Rule 11 Agreements - Part Two

Rule 11 Agreements in Texas – Unexplored Territory

Part Two

The following list of “principles” concerning Rule 11 Agreements will rehearse some things you already know and maybe a couple of things you did not.

1.      There is no legal status of separation in Texas. One is either married or unmarried.

2.      It is generally agreed that married spouses have an interest in their spouse’s homestead property. This “interest” can rarely if ever be “signed away.” [There is an agreement called “partitioning” that can, somewhat, be used to “pre-partition” community property before final divorce. But, that is another matter and not a strategy we have proposed in financing matters.]

3.      This “interest” that spouses have in homesteaded properties leads many people to (wrongly) conclude that the law requires a spouse to sign the Deed of Trust for his/her spouse’s purchase of another primary residence (as in a case wherein the purchase occurs before final divorce but after petition has been filed).

4.      The fact that there is no legal status of separation, however, does not preclude mortgage underwriting from recognizing what is tantamount to a “separation agreement.”

5.      A Rule 11 suffices for a “separation agreement” AS FAR AS MORTGAGE / FANNIE MAE GUIDELINES ARE CONCERNED. Again, there is no claim that the parties are “legally” separated; only that specific terms of the pending divorce are agreed.

6.      This is critically important because when two parties petition for divorce, this petition ² alerts the lender (which has received a loan application) that several significant features in loan approvals are “up for grabs.” Naturally, a lender cannot discern income, assets and debts if those matters are in negotiation. A final decree of divorce will (almost always) specify all of those issues and enable the underwriter to determine precisely things like income, assets, debts and obligations amongst other important elements.  

7.      Before final divorce, can such features of a loan approval be determined with legal accuracy? Yes. That’s what a Rule 11 can do.

8.      Specifically, Rule 11 Agreements are required (and useful for mortgage underwriting) before a final divorce. Thus, they serve as a “separation agreement” as far as mortgage underwriting is concerned.

9.      Rule 11 Agreements are contractual and NOT ordered by the court that is hearing the divorce cause. Any violation of the Rule 11 would be a legal matter for any procedure that hears or makes judgments about contract law (civil courts, mediators, etc.).

10.  Summary: Rule 11 Agreement function as a “separation agreement” as far as mortgage underwriting and title insuring is concerned but do not propose to establish some legal status of separation.

 

The Unifying Principle

The unifying principle in all of these considerations is that a Rule 11 Agreement is required in mortgage financing for all borrowers who have petitioned for divorce and need to obtain a mortgage loan (for purchasing or refinancing) before final divorce.

The reason Rule 11 Agreements are not more common is that most clients and professionals assume that real estate transactions cannot even occur for divorcing parties (before final divorce); but, mostly, it is because hardly any lending professional has created a path to such real estate transactions. Attorneys and realtors could, perhaps, create workable purchase agreements for cash transactions. But, most people need financing. And those lending standards become the key factor. This all began to change a few years ago when I introduced the idea of Rule 11 Agreements to mortgage underwriters.

 

Examples of Rule 11 Uses in Divorce-Financing Matters

1. A divorcing spouse wants to purchase a home, qualifying for the actual loan on his/her own but one or both parties do not want the other spouse to sign the Deed of Trust

Most lenders, realtors and title agents will tell you that this cannot be done for primary residences (homesteaded properties). They will nearly always default to “we require the signature of the spouse on the Deed of Trust if it’s a primary residence.” But, this is neither a legal nor mortgage finance requirement. In fact, married persons who are divorcing can purchase another primary residence before final divorce without their spouse’s signature on the Deed of Trust (and other ancillary documents normally required of “non-purchasing spouses”). Certain measures must be in place and such measures must be specified in a Rule 11 agreement. The actual mortgage terminology is “separation agreement.” But this is where confusion reigns. Since there is no legal status of separation in Texas, there is a premature assumption (on the part of most lenders, title agents and realtors) that no such agreement can be used in mortgage qualifying.

2. A divorcing spouse wishes to refinance a mortgage to meet the requirements of their negotiations but they need (or want) to close their mortgage transaction before final divorce. There could be several reasons for this requirement or desire. Some of them are

- a desire to close the loan while the borrower is able because qualifying in the future may not be possible.

- a desire to close the loan earlier than later because the borrower anticipates interest rates may rise.

- a need to “cash out” so that obligations might be satisfied (like payment to the soon-to-be ex-spouse. (We try to avoid such “cashing out” because the proper and superior method of paying a spouse for their interest in the property is to fund such buyouts via the Owelty agreement and lien; and, that can only happen after final divorce). Sometimes, though, the existing mortgage is a Texas Cash Out, the borrowers having formerly “cashed out.” This means that the existing mortgage can be financed (refinanced) only with another Texas Cash-Out mortgage (the “once-a-cash-out-always-a-cash-out rule).

- It’s better to close a loan when you can rather than to post-pone a loan closing until after (what could be) a long and drawn-out process.

 

3. Sometimes there is a need for a purchase transaction wherein one of the divorcing parties desires to help their spouse purchase a home, even becoming the borrower on such a loan. Most often this is one of those “amicable” divorces. It’s rare but we have had cases like such.

Any party in a petition of divorce, for a divorce not yet final, must (nearly) always have a Rule 11 Agreement in place if they require mortgage financing. The reasons were stated previously but are worth mentioning again here.

