This article distinguishes a mortgage loan controlled by the Real Estate Settlement and Procedures Act (RESPA) from a non-RESPA loan, and helps mortgage loan brokers (MLBs) identify which loans qualify for RESPA protection.
Once upon a loan
Consider a real estate investor who funds the acquisition of one-to-four unit single family residences (SFRs) by borrowing 70% of his purchase price from a mortgage lender. The investor does not occupy any of the residential properties purchased with the borrowed funds as his principal residence. Rather, he acquires them for the business purpose of his real estate investment operation.
The investor submits payments for one of his SFR mortgages to the lender but the lender misapplies the payment to another mortgage made to the same investor. As a result, the unpaid loan becomes delinquent. The lender commences foreclosure while working with the investor to get the accounting corrected – the misleading dual-track foreclosure situation. [For more information on dual-track foreclosures, see the March 2012 first tuesday article, Is $18 billion enough for California homeowners?]
The lender reports the delinquencies and the foreclosure proceedings to the credit reporting agencies. The reporting, as intended, damages the investor’s credit and causes the investor’s business operation to fail due solely to his inability to borrow and finance his investments.
The investor makes a demand on the mortgage lender for the value of his investment losses due to the lender’s destruction of the investor’s credit by wrongfully reporting a delinquency and commencing foreclosure proceedings. The investor claims his right to recover is justified under the Real Estate Settlement and Procedures Act (RESPA), since a loan secured by an SFR loan is involved.
Does the investor have any rights under RESPA to recover his losses incurred due to the lender’s mistake?
No! The investor has no right to claim consumer protection under RESPA. Why? His loan was never covered by RESPA. For RESPA to control, a loan has to:
- be secured by a one-to-four unit residential property which the owner occupies (entirely or in part) as a principal residence; and
- fulfill a consumer purpose, not a business purpose.
The single fact the loan was secured by an SFR is of no consequence since the investor did not occupy the property as his principal residence. Further, and equally critical, the investor had no RESPA rights since the purpose of his SFR-secured financing was to fund a real estate investment business operation instead of a consumer purpose. [Johnson v. Wells Fargo Home Mortgage Inc. (2011)_F3d_]
X marks the spot
RESPA, also known as Regulation X, was first passed in 1974. Its purpose was to establish fairness and transparency in the consumer experience of shopping for and obtaining a purchase-assist home loan for a principal residence. [For more information on the scope of RESPA, see the July 2008 first tuesday article, The Real Estate Settlement and Procedures Act (RESPA).]
Because of RESPA, a borrower of a purchase-assist loan secured by an SFR which he occupies as his principal residence is protected by well-known measures such as the Good Faith Estimate (GFE). The GFE, a document required of a mortgage lender, clearly discloses the costs of services associated with the funding and closing of a loan. Similar consumer protection provisions in RESPA also include Section 8, which prohibits kickbacks, improper fee-sharing and unearned fees in the loan origination process. [For more information on the GFE, see the January 2010 first tuesday article, HUD’s new GFE; for more information on RESPA-prohibited kickbacks, see the August 2011 first tuesday article, Kickbacks: the end of an opulent era.]
The investor in our story cannot claim rights under RESPA’s protective statutes for two reasons. First of all, he did not occupy the property as a principal residence. Second of all, even if he did occupy the SFR as his principal residence, his loan was acquired to fund what was primarily a business purpose. In either context, he has no claim to a consumer right under RESPA. [For more information on which SFR loans are covered by RESPA, see the January 2012 first tuesday recent case decision, RESPA inapplicable to loans funding buy-to-let SFR acquisitions.]
The RESPA Hallway
So exactly which loans are controlled by RESPA and which loans are excluded from RESPA coverage?
To answer this riddle, imagine a hallway. In this hallway are three RESPA doors. Over each of the RESPA doors is a question. You must answer each question correctly to pass through the corresponding RESPA door. Answer all questions correctly, and you will find yourself in the RESPA Coverage Room. Answer any question incorrectly, and you will be summarily expelled from the RESPA Hallway.
Shall we proceed?
