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Overview of New U.S. Law Aimed at Fixing Mortgage Meltdown
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October 20, 2008
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Howrey LLP
While HERA is not a particularly bold-sounding acronym, this new law is in fact a bold and sweeping piece of federal legislation intended to ameliorate the consequences of the unprecedented mortgage meltdown and to ensure that no such meltdown occurs again. The breadth and scope of the Housing and Economic Recovery Act of 2008 or HERA (Public Law 110-289) is evidenced by the fact that the law is 260 single-spaced pages long and encompasses no less than six new "Acts."
Enacted into law on July 30, HERA already has had a profound impact on the financial landscape. The most recent example of the force of this new law is the takeover of Fannie Mae and Freddie Mac on September 7.
This article will provide an overview of the following six new Acts, which comprise the most important elements of the landmark HERA law:
 | Federal Housing Finance Regulatory Reform Act of 2008.
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| HOPE for Homeowners Act of 2008.
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| Secure and Fair Enforcement for Mortgage Licensing Act of 2008 or "S.A.F.E. Mortgage Licensing Act of 2008."
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| FHA Modernization Act of 2008.
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| FHA Manufactured Housing Loan Modernization Act of 2008.
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| Mortgage Disclosure Improvement Act of 2008.
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Federal Housing Finance Regulatory Reform Act of 2008
HERA established the Federal Housing Finance Agency (FHFA) and shifts many regulatory oversight functions from the Office of Federal Housing Enterprise Oversight ("OFHEO") of the Department of Housing and Urban Development (HUD) to FHFA. The chief administrator of FHFA is its director, James B. Lockhart III.
HERA empowers FHFA to undertake certain actions, including proceeding with a receivership, conservatorship or liquidation if one of the "regulated entities" is in "default" or is in "danger of default." The "regulated entities" are:
| Fannie Mae (and any affiliate).
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| Freddie Mac (and any affiliate).
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| Federal Home Loan Banks.
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HERA also established the Federal Housing Finance Oversight Board to advise the director on strategies and policies. This Board consists of the Director (who serves as Chair), Secretary of the Treasury, Secretary of Housing and Urban Development and Chairman of the Securities and Exchange Commission.
The director has authority to issue regulations, guidelines and orders relating to, among other things, interest rate risk, market risk, liquidity and reserves. The Director's oversight duties are to: closely monitor the condition of any undercapitalized regulated entity; closely monitor compliance with the capital restoration plan, restrictions and requirements imposed on undercapitalized regulated entities; and periodically review the plan, restrictions and requirements applicable to an undercapitalized regulated entity to determine whether the plan, restrictions and requirements are achieving their purpose.
HERA authorized the Director to appoint FHFA as conservator or receiver for regulated entities to reorganize, rehabilitate or wind up their affairs.
In addition, FHFA, as conservator (the role it assumed on September 7 for Fannie Mae and Freddie Mac), may take action to put the regulated entity in a sound and solvent condition, to carry on the business of the regulated entity, and to preserve and conserve the assets and property of the regulated entity.
When acting as receiver, FHFA must place the regulated entity in liquidation and proceed to realize upon the assets of the regulated entity, including the sale of assets and the transfer of assets to a "limited-life regulated entity" (established by FHFA). FHFA also may, as receiver, organize a successor enterprise.
To provide protection to the secondary market and secondary market investors, HERA provides that any mortgage, pool of mortgages or interest in a pool of mortgages held in a trust, custodial or agency capacity by a regulated entity for the benefit of any person other than the regulated entity shall not be available to satisfy the claims of creditors generally. Moreover, HERA provides that any such mortgage, pool of mortgages or interest in a pool of mortgages must be held by any conservator or receiver for the beneficial owners of such mortgage, pool of mortgages or interest in accordance with the terms of the agreement creating such trust, custodial or other agency arrangement.
The Director can require a regulated entity to withhold any payment, transfer or disbursement of compensation to an executive officer or place such compensation in an escrow account during a review of the reasonableness and comparability of compensation. The Director also may prohibit or limit, by regulation or order, any "golden parachute payment" or indemnification payment.
Each regulated entity must establish and maintain procedures designed to discover whether it has purchased or sold a fraudulent loan or financial instrument or suspects a possible fraud relating to the purchase or sale of any loan or financial instrument. Each regulated entity must report to the Director any fraud it discovers.