When two parties petition for divorce, this petition alerts the lender that several significant features in loan approvals are “up for grabs.” Naturally, a lender cannot discern income, assets and debts if those matters are in negotiation. A final decree of divorce will (almost always) specify all of those issues and enable the underwriter to determine precisely things like income, assets and debts amongst other important elements.  

For this reason and on occasion, we have advised couples (or individuals) to complete their mortgage financed transaction before filing a divorce petition. This avoids the need for a lender to require terms of settlement.

So, if I am the originating lender, do I have some responsibility (ethically, legally or contractually) to alert the underwriter that a divorce is imminent? ³ Well, in some cases, I might determine to put myself under that obligation. Otherwise, the answer is “no.” For one thing, even if an underwriter knew this, it would still not be documentable or verifiable information. Nothing has formally or legally been filed or petitioned. Also, there is always the option for reconciliation even after a divorce petition is filed. Consider that the only person that a divorced person can legally marry in the 30 days after their final divorce is their ex-spouse. Moreover, if any borrower is willing to put their own capital (down payment funds), credit and income at risk by signing a promissory note, that is the essence of lending and borrowing money. The one issue to which I must be sensitive is the “occupancy” status. I cannot allow a transaction to claim that the subject property will be “owner occupied” if, in fact, there is no intention to occupy that property as the primary residence of both borrowers. (There is sometimes an allowance for one of the borrowers not having to actually occupy). The actual statement is that the borrower intends to occupy the property as their primary residence within 60 days of purchase. There is no statement that a borrower must make that binds him/her to a particular length of stay.

 

Moreover, a Rule 11 may specify that a spouse will take no interest in their spouse’s purchase of a new property. (In this case, only certain lenders and certain title insurers will “sign off” on the transaction; it is possible that a spouse will not be required to sign the DOT as non-purchasing spouse). IN REFINANCE TRANSACTIONS of homestead properties, this is never the case. The spouse will always – we assume – be required to sign lien instruments, et al. as non-purchasing spouse.

 

Footnotes

² How would a lender know that a petition for divorce has been filed? A “title search” will reveal such a filing. Title searches for real estate transactions search, not only property matters but, personal matters as well. It’s called a “name search.” Such name searches will show bankruptcies, judgments (e.g., for back child support) and divorce petitions amongst other issues of public record.

³ Nowadays, the law and mortgage regulations are tending to hold the loan officer (originator) responsible (read “liable”) for virtually every possible piece of information in a loan applicant’s life. In the new ATR (Ability To Repay) guidelines (instituted by the all-powerful CFPB), loan officers and lenders are – and I know this sounds silly – supposed to know, in advance, how borrowers might use their discretionary income or what I call the 57%. Debt ratios will soon be limited to 43% but these new rules effectively hold the lender liable for how the borrower might – in the future – manage the remaining 57%. (I do not blame you if you do not believe me at this point; I am just telling you what the rules say as they are written).

Rule 11 Agreements - Part One

Rule 11 Agreements in Texas – Unexplored Territory

Part One

 

I am not sure how often Rule 11 Agreements are used in divorce proceedings in Texas; but, I have discovered a vast and untapped “market” for them – when divorcing parties require mortgage financing.

It may come as a surprise to attorneys that Rule 11 Agreement in Texas, like Owelty agreements, have a very important use that has largely been overlooked by lenders, real estate agents and legal professionals alike. In my business (of obtaining mortgage financing for divorcing parties), I am using them more and more.

For whatever other uses they have, Rule 11 Agreement are effectively “separation agreements” as far as mortgage underwriting is concerned. And that’s where the confusion comes in. Realtors and mortgage professionals have a cursory understanding of Texas law that governs marital status. Most think that there is no separation in Texas. You will see, in the first principle below, that this is a somewhat inaccurate statement as applies to mortgage underwriting and real estate transactions. At least, it leads non-attorney real estate professionals to inaccurate conclusions about the rules of their own industry.

Allow me to illustrate. I asked a group of realtors the following four questions:

1.      Can a person purchase a house while going through a divorce (i.e., before final divorce)?

2.      Can a potential buyer purchase a primary residence without their spouse’s signature on the Deed of Trust while going through a divorce (i.e., before final divorce)?

3.      Can a potential buyer get (qualify for) a mortgage while going through a divorce (i.e., before final divorce)?

4.      Can a potential buyer use child or spousal support as qualifying income to get a mortgage while going through a divorce (i.e., before final divorce)?

The answer to all four questions was overwhelmingly ¹“NO.”

The real answer to all four questions is, “YES.” And the document that makes it possible (all other qualifying factors assumed) is a Rule 11 agreement.

To be clear, no Fannie Mae, Freddie Mac, HUD or V.A. guidelines use the term “Rule 11.” It is obviously Texas-specific. But, what they describe is, in essence, a Rule 11 agreement.

Quoting from the Fannie guidelines (concerning the issue of how support income might be considered qualifying income) …

Verification of Income From Alimony or Child Support

Document that alimony or child support will continue to be paid for at least three years after the date of the mortgage application, as verified by one of the following:

• A copy of a divorce decree or separation agreement (if the divorce is not final) that indicates payment of alimony or child support and states the amount of the award and the period of time over which it will be received.

