Let me guess: you have heard rumors, threats, scary stories, and reliable affirmations that, as written, Dodd-Frank will end our collective world as we know it, right? For the majority the extent of their understanding of Dodd-Frank is: Dodd-Frank = bad.
If you are satisfied with this level of understanding, then the rest of this article is not for you. For everyone else, I'm going to attempt to explain why the industry is adrift in an ocean surrounded by dangerous seas. If nothing is done come January, 2013, those distant threats will be crashing down on our decks as the manufactured housing industry could be forced to endure unprecedented changes.
We are adrift in dangerous waters
Imagine we are all standing on the deck of a small boat at sea. We are in the middle of the ocean, alone, all in our orange life vests. We see off to one side massive waves rolling towards us that make the waters we are currently in look like we are playing in a bath tub. Off the other side we see multiple typhoons heading menacingly in our direction. Then someone cries out, "What is that?" and points to tentacles emerging from the water belonging to a sea creature normally reserved for mythological tales. Just when we thought life couldn't get worse the radio chirps and it's the Coast Guard announcing the formation of a hurricane, the coordinates of which just happen to match those of our current location.
(Perhaps I should have given a prologue: This story is only for adult readers).
Dodd-Frank is massive. Not sea-creature massive or even hurricane massive; instead, it is Pacific Ocean massive. There are many interconnected moving parts to the 848-page legislation passed into law July 2010. The complexity grows exponentially when looking at the 70,000+ pages of anticipated proposed and final regulations emerging from Dodd-Frank. Due to the interconnectivity of so many issues and rules, one issue will bleed onto the next, and changing one aspect has ripples extending into other adjacent issues.
At this point, admittedly, I have done nothing to educate beyond Dodd-Frank = bad, but perhaps some of you will give me credit for trying to make federal law and regulations at least somewhat interesting.
The Dangers at Sea
Now with the scene painted, let’s talk about the big waves, the destructive typhoons, the sea creature, and the hurricane.
There are four main issues to focus on when trying to wrap your head around Dodd-Frank and the regulatory rules currently in the works. There are many other issues, but for those looking for the SportsCenter highlights, let’s start with the big four:
1) Qualified Mortgage
2) Appraisals Requirements
3) High Cost Mortgage Loans (aka "predatory loans")
4) SAFE Act
Carrots and Sticks
The foundational concept for the mortgage regulation in Dodd-Frank is as basic as "carrots and sticks." The "carrots" say if a lender makes a particular type of loan with low interest rates, low origination fees and is based on a borrower’s ability to repay, then the lender is blessed with all sorts of assumptions and protections. The "carrots" are carrots, not jelly donuts, meaning they provide a significant incentive, but they aren't the best thing in the world.
How does one become eligible for these carrots? Learn the term "qualified mortgage" (QM). This is what the 2010 Congress and the government regulators want every mortgage loan to be. If you just follow their rules and make these types of loans, then they grant all sorts of allowances and exceptions.
What is the huge wave that is a Qualified Mortgage?
A QM is a mortgage loan where:
The principal does not increase;
There is no deferral of repayment of principal (Exception: Balloon Loans in “rural and underserved” areas);
- No balloon loans (Except in “rural and underserved” areas);
- Income of borrower is “verified and documented”;
- For Fixed rate loan: Fully amortized loan over full term with taxes and insurance included;
- For Variable Rate Loan: uses a maximum rate for first 5 years to fully amortize with taxes and insurance;
- The loan term doesn't exceed 30 years;
- The loan falls within the monthly debt-to-income ratios prescribed by the Board, which have yet to be determined, but will be in the next six months; and
- Points and fees don’t exceed 3 percent (Exception: for smaller loan values, the percentage can increase but cannot exceed 5 percent); or
- The interest rate on a loan cannot exceed the "prime offer rate" (Prime) by 6.5 percent for loans over $50,000 (8.5 percent for personal property loans less than $50,000).*
*This provision is not specifically listed in the definition of a QM, however it is from the definition of a “high-cost mortgage loan,” which as concomitantly defined cannot also be a QM, thus it works as another condition of a QM.
