DRE Regulation # 2844

Effective: August 15, 2008

Mortgage loan broker regulations for originating ARM loans

Real estate brokers acting as mortgage loan brokers (MLBs) must now follow the Rules for Nontraditional Mortgage Product Adjustable Rate Mortgage (ARM) risks published on Nov. 14, 2006 by the Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators. They must also follow the rules of the Statement on Subprime Mortgage Lending ARMs published on July 17, 2007 by the Conference of State Bank Supervisors, the American Association of Residential Mortgage Regulators, and the National Association of Consumer Credit Administrators. The minimum requirements include:

1. Risk Management Practices

MLBs must:

  • consider the borrower’s ability to repay an ARM loan as the primary basis for making the loan;
  • ensure that the loan results in a discernable benefit to the borrower, and not induce a borrower to repeatedly refinance in order to charge high points and fees; and
  • fully disclose the true nature of the ARM loan obligation to the borrower.

2. Underwriting Standards

MLBs must:

  • analyze the borrower’s ability to repay the ARM loan by final maturity at the fully indexed rate under a fully amortizing repayment schedule. If the product permits negative amortization, a repayment analysis should be based on the initial loan amount plus any potential balance accruing from the negative amortization;
  • avoid combining ARM loan features like interest-only or negative amortization loans with reduced documentation or simultaneous second-lien loans unless there are mitigating factors like:

  1. high credit scores;
  2. low loan to value ratios and debt income ratios;
  3. significant liquid assets;
  4. mortgage insurance; or
  5. other credit enhancements.

  • accept stated income or reduced documentation only if there are documented factors minimizing the need for to verify the borrower’s repayment;
  • consider the spread between the introductory rate and the fully indexed rate when setting introductory rates on ARMs;
  • ensure that loans to subprime borrowers do not feature terms that could become predatory or abusive;
  • qualify borrowers who finance investment properties on their ability to service the debt over the life of the loan, and require evidence that he borrower has sufficient cash reserves to service the loan, considering the possibility of extended periods of vacancy and the variability of debt service requirements; and
  • qualify a borrower’s repayment capacity by a debt-to-income ratio, assessing the borrower’s total monthly housing-related payments and total monthly obligations as a percentage of gross income.

3. Control Systems

MLBs must:

  • design compensation programs that do not encourage originations contrary to sound underwriting and consumer protection principles or lead consumers exclusively to products resulting in payment shock, or products containing prepayment penalties, balloon payments or higher costs due to reduced documentation or stated income; and
  • insure that third party originations reflect the broker’s lending standards and comply with all laws and regulations.

4. Consumer Protection

MLBs must:

  • approve or deny loans based on the borrower’s ability to repay them;
  • provide information to borrowers that enables them to understand material terms, costs, and risks of loan products;
  • when offering mortgage product descriptions and advertisements, provide the borrower with clear and detailed information about the costs, terms, features, and risks of the loan, including:
  1. potential payment shock
  2. negative amortization;
  3. prepayment penalties;
  4. balloon payments;
  5. cost of reduced documentation loans; and
  6. responsibility for taxes and insurance.
  • provide monthly statements to borrowers who have Payment Option ARMs which give information enabling them to make informed prepayment choices, including explanations of each payment option available and the impact of those choices on loan balances; and
  • avoid leading borrowers who have Payment Option ARMs to select non-amortizing or negatively amortizing payments.