Note: If a borrower who is separated does not have a separation agreement that specifies alimony or child support payments, the lender should not consider any proposed or voluntary payments as income.

• Any other type of written legal agreement or court decree describing the payment terms for the alimony or child support.

 

The part that says “If a borrower who is separated does not have a separation agreement…” is the part that stalls mortgage professionals. They reason that since there is “no separation” in Texas, there can surely be no “separation agreement.” But, lending guidelines are insensitive to separation’s lack of legal status. They allow for such agreements. Notice that the guidelines then allow for “any other type of written legal agreement” in place of a formal “separation agreement.”

Texas lawyers immediately recognize this as a Rule 11. That’s how I discovered it. I recommended the use of an agreement typed out – as an underwriter instructed me – “on an attorney’s letterhead and signed by both attorneys.” One of my referring attorneys said, “Sure, that’s a Rule 11.” The only change we advise is that both parties sign the agreement as well.

So, under certain prescribed circumstances – as agreed by parties and specified in an executed Rule 11 Agreement – divorcing (but not yet finally divorced) parties can purchase homes, do so without their spouse’s signature at closing on the security instruments (e.g., Deed of Trust), and qualify with spousal and/or child support.


Footnotes

¹ Actually, a small minority of realtors were familiar with transactions wherein a divorcing (but not yet finally divorced) person had purchased residential real estate. But, they were clueless about any features that made such transactions possible.

Rule 11 Agreements like you never imagined them!

Did you know that mortgage underwriting allows for separation agreements even though there is no legal status of separation in Texas? Lenders see them as having nearly the same force as final decrees of divorce; at least for establishing factors in loan approvals. It's really quite amazing.

This means that, while most divorcing folks (along with nearly all real estate and mortgage professionals) think that they cannot qualify for mortgage financing before final divorce, with the proper agreements in place, they really can. They just need the right person who knows how to steer them through the intersection of divorce and mortgage finance.

It means that your divorcing clients can purchase homes before final divorce provided certain agreements are in place - no need to wait until final divorce.

It's also possible for support income - paid as good faith payments in anticipation of ordered support - can be used to qualify borrowers for mortgages. The key is a Rule 11 Agreement.

We've opened up an entirely new and unexplored world for divorcing clients. And I want you to know about it so that you can be the first to offer your clients that extra value and service you are known to offer.

 

Here's how you can be at the forefront of this untapped and unused knowledge:

First - watch for my articles in the next several days. They will give you clear principles about the use of Rule 11 Agreements as it relates to obtaining mortgage financing in divorce. The articles will appear on my blog about Divorce-Mortgage issues -http://divorce-mortgage.blogspot.com/

Second - Host this new CLE-Accredited presentation "Untapped Uses for Rule 11 Agreements."

It will be a one-hour course best presented over lunch in your conference room or at a Bar or Section meeting. I love speaking to collaborative practice groups as well. Call me at 817-454-4555 or email me at noel@themortgageinstitute.com.

I really love what I do - and these presentations are more than seminars and speeches - they are lab environments where we solve problems.

Call me or email me TODAY so we can get your CLE-accredited course scheduled.

 

 

5 Tips That Will Set You Apart

As A Family Law Attorney

If you include some or all of these 5 elements into your divorce settlements, you will set yourself apart from the thousands of family law attorneys in Texas who do not know these principles of mortgage qualifying. Yet, there is no “down side” to applying what I am about to tell you. Moreover, no one is saying these things to family law attorneys. We at The Mortgage Institute apply these principles in the context of a specific case wherein a client is actually qualifying, real-time, for a mortgage transaction. (These include, especially, refinances to remove a spouse from the mortgage obligation, refinancing to include a buyout to an ex-spouse and purchasing a new home using support as qualifying income, et al).

Of course there is a disclaimer – DO NOT TRY THIS AT HOME. You can actually describe and discuss these principles in meetings to the benefit of all concerned. But, as in all of mortgage qualifying, your client needs a specific Assessment/Approval with recommendations for the settlement. You can call or write me for that.

1.      First, structure income as support income wherever possible. You will see (#3) that, in the mortgage world, there is a difference between income and qualifying income. And, certain rules of documentation apply. Whereas child or spousal support requires a pay history of 3-6 months, receipt of payments from a “note” or “payout” requires a 12-month pay history. In a recent case, the agreement was for one spouse to pay $3,000/month in child support and $5,000 in a payout over time for the other spouse’s interest in a company. Mortgage guidelines require a longer pay history for the payout of the “note” (12 months) than they do for child support (3-6 months). So, while the spouse is receiving $8,000 each month, her qualifying income is only $3,000/month (after the required history of payments has been received and documented).