Generally speaking, if you fall within this framework when making loans, then you have done what the government wants.
You have made a low-interest, low-cost loan with payment terms that do not vary (or varies only slightly) to a consumer who has clearly demonstrated they can afford the loan.
So what are the "carrots?" The carrots are certain exceptions and additional allowances written into the law and rules to incentivize lenders. Some of the carrots are still being worked out, but QMs have exceptions to things like the new appraisal requirements and verification of ability to repay. Also, they avoid the newly created foreclosure defenses and increased civil liability, and they enjoy protection that all the requirements needed to satisfy qualifying for a QM are assumed to be true. Additionally, for traditional site-built lending, satisfying the QM provisions drastically increases the likelihood of access to the liquidity of government-backed securitization.
The trouble is most of the lending needed to sell homes does not qualify as QMs. This is not just within our industry. At a recent Texas House interim hearing a representative of the Texas Mortgage Bankers Association testified, based on 2009 loans, only 30 percent of the loans originated would have qualified as QMs. For our industry the numbers are even bleaker.
Enough carrots; tell us about the sticks
The "carrots" don't have to be super sweet simply because the "stick" is more like a medieval mace. The disincentives are such that lenders will either make a wholesale exit from these markets or at least dramatically reduce their presence. Remember when I said, "Dodd-Frank = bad"? Now I'm going to tell you what that means.
If a loan fails to satisfy the provisions of a QM, and the interest charged is more than 1.5 percent over Prime, then the first problem is a requirement the loan amount match to an appraisal. An appraisal requirement is not nearly as big of an issue for the majority of site-built housing with sales comparison databases and the Multiple Listing Service (MLS). However, for appraisals on manufactured housing, the current requirements are absolute killers.
Dodd-Frank requires every appraisal be done by a “certified or licensed appraiser” who must perform the appraisal to the Uniform Standards of Professional Appraisal Practice. The law requires a physical property visit of the interior of the home. The lender must provide, “without charge” a copy of the appraisal to the borrower at least three days prior to closing. The lender must also provide a new notice to the borrower that the appraisal is for the sole use of the creditor and the borrower may choose, at their expense, to have their own separate appraisal.
The hurricane-like destruction the new appraisal requirements would wreak upon our industry stems from the complete lack of comparable resale data for home-only sales. Real estate appraisers do not recognize sales data from home-only sales off retail lots or within communities. There is no comparable data source (with the exception of California) for home-only sales, as well as massive disparities in home values for anything close to comparative data in rural markets.
This mandate illustrates a lack of understanding of the basic nature of sales in the manufactured home retail setting. The requirement of an individual “interior” appraisal fails to understand our sales logistics when homes are sold off retail lots based on models, and an order is placed with a factory for the specific home purchased. Meanwhile, site-preparation and expenses associated with site-prep are underway. Only then is the home shipped and installed at the location. All of this must occur prior to there even being a possibility of physically inspecting the interior of a specific home.
Lastly, the increased liability exposure coupled with the basic fact an appraisal (assuming one could even be done for home-only, which it cannot) will increase the price of the home by an estimated $500 - $700, which will only serve to price some potential home buyers out of the market.
An estimated 70-75 percent of manufactured home sales nationally are home-only transactions. Instituting mandatory comparable sale appraisals where comparisons either wholly don’t exist or are tremendously lower than the actual product being sold means this requirement alone can sink our industry to the deepest fathoms of the sea.
High Cost Mortgage Loans: a sea creature by any other name
The law and proposed rules place various interest rate caps, or thresholds, as well as limiting the percentage on a loan that can be charged as "points and fees." If you exceed the designated threshold, you are likely to be eaten by the sea creature.
