid ethical and legal liability for referrals is to offer or receive nothing in return other than a thank you note. When referrals take place between affiliated businesses that have a legitimate arrangement, providing loan applicants with the Affiliated Business Disclosure Statement is mandatory and is an important aspect of RESPA compliance (12 C.F.R. §1024.15). Regulation X also permits "Normal promotional and educational activities that are not conditioned on the referral of business and that do not involve the defraying of expenses that otherwise would be incurred by persons in a position to refer settlement services or business incident thereto" (12 C.F.R. §1024.14(g)(1)(vi)). For example, an insurance company can give a mortgage broker pens and notepads inscribed with its name, and the broker may then make these items available to customers.

Unfair, Deceptive, or Abusive Acts or Practices

When Congress adopted the Dodd-Frank Act in 2010, it adopted a provision that prohibits all providers of consumer financial products and services from engaging in unfair, deceptive, or abusive acts or practices (UDAAP). The CFPB has authority to bring enforcement actions pursuant to the federal UDAAP law. In a bulletin that it published in 2013, the CFPB describes unfair, deceptive, or abusive acts or practices as follows.

Consumer Education

When Congress established the CFPB through Title X of the Dodd-Frank Act, it listed the creation of financial education programs as one of the CFPB's "primary functions" (12 U.S.C. §5511(c)). Congress also directed the CFPB to establish an Office of Financial Education, giving instructions for this office to create programs for educating consumers to make better informed financial decisions and to develop and implement a strategy to improve the financial literacy of consumers (12 U.S.C. §5493(d)(1), (2)). The CFPB is required by law to submit annual reports to Congress on its financial literacy activities and strategy.

Changed Circumstances and Revised Loan Costs

When providing a consumer with an estimate of fees for a mortgage loan, creditors are legally obligated to provide the estimate in good faith. Loan Estimates are considered to be made in good faith when estimated and actual costs do not differ outside of established tolerance limits set forth by the TRID Rule. To ensure that creditors provide consumers with a cost estimate on which they can rely, the TRID Rule restricts the circumstances in which creditors are allowed to revise estimates of loan costs to show fee increases. Generally, creditors are not allowed to increase fees and issue revised estimates that reflect higher loan costs when the fees subject to increase are controlled by or known to the creditor. For example, variances are not permitted for: Fees charged by a creditor or one of its affiliates Fees paid to a provider of settlement services if the loan applicant is not allowed to shop Fees paid to a mortgage broker Fees paid for transfer taxes (Official Interpretations of 12 C.F.R. §1026.19(e)(3)(i)(1)) Costs that may change include those for settlement services for which the consumer has shopped and that are performed by a provider that is not affiliated with the creditor. Even in these circumstances, the legal variance between estimated and actual costs is limited to a 10% increase between estimated aggregated costs and the actual aggregated costs for settlement services.

Ethical Behavior of Consumers

When working with a borrower to originate a loan, it is extremely important to remind him/her that by providing inaccurate information or by making misrepresentations on a loan application, he/she is violating the law and may be subject to fines and even imprisonment. When providing income and employment information, listing assets and liabilities, and providing declarations of outstanding judgments, bankruptcies, or other financially significant facts, buyers are legally and ethically obligated to be truthful. Loan originators may save themselves hours of wasted effort and may save consumers from the risk of prosecution if they take the time to explain the repercussions of falsely stating that the information contained in a loan application is true. The loan applicant should be aware that his/her failure to truthfully complete the application could result in civil liability or criminal prosecution for mortgage fraud.

Discussion Scenario: Ethical Requirements of Federal Lending Laws

Zack is a mortgage broker who advertises himself as "the lender who works for the people!" He reaches out to "the people" in neighborhoods largely populated by elderly and Latino residents. Zack offers them adjustable-rate mortgages that typically have fixed rates for the first two years, then adjust each year thereafter. Zack regularly works with a contractor, Joe, who occasionally drives through these neighborhoods and spots houses in need of work. After offering his services as a contractor, Joe tells his potential clients that he can offer them a great deal on financing from a good lender who will "get you enough money to get the job done and put cash in your pocket!" Naturally, this lender is Zack, and he gives Joe a 10% cut of every origination fee that he makes off of one of the contractor's referrals. For his part, Joe provides inflated estimates for the work he agrees to perform for the elderly homeowners he targets, encouraging them to take out loans for more money than they actually need. Joe is an expert at painting over water damage and making incomplete roofing jobs look flawless - from the ground. Zack does not rely exclusively on Joe's door-to-door solicitations for business; he speaks fluent Spanish, and he uses this ability to advertise to local neighborhoods largely occupied by first- and second-generation migrant families. Zack stuffs apartment mailboxes with flyers for his company; the flyers are written in Spanish and state the following: "Low interest! Fixed rates! Become a homeowner today!" Zack understands federal lending laws, and wants to avoid the extra disclosures and requirements that come along with high-cost loans. He feels that these are too restrictive for him to make a comfortable profit from his efforts, so he is careful to keep APR and points and fees for his loans below the HOEPA thresholds. However, he strategically places borrowers with loans that they will need to refinance after their interest rates begin to adjust. Zack has built a robust business with these refinances.