2.      Secondly, get the clients to begin support payments IMMEDIATELY if at all possible. You will see (in #3) that a pay history must be developed. So why would a husband, for example, want to  begin paying child support or – gasp – spousal support before final divorce or before/without some order from the court (vis a vis a final decree of divorce or other orders)? It’s really straight-forward – that husband wishes for his wife to refinance the mortgage in order to remove it from his liability, perhaps to roll in a buyout to him of an agreed amount or for her to be able to purchase a home nearby for their children’s wellbeing. These are personal reasons why it is in the best interest of all concerned.  But, how could a payer manage to begin “supporting” his/her own children and spouse when, many times, they are already doing this by making the mortgage payments and buying the groceries? Actually, it’s easier than one might think. If, for example, a husband will be paying child and/or spousal support to his wife and she will be refinancing the mortgage into her own name and liability, he can begin support payments to her and she can, in turn, make the current mortgage payments and buy the groceries with her new income. As the colloquialism goes, “it’s six one and half-dozen the other.” This is more than “gaming the system.” It’s creating a documented paper trail that shows the husband’s ability and willingness to make support payments – a real key in mortgage qualifying. Here’s a sub-tip: Make sure that the payer pays from their sole/separate bank account into the payee’s sole/separate bank account. Payments to or from joint accounts do not count.

3.      Thirdly, remember the 3/36 or 6/36 rule. The 3 and the 6 represent months. For FHA loans, a “pay history” of 3 months of support payments must be documented. For conventional (aka Fannie Mae or Freddie Mac) – generally preferred – the requirement is more stringent, 6 months. The borrower must have received 3 months (FHA) or 6 months (conventional) of support income in order for that amount to be considered “qualifying income.” But, that’s not all. The second number – the 36 – represents the number of months which the support income must continue after loan closing. Note that this is after loan closing, not after final divorce. This is critical because when an attorney thinks of “continuance” they are generally thinking of how long some provision may continue after its start date or final divorce. Mortgage guidelines apply to the date on which the loan closes. One more thing – 35 months will not suffice. It must be 36 or more months remaining in the support payment schedule. Yes – it’s that tight. There are some variations – none which are more lenient – to this rule. About one year ago, conventional financing guidelines changed from requiring 3 months to now requiring 6 months of pay history. The 3 year (or 36 months) rule has been standard for many years now and also guides other types of income. For example, for wage-earner borrowers, there is the same expectation for 3 or more years of employment. The standard Verification of Employment form has a box for “Probability of Continued Employment.” Most employers avoid answering that question for obvious reasons. But, if there is a definite end to employment (as in the case of a wage earner who is also under a contract with the employer) that is stated as earlier than 3 years after projected loan closing, the applicant’s income cannot be considered as “qualifying.”

4.      Fourthly, convert assets to an income stream when there is a potential need for the recipient to qualify (with support income) for a mortgage. In higher net worth divorces, there is often a transfer or division of financial assets to “equalize” the property settlement. While such an agreement may satisfy a logical agreement to split assets, it often leaves the recipient of such largesse without qualifying income and, therefore, without the ability to obtain their own financing. How many times has this happened? Two attorneys, two clients and a couple of ancillary personnel are seated around a large conference room. One attorney says, concerning opposing client, “Well, we’re giving her $300,000, the house is worth at least a $1,000,000 and the mortgage is only $100,000; any bank would be happy to have that loan.” Well, maybe so. But, after January 1, 2014 (see my blog on the CFPB’s new rules) it will be virtually illegal to make that loan without the client having their own, separate income from some other source. And even now, there would be no standard (FHA or conventional) mortgage available for that scenario. Why? No income. (Actually, $300,000 can possibly be considered as $833/month – 1/360^th of $300,000. But, that income wouldn’t service the taxes on such a property). But, by dividing $300,000 into, let’s say 46 months, the qualifying income could be about $6,520/month. Now, we something in the range of qualifying for a real mortgage.

5.      Never rely on what you’ve heard “on the street” or what an amateur advises. Always call to verify. Call me, have your client call me, have the other attorney call me – but call. Even though I am giving you these tips – even outlined as principles – no tip or principle is as important as involving a professional Divorce-Mortgage Specialist. And the earlier someone calls the better for everyone. Guidelines are in a constant state of flux. And all lenders “layer” their own guidelines on top of FHA/VA/Fannie/Freddie guidelines.

I’ve given some general guidelines which could be subject to change but have remained in their present form for quite a while. If you had to memorize only one of these tips – make it #5. Always call. I’ll work it out.

 

Noel can be reached at noel@themortgageinstitute.com or 817-454-4555.

The 3% Rule – Part Two

As a follow up to the article about the 3% rule

(http://divorce-mortgage.blogspot.com/2013/07/the-we-didnt-think-this-one-through-rule.html), we have received a clarification. The CFPB has recently announced that Loan Officer Compensation (LO Comp) will not count against the 3% limitation for bankers but it will count against the limit for brokers. This is the proverbial “nail in the coffin” for the broker industry. No one is expected to attend the funeral. Since we do not have parallel universes, consumers will not miss the broker because there will be no measuring stick. Two bits of information might be helpful (in understanding our current plight) while it does nothing to truly help any consumer. First of all, according to the preeminent researcher for the banking and broker industry – Tom LaMalfa – independent mortgage brokers provided lower rates and fees for consumers than their mammoth competition, the big banks. Secondly, according to J. D. Power & Associates, consumers were more satisfied with brokers than they were with the big banks. One reason was because brokers provided alternatives and choices. They were, in effect, one-stop shops. You could stick with a good broker for life. Well, for life until Chris Dudd and Barney Freak killed ‘em. To be honest, brokers were under attack from George Bush’s HUD Secretary, Mel Martinez who, interestingly enough, had been head of the Texas Savings and Mortgage Lending Department under W.