Dodd-Frank defines a “high cost mortgage loan” (HCML) as a loan over 6.5 percent above Prime for loans above $50,000 and 8.5 percent above Prime for personal property loans below $50,000. The math gets simple: if the prime offer rate is 3.75 percent and the loan is made for less than $50,000 with an interest rate above 12.25 percent, then you hit the trigger and you are in the colloquial "predatory" lending business. To operate in this space is essentially untenable for nearly every lender due to the bludgeoning “sticks” the new law attributes to these types of loans. When lending on an HCML the law requires mandatory third-party credit counseling, significant increases in lender liability, significant new borrower protections and anti-foreclosure provisions, not to mention the perceived stigma of being a “predatory lender.”
Why the sea creature will eat a large chunk of our boat
The problem with HCML comes down to basic math. There is a significant segment of lending in our industry in the lower loan value, higher-credit-risk borrower market. Additionally, the cost of capital to our lenders is substantially higher than other depository lenders and banks with credit availability from the Federal Reserve. When many industry lenders examine their portfolios in these markets they are unable to make loans with their cost of capital, risk of default and fixed costs while sustaining profitability under the interest rate thresholds.
Typically, a lender can make up the difference in less interest on the loan with higher points and fees at the time of origination. But here is where this sea creature squeezes our ship’s hull from both sides. HCML are limited in the amount of points and fees that can be charged. For loans over $20,000 no more than 5 percent can be charged in points and fees. For loans under $20,000 points and fees are limited to 8 percent or $1,000, whichever is less. By limiting points and fees and setting thresholds for interest rates, lenders will be forced to decide if they will endure the limitations and added liability of making HCML or simply exit this market entirely.
In fact, several of the larger lenders have indicated they will not be in the “predatory loan” business, opting to exit the market rather than play by the HCML rules. Without final rules exact estimates are difficult to predict, but conservative estimates start at 15 percent of the national lending effectively being eliminated practically overnight due to these laws and rules.
For a more personal impact, look back over the past several years at homes you sold with financing that would be considered HCMLs. Without changes to these rules, you can count on the sea creature consuming those sales in the future.
Future sales are not the only casualties to this monster. Nearly the entire used home resale market exists in the lending space below $50,000. If current lenders exit this market and private money lenders similarly flee when the market ceases to be profitable, there will be a tremendous void in this lower value market of available financing. Without financing any consumer choosing to sell their home will face a drastically lower equity position. Homeowners will face a new reality where they can only sell their homes to cash buyers. This will greatly diminish their home’s value.
And for those curious as to how this might surface, it can and will happen practically overnight. If the regulations remain unchanged, the day they go into effect you will immediately see lenders exiting markets or, at a minimum, requiring significant retailer “buy-down” on loans in homes in this market to remain under the caps.
The typhoons of SAFE Act and Mortgage Loan Originator Compensation
By now most in the industry are familiar with the SAFE Act. The SAFE Act law was passed in 2008 and the Texas version was passed in June, 2009, so we have had SAFE Act on the books for several years now. Over this span of time the Texas SAFE Act has had limited application in the retail segment of our industry. The Texas law clearly establishes an exception from licensing if the compensation received on a sale is the same in a cash transaction as in a financed transaction. We were able to add to the exceptions in Texas during the 2011 session creating an exemption for anyone who sells five or less owner-financed sales in a 12-month period.
The trouble on the horizon related to SAFE Act is the uncertainty at the federal level and its impact on the states.
Dodd-Frank did several key things related to the SAFE Act. First, Dodd-Frank gave the federal authority over SAFE Act to the CFPB. Originally the federal SAFE Act was under HUD’s jurisdiction, but Dodd-Frank changed the responsible agency to the CFPB. The CFPB now has the authority and responsibility to review state law and deem whether each state’s SAFE Act is in their view compliant with the federal law.
In addition, prior to the changing of authority HUD issued final rules on the federal SAFE Act, which are currently in place. The final rules by HUD, now controlled by the CFPB, call into question many of the variations of the state- level SAFE Act laws on the books around the nation. This includes our Texas law. How the CFPB ultimately interprets HUDs rules, and then chooses follow, modify, and enforce the SAFE Act, will have a direct impact on state law when state legislatures meet again.