HERA authorized the Treasury Secretary to purchase any obligations and other securities issued by Fannie Mae, Freddie Mac or Federal Home Loan Bank. This authority expires, however, on December 31, 2009.
Fannie Mae and Freddie Mac must obtain the approval of the Director for any new products before offering them. The Director, before approving the product, first must determine that the product is consistent with the safety and soundness of the requesting entity or the mortgage finance system and must have published a notice of the request and have afforded a 30-day public comment period.
HERA amended Fannie Mae and Freddie Mac loan limits to provide that the general limits on their single family loans would be $417,000. This limit is subject to adjustments on January 1 of each year.
Fannie Mae and Freddie Mac must disclose the same Home Mortgage Disclosure Act information as banks.
HERA directs the Director to establish housing goals regarding the purchase of mortgages, if any, by the Federal Home Loan Banks.
HERA abolishes as of July 30, 2009, the Office of Federal Housing Enterprise Oversight of the Department of Housing and Urban Development and the Federal Housing Finance Board. Their regulations remain in effect according to their terms until amended by the Director or the HUD Secretary.
HOPE for Homeowners Act of 2008
Title IV (§§1401, et seq.) of HERA is the "HOPE for Homeowners Act of 2008." Its purpose is to provide HUD-insured low-interest/reduced principal refinancing loans to homeowners.
To be eligible for a HOPE loan, the mortgagor must occupy the mortgaged property as his principal residence and cannot (subject to standards established by the Federal Housing Finance Oversight Board) afford their mortgage payments under a loan originated on or before January 1, 2008.
The HUD Secretary is authorized to insure any "eligible mortgage" that has been refinanced and meets the following requirements:
| The mortgagor must certify that the mortgagor has not intentionally defaulted on the mortgage or any other debt and has not knowingly or willfully and with actual knowledge furnished material information known to be false for the purpose of obtaining an eligible mortgage.
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| The mortgagor must agree in writing that the mortgagor will be liable to repay to the FHA any direct financial benefit achieved from the reduction of indebtedness on the existing mortgages on the residence refinanced under the HOPE for Homeowners Program derived from misrepresentations made in the certifications and documentation.
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| As of March 1, 2008, the mortgagor must have had a ratio of mortgage debt payments to income (taking into consideration all existing mortgages of that mortgagor) greater than 31 percent or such higher amount as the "Board" determines appropriate. (This "Board" consists of the agency heads of HUD, Treasury Department, Federal Reserve and Federal Deposit Insurance Corporation.) The reduced principal obligation amount of the refinanced mortgage to be insured must be determined by the reasonable ability of the mortgagor to make his or her mortgage payments and must not exceed 90 percent of the appraised value of the mortgaged property.
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| All penalties for prepayment or refinancing of the eligible mortgage and all fees and penalties related to default or delinquency on the eligible mortgage must be waived or forgiven.
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| All holders of outstanding mortgage liens on the mortgaged property must agree to accept the proceeds of the new HUD insured loan as payment in full of all indebtedness under the mortgage. All encumbrances related to such mortgage must be removed.
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| The Board must establish standards and policies that will allow for payment to the holder of any existing subordinate mortgage of a portion of any future appreciation in the property secured by the mortgage that will be held by the HUD Secretary.
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| The refinanced eligible mortgage to be insured must: 1) bear interest at a single rate that is fixed for the entire term of the mortgage; and 2) have a maturity of not less than 30 years from the beginning of amortization of the refinanced eligible mortgage.
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| The principal obligation amount of the eligible mortgage to be insured must not exceed 132 percent of the 2007 dollar amount limit for Freddie Mac loans ($550,440).
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| A mortgagor may not grant a new second lien on the mortgaged property during the first five years of the term of the new mortgage (subject to certain exceptions such as a lien to ensure the maintenance of property standards).
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| Any appraisal conducted in connection with the eligible new mortgage must, among other things: 1) be based on the current value of the property; and 2) be consistent with HERA appraisal standards, practices and procedures as well as with the HERA's requirements concerning appraisal independence.
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| The mortgagee must document and verify the income of the mortgagor with: 1) an income tax return transcript of the income tax returns of the mortgagor; or 2) a copy of the income tax returns from the IRS for the two most recent years.