Nevertheless, brokers will no longer exist after January 1^st, 2014. Oh yes, to be considerate of time lines, the CFPB moved the date of the announced changes from January 14^th to January 1^st because changing the books in the middle of the month would be unhelpful. So glad they’re watching out for us.

Oh! You want to know why brokers cannot exist under the new 3% rule, eh? I suppose I should explain. With a 3% cap on closing costs, lower loan amounts will be subject to higher rates and, many times, loan denials because there simply is not enough room in the 3% cap to include all of the costs of doing a loan; and the rate will have to be raised in order to recoup costs through the higher yields that higher rates bring in the secondary market.  For brokers, their compensation – anywhere from .750 to 2.00% generally – the 3% cap becomes a 1% - 2.250% cap because we have the broker has to subtract his/her compensation from the 3% and make all costs fit under that amount. This is simply impossible for loan amounts lower than about $350,000. In theory, brokers who service high dollar markets – loan amounts of not less than $300,000 or so – can still operate. The problem is that so few of them will be able to operate that the lenders/banks who received loans from them will no longer keep a broker line (called “wholesale”) open for the few remaining brokers. In fact, major banks like Wells Fargo and Bank of America shut down their broker lines a few years ago.

Why whine and complain and moan about the loss of the broker industry? Politically, it’s important because it demonstrates that our government cares less about what is truly good for the consumer and more about the lobbyists (like the big banks) who wrote the rules and monopolized the lending industry. Practically, it’s important because fewer people can obtain mortgages and fewer still will be able to shop for good service. Very soon, the borrowing public will have a choice between about 3-5 major banks. You know, those banks that cannot be allowed to get “too big to fail.” Personally, I have minimized the impact upon me because for almost 4 years now, I have been a “banker” and needed “broker” outlets only occasionally. So, the rule affects me and my colleagues only minimally. (A few of our loans are brokered because we have broker agreements as opposed to “correspondent” agreements with certain lenders who, from time to time, are able to do loans that our “correspondent” lenders cannot or will not do). The consumer will be more hurt than we will be.

Within our industry, here’s the buzz...I mean, the spin. “Let’s quit complaining about the regulatory changes, the loss of income or the increased work load because of compliance. The good news is that masses of people have exited the industry which leaves only the strong standing. If you’ve made it this far, guess what – consumers out there don’t have as many options. Your competition has vanished!”

What a perverted way to make a living.  

Personally, I’ve never been bothered by competition. It’s never occurred to me that I should be in the enviable position of the monopolist. Competition is good for the consumer and ultimately good for the industry. Competition encourages excellence, efficiency and lower costs. But, I’m naïve. And my government is astute to its own devices and designs. So, the consumer suffers without knowing that the difficulties need not be so difficult.

Repeal Dodd-Frank. Return this country to constitutional government. Eradicate monopolies and uneven regulations which are designed to enrich political allies and impoverish political “nobodies.”

The "We Didn't Think This One Through" Rule

New rules from the *CFPB will dramatically affect the ability of all borrowers to obtain mortgages. This post will analyze and expose the devastating effects of a second rule – the 3% rule.

The “We-Didn’t-Think-This-One-Through-Just-Ask-Texas-Mortgage-Originators” 3% Rule

The bureau’s general guideline reads

No excess upfront points and fees: A Qualified Mortgage limits points and fees including those used to compensate loan originators, such as loan officers and brokers. When lenders tack on excessive points and fees to the origination costs, consumers end up paying a lot more than planned.

The last post began with “Richard Cordray of the CFPB declares ‘All American borrowers are stupid and we have to save them.’" Of course, he didn’t say it exactly that way but the proposed rules effectively say it. [That's him on the right. Don't be fooled - I'm sure no head of a bureau created by Dodd-Frank could possibly be a political activist. Ignore the Barack Obama poster in front of him.]

One of those rules that will allegedly protect consumers is the 3% Rule.

The 3% Rule is a cap on closing costs. It requires that closing costs cannot exceed 3% of the loan amount. (There is some variance for loan amount less than $100,000). Also, the bureau has only vaguely specified what fees might be exempt from this accounting. It has, however, signaled that the loan officer compensation will be counted against this fee cap. While a CFPB bulletin in January 2013 stated that

The Bureau has decided not to finalize the proposal [something about LO compensation] at this time, however, because of concerns that it would have created consumer confusion and other negative outcomes. The Bureau has decided instead to issue a complete exemption to the prohibition on upfront points and fees pursuant to its exemption authority under section 1403 while it scrutinizes several crucial issues relating to the proposal’s design, operation, and possible effects in a mortgage market undergoing regulatory overhaul.

A **bulletin released in April of this year indicates the full implementation to include Loan Officer Compensation in the 3% limitation on closing costs.

 

To those outside the industry, this may appear confusing at worst and falsely helpful at best. Let me give you 5 facts that will help clarify:

1.    Costs are not the same as prices. The many costs that comprise “closing costs” are insensitive to government regulations. Appraisers, for example, do not lower their fees because some agency requires that the total fees not exceed a certain amount. Neither do the gas stations (from which they purchase the fuel to power their vehicles) lower the price of their product as the appraisers travel to the properties to perform their inspections. While prices are capped by government, costs cannot be so easily controlled.

2. Loan Officer Compensation is not the same as the origination fee, the processing fee or other fees listed as going to the lender.

