A Review of the OCC’s Recent
Residential Mortgage Lending Standards

by Stephanie Caputo, community development expert, Community Affairs Department, OCC

Predatory mortgage lending continues to be a problem in many communities. In addition to victimizing would-be homeowners, it creates economic instability by producing high foreclosure rates and undermining community revitalization efforts. Although the OCC has not seen evidence that national banks are engaging in such activities, we have issued regulatory and other guidance to ensure that banks operating in various segments of the mortgage market are aware of their compliance obligations, and to support them in promoting the goal of treating all customers fairly.

The OCC’s Response

The OCC recently adopted Guidelines for Residential Mortgage Lending Standards, comprising appendix C to part 30 of our regulations. These standards, which we refer to as “part 30,” became effective in April 2005. They further the goal of ensuring that national banks and their operating subsidiaries are not involved, directly or indirectly, in predatory or abusive residential mortgage lending practices. The guidelines reinforce the substance of earlier guidance in the OCC’s 2004 revisions to the real estate lending regulations and advisory letters 2003-2 and 2003-3. The amendments to our regulations preclude lending based predominantly on the realization of the foreclosure or liquidation value of the borrower’s collateral without regard to the borrower’s ability to repay the loan according to its terms. They also prohibit banks from engaging in unfair and deceptive practices as defined in section 5 of the Federal Trade Commission Act. The advisory letters provide guidance concerning avoidance of abusive lending practices relating to the origination and purchase of mortgage loans and the use of third party lenders.

Practices Inconsistent with Sound Residential Mortgage Lending Activities

The new “part 30” guidelines stipulate that national banks should not become involved, directly or indirectly, in residential mortgage lending activities involving abusive, predatory, unfair, or deceptive lending practices, including – but not limited to – the following:

• Equity Stripping and Fee Packing: Multiple refinancings that siphon the unwary borrower’s equity through excessive fees.
• Loan Flipping: Repeated refinancings under circumstances in which the terms and costs of the new loan do not provide a tangible economic benefit to the borrower.
• Refinancings of Special Mortgages: Refinancing a subsidized mortgage that has favorable terms with a loan that provides no tangible economic advantage to the borrower.
• Encouragement of Default: Encouraging a borrower to default on an existing loan for the purpose of refinancing that loan.

The OCC recognizes that certain loan terms, features, and conditions, while subject to abuse, may represent acceptable risk mitigation measures that benefit customers and are consistent with safety and soundness standards. The part 30 guidelines state that national banks should give careful consideration to the circumstances, including the characteristics of the targeted market and applicable consumer and safety and soundness safeguards, under which the bank will engage directly or indirectly in making residential loans that have the following terms, features, and conditions:

• Financing single premium credit life, disability, or unemployment insurance.
• Negative amortization.
• Balloon payments on short-term transactions.
• Prepayment penalties that are not limited to the early years of the loan, particularly in subprime loans.
• Interest rate increases upon default at a level not commensurate with risk mitigation.
• Call provisions permitting the bank to accelerate payment of the loan under circumstances other than the borrower’s default under the credit agreement or to mitigate the bank’s exposure to loss.
• Absence of an appropriate assessment and documentation of a consumer’s ability to repay the loan in accordance with its terms, commensurate with the type of loan.
• Mandatory arbitration clauses or agreements, particularly if the eligibility of the loan for purchase in the secondary market is impaired.
• Pricing terms that fall within the Home Ownership and Equity Protection Act (HOEPA).
• Original principal balance of the loan in excess of appraised value.
• Payment schedules that consolidate more than two periodic payments and pay them in advance from the loan proceeds.
• Payments to home improvement contractors other than by an instrument payable to the consumer, or jointly to the consumer and the contractor, or through an independent third-party arrangement.

A national bank should exercise great care if it uses these residential loan terms, conditions, and features. A bank’s residential mortgage lending activities should include provision of timely, sufficient, and accurate information to consumers with respect to the terms and costs, and the risks and benefits, of the loan products offered.

Managing Third-Party Origination Channels

Reliance on third-party relationships can significantly increase a bank’s risk exposure, notably reputation, compliance, and credit risks. Predatory and abusive loans originated through brokers or by third-party lenders raise fundamental safety and soundness issues, and also present a wide range of heightened legal risks for national banks – risks that could subject them to civil liability as well as supervisory action.

The part 30 guidelines and advisory letter 2003-3 stipulate that a national bank should have an effective and comprehensive process for managing the risks associated with third-party relationships. When a bank purchases consumer residential loans or makes them through a mortgage broker or other intermediary, part 30 guidelines require standards and practices to be consistent with those applied by the bank in its direct lending activities and include appropriate measures to mitigate risks, such as the following:

• Criteria for entering into and continuing relationships with intermediaries and originators, including due diligence requirements.
• Underwriting and appraisal requirements.
• Standards related to total loan compensation and total compensation of intermediaries, including maximum rates, points, and other charges, and the use of overages and yield-spread premiums, structured to avoid providing an incentive to originate loans with predatory or abusive characteristics.
• Requirements for agreements with intermediaries and originators, including, with respect to risks identified in the due diligence process, compliance with appropriate bank policies, procedures, and practices and with applicable law (including remedies for failure to comply), protection of the bank against risk, and termination procedures.
• Loan documentation procedures, management information systems, quality control reviews, and other methods through which the bank will verify compliance with agreements, bank policies, and applicable laws, and otherwise retain appropriate oversight of mortgage origination functions, including loan sourcing, underwriting, and loan closings.
• Criteria and procedures for the bank to take appropriate corrective action, including modification of loan terms and termination of the relationship with the intermediary or originator in question.

Conclusion

The OCC’s decision to issue the part 30 guidelines as part of its safety and soundness framework affords it the necessary flexibility to take the most appropriate course of action if examiners find evidence that abusive practices are occurring. For example, the OCC could notify a bank of its concern and require the bank to submit a plan specifying the steps it will take to ensure compliance with the standards. Having the flexibility to act on a case-by-case basis will help the agency – and the banking community – to protect consumers and promote fair lending practices nationwide.