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| The mortgagor must not have been convicted under federal or state law of fraud in the 10 years before the mortgage was insured.
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| The residence must be occupied by the mortgagor as the primary residence of the mortgagor and be the only residence in which the mortgagor has any present ownership interest.
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HERA prohibits certain interested parties, including mortgage lenders, mortgage brokers and real estate brokers, from improperly influencing or attempting to improperly influence the real estate appraisal in connection with the mortgage.
For each refinanced eligible mortgage insured under the HOPE for Homeowners Program, HUD will collect: 1) a single initial premium payment equal to 3 percent of the amount of the original insured principal obligation of the refinanced eligible mortgage (to be paid from the proceeds of the mortgage being insured); and 2) an annual premium of 1.5 percent of the amount of the remaining insured principal balance of the mortgage.
The Secretary and the mortgagor, upon any sale or disposition of the mortgaged property or upon the refinancing of the mortgage, are to share in any equity created as a direct result of such sale or refinancing. The Secretary's share is 100 percent of the equity in the first year and declines by 10 percent each year until the sixth year, at which time it becomes 50 percent for the remainder of the loan.
Upon a sale, the Secretary will be entitled to 50 percent of any appreciation in value of the appraised value of such property that occurred after the mortgage was insured.
HERA established a revolving fund known as the Home Ownership Preservation Entity Fund for carrying out the mortgage insurance obligations under HERA. HERA limits the aggregate original principal obligation of all such insured mortgages to $300 billion. HERA authorized the Government National Mortgage Association to enter into new commitments to issue guarantees of securities based on or backed by insured mortgages under the HOPE for Homeowners Program up to $300 billion.
The Secretary's authority to operate the program commences October 1, 2008, and will expire (i.e., "sunset") on September 30, 2011.
HERA authorizes the Treasury Secretary to issue federal credit instruments, to be known as "HOPE Bonds," that are callable at the discretion of the Secretary up to $300 billion. The Hope Bonds would provide the subsidy amounts necessary for loan guarantees under the HOPE for Homeowners Program and pay for the net costs to the federal government of the HOPE for Homeowners Program, including administrative costs.
HERA §1403 amends the Truth in Lending Act (15 USC §§1601, et seq.) by imposing a fiduciary duty on servicers of pooled residential mortgages (unless an investment contract between a servicer of pooled residential mortgages and an investor provides that the servicer does not have such obligations to investors).
S.A.F.E. Mortgage Licensing Act
HERA §§1501, et seq., the "Secure and Fair Enforcement for Mortgage Licensing Act of 2008" or "S.A.F.E. Mortgage Licensing Act of 2008," encourages the Conference of State Bank Supervisors and American Association of Residential Mortgage Regulators to establish a Nationwide Mortgage Licensing System and Registry for the residential mortgage industry to, among other things:
| Provide uniform license applications and reporting requirements for state-licensed loan originators.
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| Provide a comprehensive licensing and supervisory database.
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| Enhance consumer protections and support anti-fraud measures.
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| Facilitate responsible behavior in the subprime mortgage marketplace and provide comprehensive training and examination requirements related to subprime mortgage lending.
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Under HERA, a "loan originator" means an individual who: 1) takes a residential mortgage loan application; and 2) offers or negotiates terms of a residential mortgage loan for compensation or gain.
A "registered loan originator" is a person who is a loan originator and is an employee of a depository institution (e.g., a bank or credit union).
A "state-licensed loan originator" is a loan originator that is licensed but is not a "registered loan originator."
HERA provides that a person may not engage in the business of a loan originator without obtaining and maintaining: 1) a registration as a registered loan originator; or 2) a license and registration as a state-licensed loan originator. Independent contractors cannot engage in residential mortgage loan origination activities as a loan processor or underwriter unless the independent contractor is a state-licensed loan originator.
Applicants must submit: 1) fingerprints; 2) personal history and experience, including authorization to obtain an independent credit report obtained from a consumer reporting agency and information related to any administrative, civil or criminal findings by a government agency.
HERA imposes the following standards, among others, for the issuance of a license:
| The applicant’s loan originator license never has been revoked by any government agency.