3. Loan Officers are most frequently paid not only from any “origination fee” but from the yield paid by the investor-lender which funds the loan. Think about those things that are almost a thing-of-the-past, the “no closing cost” loan. With no closing costs, including no origination fee, how do you think anyone was paid. They were paid by the investor who purchased the loan which was made at a higher than “par rate” which paid a specific percentage of the loan amount.

4. These yields can go as high as 7%-8% but are often “eaten up” in other costs. (More on that later; but, they are called LLPA’s Loan Level Pricing Adjustments . . . another way for Fannie and Freddie to collect fees).

5. Loan officers typically make .7% - 2% as a commission on their loans per their contract with their employing lender. Many economic factors affect this commission structure, not the least of which is the market in which the loan officer works. That is, the loan officer who serves a market of mostly $80,000 mortgages and makes 2% on her loans will work just as hard and diligently as the loan officer who serves a market of mostly $400,000 mortgages making only .7% on his loans, yet she will net less real dollar for the same number of loans closed as her counterpart in the higher dollar market.

 

The CFPB’s proposed rules – specifically the 3% Rule - regarding the “ability to repay” are unnecessary and harmful to the economy and the lending industry but mostly to consumers. Here’s why, point by point.

Price controls never work to the benefit of consumers. The proposed 3% limit on closing costs cannot fare any better than any other price controls. And because the proposal also includes restrictions upon the wages of the mortgage professionals, it’s quite possibly unconstitutional, not to mention insane. But whether it’s insane, illegal or just pure nonsense, one thing is inescapable – it’s still harmful to the consumer. Wage and price controls have never inured to the benefit of the consumers. They always – without exception – produce shortages (a lack of available credit) and diminished quality (a lack of service and ultimately a lack of access to credit). In the case of mortgages, the shortage is simply running out of dollars (allowed by law) available to pay the fixed costs.

A fixed percentage unfairly discriminates against borrowers with lower loan amounts. By placing limits on closing costs AS A PERCENTAGE OF A LOAN AMOUNT, the CFPB effectively denies the “do-ability” of loan amounts below certain thresholds. This should be obvious. But, obvious it is not. So, let me illustrate. Nearly all closing “costs” are fixed. If they are not fixed they are certainly not subject to percentages. For example, the costs to have attorneys draw up the loan documents is about $350. Doc prep attorneys charge this amount whether the loan amount is $100,000 or $500,000. That means that – AS A PERCENTAGE OF THE LOAN AMOUNT – doc prep fees range (in this illustration) from .35% to .07%. In the latter case, there doesn’t seem to be a problem. But, in the former we only have 2.65% left to go and we are just getting started with one of the minimal fees. Underwriting and related fees typically range from $900 to $1600. Again, for an average set of underwriting costs of $1250, that’s 1.25% for a loan amount of $100,000 but only .25% of the $500,000 loan amount. It should take an Einstein to see that fixed loan costs quickly amount to more than 3% of loan amounts of $100,000 or so.

There are many fixed costs in loans. A percentage limitation does not allow enough flexibility to cover such costs. Other fixed costs include flood certifications, tax certifications, tax service fees, appraisals (having risen over 150% in costs since the advent of HVCC and Dodd-Frank), appraisal reviews, title/escrow fees, title insurance (varying from state to state although 3% works the same mathematically across the entire universe not to mention across state boundaries), courier fees. These fees represent individuals or firms who actually perform work on a loan file. Increasingly they represent people or firms who perform work that is required by government regulation. For example, the HVCC (Home Value Code of Conduct) rule (now under Dodd-Frank) created the need for appraisal management companies which, oddly enough, cannot perform their tasks for free or out of the goodness of their hearts. Real people working real hours in need of paying their own mortgages and putting food on their own table have to perform these tasks. How are these fees to be paid when an arbitrarily fixed percentage is mandated by a bureaucracy sitting in Washington, D.C. and does not allow for such costs; and such a fixed percentage especially is harmful when, because of inflation and government regulations, these costs actually rise sometimes when home prices are flat or actually declining.

Texas has proved that this fixed percentage does not work to the benefit of borrowers. Texas already has this rule (since about 1998) for equity loans. Because costs cannot exceed 3% of the loan amount and because THOSE COSTS DO NOT MAGICALLY GO AWAY JUST BECAUSE LEGISLATORS IN AUSTIN DECLARED THEY WERE UNLAWFUL, they still have to be paid. How are they paid? Those who know anything about lending understand that the lender must charge a higher interest rate to recoup the fixed costs in a loan. The higher the rate - the higher the yield. And since lenders cannot lose money by making loans, they must find a way to pay for these fees.

This 3% rule will mean higher interest rates for borrowers with lower loan amounts who already pay higher rates because of rate adjustments for low loan amounts. How does that benefit the consumer?  They pay a higher rate because a legislator (or in this case, a CFPB staffer) decided that an arbitrarily-contrived percentage was just enough, above which consumers should not pay without being “harmed.”

Even higher rates will not alleviate the shortage that this rule will produce. But, the problem is not solved by simply charging a higher interest rate. Yields which certain rates produce are not unlimited. That is, there is a point at which a higher rate not only does not pay more dollars but actually pays less. In other words, there is a ceiling limit beyond which a rate will pay no more dollars. What then does a lender do? How then will this conundrum be resolved? For years now, lenders have published loan amounts below which they will not lend. The reason is quite clear for anyone who cares to know the economics of lending and borrowing. Those minimal loan amounts will necessarily be instituted; if not by the actual lending company, by the originator.