At the first RESPA door, answer this: Is the loan a federally-related mortgage loan?
As a general rule, all federally-related mortgage loans are controlled by RESPA. This includes all loans secured by a trust deed lien on one-to-four unit residential property. If you answer yes, proceed to the next door. If you answer no, exit and wave goodbye. You’re out. [24 Code of Federal Regulations §3500.5]
But hold on, all you who answered yes. Even if you have a federally-related mortgage loan funding the acquisition of a one-to-four unit SFR, the loan may still not qualify for coverage under RESPA. Move on to the next door. [24 CFR §3500.2]
At the second RESPA door, answer this: Does the loan primarily fund a consumer purpose or a business purpose?
If you answer “business purpose,” then it was nice knowing you, but see you later. You’re taking the same exit as our friend the investor in the scenario earlier.
Though you have a federally-related mortgage loan – such as a purchase-assist loan, equity loan or a home equity line of credit (HELOC) on an SFR – and passed through the first door, you cannot move through the second door unless the loan funds a consumer purpose, that is, a loan which funds the borrower’s personal consumption needs.
Any loan which funds a business purpose – a loan made for the purpose of funding a business investment, commercial or agricultural operation – is exempt from RESPA.
If you answered yes to the question, proceed to the next door. [12 CFR §226.3(a)(1)]
At the third RESPA door, answer this: Does the borrower occupy or intend to occupy the property secured by the loan as a principal residence?
If you answer no, you must leave; fare thee well. You can’t claim RESPA on loans secured by real estate such as second homes, vacation homes or investment properties. If you answer yes and this property is the proverbial home sweet home – the principal residence – you’ve ended up in the RESPA Coverage Room.
The sharpest mortgage loan brokers (MLBs) know just because a borrower occupies an SFR property as a principal residence doesn’t always mean there is RESPA coverage. Remember, in order to be covered by RESPA, the loan must pass through all three RESPA doorways, i.e., it must meet all three conditions we just discussed.
Got all that? Let’s test your RESPA fundamentals then.
More RESPA riddles for mortgage loan brokers
MLBs, figure this question out: Consider a buyer who obtains a loan to fund the acquisition, improvement and maintenance of a duplex. The buyer does not occupy the property as his principal residence. Is the loan RESPA-controlled?
No! The number of housing units is irrelevant in this case because the buyer did not occupy the property. It is non-owner-occupied property (read: not a principal residence), making the loan funding its acquisition a business purpose loan and thus excluded from RESPA coverage.
Want another go at a RESPA riddle? Try this: Consider a buyer who obtains loan funding for the acquisition, improvement and maintenance of a residential property with more than four housing units. This time, the buyer occupies one of the units on the property as his principal residence within a year of the acquisition. Is the loan RESPA-controlled?
No again! Different rules apply for owner-occupied property. Just because the owner occupies the property does not mean the loan funding the property qualifies for RESPA coverage. Remember, the number of housing units also determines the purpose of the loan. The property the owner occupied is not a one-to-four unit residential property, thus it is not a federally-related mortgage, making it excluded from RESPA coverage.
As Johnson v. Wells Fargo Home Mortgage Inc. teaches, key for MLBs interpreting RESPA application to a loan is to remember this: the purpose for which a loan is used to fund purchases or refinancing is just as important as the type and use of the property the loan secures.
MLBs who arrange SFR loans must inform prospective buyers and owners of their rights as a borrower under RESPA – that is if they made it past the third door and qualify for RESPA coverage. No good business comes out of sloppy RESPA fundamentals. [For more information on how MLBs can work with RESPA rules, see the October 2010 first tuesday article, How to make money as an endorsed, registered, law-abiding RESPA mortgage loan broker.]
Editor’s note – Brokers counseling or servicing homebuyers and owners through the loan settlement process must take note that effective July 21, 2011, the Consumer Financial Protection Bureau (CFPB) assumed administration and enforcement of RESPA. All consumer questions and complaints related to RESPA-controlled mortgages can be handled by calling the CFPB Consumer Response Team at (855) 411-2372 or submitting a mortgage complaint form online here.