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| The applicant has not been convicted of, pleaded guilty to or pleaded nolo contendere to a felony in a domestic, foreign or military court in the seven years before applying for licensing and registration or, if the felony involved fraud, dishonesty, breach of trust or money laundering, at any time.
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| The applicant has completed pre-licensing education requirements, passed a written test, has met either a net worth or surety bond requirement, or has paid into a state fund.
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The federal banking agencies must jointly develop and maintain a system for registering "registered loan originators" by July 30, 2009. HERA authorizes the HUD Secretary to establish a "backup licensing system" in the event that a state does not have a system for licensing and registering loan originators that meets HERA requirements or does not participate in the Nationwide Mortgage Licensing System and Registry by 2010 at the latest.
FHA Modernization Act of 2008
To qualify for FHA mortgage insurance, a mortgagor must have paid, in cash or its equivalent, a down payment equal to at least 3.5 percent of the appraised value of the property or a larger amount set by the HUD Secretary. The Secretary will consider as cash or its equivalent amounts borrowed from a family member, subject to certain requirements.
As initially adopted, the 3.5 percent down payment cannot consist of funds provided by any of the following parties before, during or after closing of the property sale:
| The seller or any other person or entity that financially benefits from the transaction.
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| Any third party or entity that is reimbursed, directly or indirectly, by any of the parties described in the prior paragraph.
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HERA provides that the mortgagor of an insured mortgage must not be required by the mortgagee or any other party to purchase an insurance policy, annuity or other similar product as a condition of eligibility for insurance from HUD. This restriction does not apply to title, hazard, flood or other peril insurance or other such products that are customary and normal.
HUD will establish limits on the origination fee that may be charged to a mortgagor under a mortgage insured by FHA to 2 percent of the maximum claim amount of the mortgage, up to a maximum claim amount of $200,000, plus 1 percent of any portion of the maximum claim amount that is greater than $200,000. HUD can adjust this limit annually.
HERA §2124 directs the Secretary to conduct a pilot program to establish and make available to mortgagees an automated process for providing alternative credit rating information on mortgagors and prospective mortgagors for one- to four-family residences who otherwise have insufficient credit histories for determining their creditworthiness. Such alternative credit rating information may include rent, utilities and insurance payment histories and such other information as the Secretary considers appropriate.
HERA also authorized HUD to establish and conduct a demonstration program to test the effectiveness of alternative forms of pre-purchase homeownership counseling for eligible homebuyers. The forms of counseling could consist of telephone counseling, individualized in-person counseling, Web-based counseling, counseling classes, or any other form or type of counseling that HUD may determine appropriate.
FHA Manufactured Housing Loan Modernization Act of 2008
HERA provides that the prohibitions against kickbacks and unearned fees under the Real Estate Settlement Procedures Act of 1974 ("RESPA") apply to sales of manufactured homes financed with an FHA-insured loan or extension of credit and to services rendered in connection with such transactions.
Mortgage Disclosure Improvement Act
HERA §§2501, et seq. constitutes the Mortgage Disclosure Improvement Act of 2008. It requires that consumer disclosures in connection with mortgage loans be made at least seven business days before consummation of the transaction (which generally is treated as the loan closing).
The disclosures must state in conspicuous type size and format that: "You are not required to complete this agreement merely because you have received these disclosures or signed a loan application." For variable rate loans for which regular payments may vary, the disclosures must state "Payment Schedule: Payments Will Vary Based on Interest Rate Changes" in conspicuous type size and format. The disclosures must include an example of the maximum payment amount due under the loan.
If the "initial disclosures" provided to consumers contain an annual interest percentage rate that no longer is accurate, the creditor must furnish an additional, corrected Truth-in-Lending Disclosure statement to the consumer at least three business days before closing.
The statutory liability of creditors for truth-in-lending violations was increased from a minimum of $200 and maximum of $2,000 to a minimum of $400 and a maximum of $4,000.
These amendments go into effect on July 30, 2009. The new variable rate disclosures become effective on the earlier of: 1) the compliance date established by the Federal Reserve Board; or 2) January 30, 2011.
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For more information about the issues covered in this report, please contact Paul Berning in our San Francisco office at 415-848-4996 or at paulberning@howrey.com or contact your Howrey attorney. For more information about Howrey’s Construction Practice Group, click here.
©2008 Howrey LLP
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