How The Inclusion of Loan Officer Compensation Affects The Actual Price and Cost of a Mortgage

To make matters worse, loan officer compensation must be included in the 3% limitation. Besides the purely insane, Marxist nature of such a proposal, let us examine the practical effect of such a measure. As I have already demonstrated, the fixed costs can hardly be contained within the 3% limit on $100,000 loans in many cases. So, where now will loan officer compensation fit in such a scheme? It will fit ONLY IN LARGER LOAN AMOUNTS. That is also to say that the law of diminishing returns means that loan originators cannot afford to do loans below certain thresholds. It is not because they do not want to or because they would be unwilling to make a little less on one loan than another. The fact is, they would have to work for free – at certain loan amount thresholds, the originator would make $0 or, worse, pay a lender for the privilege of doing a loan for a customer.

Such a rule will produce the same moral hazard that all price controls produce – it will give rise to a black market whereby loan originators will perform task for favored individuals in exchange for money or favors that are completely off the grid. The indignation that politicians, government officials or CFPB staffers may express does nothing to produce access to credit for consumers.

The wiser and saner route for equal access to credit, good and fair prices and a robust housing market is really straightforward – do not institute the wage and price control measures currently ordered in the 3% closing costs limitations and its corollary limitation on loan officer compensation.

 

*The CFPB is the Consumer Finance Protection Bureau created by Dodd-Frank [Wall Street Reform and Consumer Protection Act] (2010) to regulate America’s finance industry. It has unquestioned authority, writes its own rules and can levy sizeable enough fines to put a medium sized mortgage company out of business.

**The CFPB bulletins and publications are poorly dated but the URL address above indicates that the publication is most likely from January of 2013. But the readiness guide dated 7/8/2013 (http://files.consumerfinance.gov/f/201307_cfpb_mortgage-implementation-readiness-guide.pdf) has listed the following web-based publication which lays out guidelines for caps on points and fees which are to include Loan Officer Compensation. As you can tell, it is dated in April of this year. http://files.consumerfinance.gov/f/201304_cfpb_compliance-guide_atr-qm-rule.pdf

New CFPB Rules: #1 - The 43% Rule . . . er, um, Scratch That - It's the 57% Rule

Richard Cordray of the CFPB declares "All American borrowers are stupid and we have to save them."

 

 

Well, he didn't use those exact words . . .

 

The CFPB is the Consumer Finance Protection Bureau created by Dodd-Frank [Wall Street Reform and Consumer Protection Act] (2010) to regulate America’s finance industry. It has unquestioned authority, writes its own rules and can levy sizeable enough fines to put a medium sized mortgage company out of business.

The CFPB’s new rules will dramatically change mortgages beginning January 2014. The lynchpin of Dodd-Frank’s answer to the mortgage crisis is called the “Ability to Repay.” By adhering to a set of prescribed guidelines, the CFPB has created a “qualified mortgage” or QM. This QM is supposed to help lenders escape government scorn and reprimand (which can be very expensive for the offending lenders). But, to the casual reader, the new QM seems to also avoid legal peril - borrowers that come back and charge them with indigence; that is, failing to verify that the borrower could repay the loan.

According the proposed rules (and keep in mind that the CFPB proposes rules to itself and decides whether or not to accept its own proposals), the CFPB has effectively created the model mortgage. Deviate from it and a lender’s borrower can sue them to “forgive” the entire loan. The only things that are unclear as of March 2013 are the exceptions. For example, one theoretical exception is if the loan qualifies to be sold to Fannie Mae or Freddie Mac. In other words, if the Fannie/Freddie automated underwriting engines approve a loan (and an underwriter verifies that the loan file meets the specified conditions of this automated approval), then the loan is presumed to be a Qualified Mortgage. What we do not know is to what extent Fannie’s and Freddie’s guidelines will conform to the new QM rules. Inasmuch as there is only a “temporary” time period in which Fannie/Freddie approved loans transcend this rule, it’s virtually guaranteed that the first feature which the mortgage giants are likely to adopt is the 43% rule; or, as I like to call it . . .

The “Moron-Borrower” 43% Rule

To be fair, allow me to quote from the CFPB bulletin.

Cap on how much income can go toward debt: Qualified Mortgages generally will be provided to people who have debt-to-income ratios less than or equal to 43 percent. This cap on debt ensures consumers are only getting what they can likely afford. Before the crisis, many consumers took on mortgages that raised their debt levels so high that it was nearly impossible for them to repay the loan considering all their financial obligations. For a temporary, transitional period, loans that do not have a 43 percent debt-to-income ratio but meet government affordability or other standards such as that they are eligible for purchase by the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Mortgage Corporation (Freddie Mac) will be considered Qualified Mortgages.

Before you decide whether 43% is too cold, too hot or juuuuuust right, consider

-       The old fashioned total debt ratio was 36% (27% housing obligation ratio; 36% total debt including housing ratio)

-       In the past 10 or more years, Fannie’s and Freddie’s automated underwriting systems routinely approved debt ratios of up to 60% and I’ve seen even higher than that.