Specifically at issue in Texas is whether the CFPB will allow the current laws to stand unchanged. This is obviously our preference, but the fear is CFPB will use the HUD final rule to make a determination that the Texas law is deficient. The CFPB would then effectively force Texas to change its law or face being defaulted to direct federal regulation. At stake is our currently clear “same as cash” exclusion for retailers and salespersons, as well as the exclusion for small volume owner-financed sellers of five or less in a 12 month period.
If the CFPB finds fault with these provisions and forces state law changes, the SAFE Act requirements in Texas could change dramatically. This could include a much more encompassing scope of required licensure.
Currently there is no specific definition in Truth in Lending, Dodd-Frank, Reg Z or the federal SAFE Act as to what constitutes “compensation.” The only place compensation is defined is in the SAFE Act final rules from HUD, which interpret compensation incredibly broadly. Compensation is when a person, “receives or expects to receive payment of money or anything of value in connection with [presenting] for consideration by a borrower or prospective borrower particular residential mortgage loan terms or as a result of any residential mortgage loan terms entered into as a result of such activities [presenting particular loan terms].”
The question is if CFPB agrees with this definition and chooses to incorporate it into its rules, or if they will change their definition of “compensation.” If the CFPB adopts a broad interpretation they will further limit specific activities a person may do without being licensed. They could also serve as the basis for an eventual CFPB audit of state law, which one would presume will force states to conform to their interpretation of SAFE Act.
How we plan to navigate these treacherous waters
It’s fair to assume you now know the swells are already lapping over the sides of our boat, the wind is howling and the downpour of rain is stinging our face. We are hanging on to the railings for dear life as the boat pitches in the waves. Now what?
I wish I could report a rescue helicopter was in route, or someone just discovered stockpiled supplies of anti-sea creature spray below deck, but I can’t. There isn’t an easy solution.
However, this is not to say we don’t have a plan to try to navigate out of harm’s way. The plan requires multiple steps and fighting multiple battles on several fronts simultaneously.
Our first step is to get an audience with the specific regulators who are actually drafting the regulations. Once in front of these regulators we must convince them to care about our consumers. This might seem like a given, but with so many players and so many issues in the area of mortgage lending, getting an audience with the right regulator is tough.
If we can get them to care, then they have to believe us. This step is critical and one of the most difficult. This effort requires tremendous work, data collection, organization and proper presentation. (Not to mention a fair amount of luck).
What gets us into bright sunshine and calm water once again?
Assuming we accomplish the critical first steps, what are our goals? Our overarching goal is to continue to allow our current selling and lending practices to remain as close to unchanged from what we do now as possible.
Specifically, we need changes so the low loan value segment of our lending space is not dragged into the world of “predatory lending.” We can accomplish this in several ways: either expand the QM standards so more of our loans fall within its protection, or obtain some level of relief on the interest rate or points and fees thresholds on high-cost mortgage loans.
We also need specific relief and allowances on appraisals providing either exemptions or create a unique manufactured home valuation method that fits our industry.
Finally, we need clarification and consistency in the application of the triggers that determine when a person must be licensed. Our two goals are to 1) clarify compensation earned as a result of a retail sale for a home that happens to be financed does not require the retailer to become a licensed mortgage loan originator (i.e. SAFE Act licensed), and 2) the CFPB will defer to the states to set or define in state law the amount of limited owner-financed sales in a year that don’t result in “habitualness or repetitive” as described in the final federal rules for SAFE Act.
Ideally we hope to make the best case for why our unique segment in housing, mortgage lending in particular, needs to be separated out and dealt with in a manner befitting the market we serve.
We are a square peg being forced into a round hole. Our hope is to convince the CFPB we need to find a square hole for us…not that they simply need to use a bigger hammer to hit us with harder.