-       Currently, Fannie, Freddie and HUD (for FHA, which used Fannie/Freddie underwriting engine) are approving debt ratios as high as 55%.

-       Foreclosure rates have dropped dramatically in the past three years; from their high point in 2010, they are now lower than at any time since the crisis began in early 2007. While there are many factors that contribute to this, tightened underwriting standards are being given some of the credit. This is a somewhat dubious claim since it is rarely newly financed homes that go into foreclosure. A longer timeline is necessary to measure the effect of underwriting standards on foreclosure rates. But, we cannot deny that there is some cause and effect. Clearly, the underwriting giants have taken maximum debt ratios into account when setting the parameters of loan approvals. This means, then, that debt ratios of higher than 43% pose no hard-and-fast negative factor to Fannie/Freddie/FHA.

-       43% total debt ratio leaves fewer dollars left over as “disposable” income for a lower income earner than for a higher income earner. For the income earner making $2,000/month, $1,140 is “left over” after 43% goes to debt. For the person making $10,000 per month, $5,700 is “left over.” And this is after taking into account the Jaguar payments. One can only pay so much for a pound of chicken. Which bring me to . . .

 

More importantly, it’s really not the 43% rule; rather, it’s the 57% rule. Consider the following excerpt from the proposed rules. Under Types of Qualified Mortgages: Qualified Mortgages with rebuttable presumption, the borrower has recourse if “the creditor did not consider their living expenses after their mortgage and other debts.” [emphasis mine] This means that the lender no longer just considers the now-famous “debt to income ratio” but the remaining income both as a dollar amount and a percentage of total income.

If you thought borrowers were frustrated with increased demands for more and more documentation, wait until we tell them there is an upfront charge of $750 for an independent CPA’s audit of the last two years of their personal finances; that is, enough information to underwrite the remaining 57% of gross income.

To truly take this rule into account and in order to prevent lawsuits, lenders will need to know what households spend on cable TV, groceries, restaurants, church and charitable contributions (some people give 10% and more of their gross income to “charities”), school fees/tuitions/supplies, gymnastics or cheer activities (have you seen the thousands of families whose lives nearly center around their child’s cheerleading or gymnastics?), clothing, work or union dues/expenses, vacations, sports, gambling excesses . . . the list is inexhaustible. And higher income earners have a whole range of other “high-dollar” activities. In order to keep a child in the equestrian sport or advanced “go-kart” racing, parents could easily spend $10,000/month or more.

And underwriters can only measure the past as a way to predict the future. So, what and how your clients are spending right now may well affect their loan approvals next year.

 

It is my view that the greatest fault of this rule is the “moral hazard.” It removes the responsibility for financial decision-making from the borrower and places it, nearly, solely upon the lender. This is not to say that the lender should not set its own standards. It is to say that folks with good credit are often qualified to borrow more money than they have good sense to borrow. And, one of the major reasons they are a (credit, income and asset) qualified borrower is because they have exercised that good sense. It is likely that this sort of consumer will continue to exercise good sense. But, economic moral hazards are about incentives. And the CFPB’s rule introduces the wrong sort of incentive – that of placing nearly all of the responsibility for spending too much or too little on goods and services with the creditor, and virtually none of it on the borrower.

That’s why I call it the “Moron-Borrower” rule. The all-superintending state assumes that all borrowers are morons and completely indigent, ill-motivated ones at that. Moreover, the rules assumes that it is the state's role to save American borrowers from themselves.

Divorcing/divorced borrowers will be especially affected. To date, those little extra elements in a decree that order spouses to pay certain fees, tuitions, health insurance premiums and innumerable other expenses have not been counted in a borrower’s debt ratio calculation. Only child support and alimony or spousal support payments (and sometimes loan repayment to ex-spouses) have been counted in debt ratios (either as income or as debt). I expect that lenders will be required to either count those heretofore excluded obligations in the debt ratio (maximum 43%) or will have to consider them in the remaining 57% calculation.

So, remember that it is really not the 43% rule. It’s the 57% rule.

A bit of a rabbit trail here but still relevant. Income (one half of the debt-to-income ratio) is likely to be scrutinized more severely – especially support income. Up until this past October, both conventional and FHA loans typically required a “pay history” of only 3 months in order for child or spousal support to be considered “qualifying” income. (That, and the other requirement that such income continue for 3 years after loan closing were the 2 factors that produced “qualifying” income). Conventional loans now require a pay history of 6 months and, in theory, may require up to 12 - 24 months of such history. FHA guidelines still allow for a 3-month pay history but I expect that to change as underwriting guidelines are evolving into a monolithic, government-sanctioned tablet from Mt. Sinai.

Well, let me ask you. When the feds (CFPB) really look at the fact that the demographic that is most likely to default on their mortgage debt is the newly-divorced mother, how do you think they will rule on the matter?

It is more important now than ever that those who are even considering divorce immediately begin my pre-divorce strategy that will allow both parties to qualify for their next mortgage; whether it is for refinancing or purchasing. Else, they will be waiting for a minimum of 3 months longer for their financing – not good for many clients who have to purchase immediately after final divorce using support income to qualify.

Please give me your comments and follow-up questions. I enjoy hearing from you and will take the time to respond thoughtfully and responsibly. noel@themortgageinstitute.com or 817-454-4555.

Noel Cookman