June 2008 www.klgates.com

Authors:

Laurence E. Platt+1.202.778.9034 larry.platt@klgates.com

Nanci L. Weissgold+1.202.778.9314 nanci.weissgold@klgates.com

K&L Gates comprises approximately 1,500 lawyers in 24 offices located in North America, Europe and Asia, and represents capital markets participants, entrepreneurs, growth and middle market companies, leading FORTUNE 100 and FTSE 100 global corporations and public sector entities. For more information, please visit www.klgates.com.

Mortgage Banking & Consumer Credit Alert

Cook County Database Redux, with an Anti-Predatory Lending Kicker - New Statewide Anti-Predatory Lending Requirements

Some ideas die hard. Illinois HB 4050 (Public Act 94-2080) established an anti-predatory lending database, a pilot program for residential mortgage loans in Cook County, Illinois that was in effect for only four short months in 2006 before the controversial law was shelved. Well, it’s back – in slightly revised form but with new anti-predatory lending standards. Will it cause the havoc of its earlier, short-lived iteration that was suspended amidst fair lending concerns? SB 1167 (Public Act 95-0691), the revived version of the Cook County anti-predatory lending database law (the “Database Law”), was signed by Governor Rod Blagojevich on November 2, 2007 and is scheduled to take effect on July 1, 2008.

The Cook County redux program is strikingly similar to HB 4050 and raises many of the same questions we raised in our August 2006 Mortgage Banking/Consumer Finance Commentary.1 Will this cause delays in closing loans in Cook County? Will title companies issue clean title policies without exception for Cook County loans? Will investors purchase loans in the program area? Do the credit counselors know what they are doing? What happens if a credit counselor issues a negative recommendation? And these don’t even touch privacy concerns.

The “pilot” program has been removed, suggesting it is here to stay. Also, in an attempt to minimize redlining claims, it applies to all of Cook County, Illinois (not just 10 designated zip codes). There are other notable differences in the amended law that will hopefully reduce the havoc its predecessor played on the marketplace. Most significantly, the scope of loans subject to mandatory counseling is significantly reduced. Rather than applying to virtually every loan in Cook County, counseling is required only for first-time homebuyers or borrowers refinancing primary residences and where the mortgage loan (a) permits interest only payments, (b) may result in negative amortization, (c) includes a prepayment fee, (d) is an ARM loan with adjustments in the first three years (an “ARM loan”), or (e) has total points and fees exceeding 5%. Many of these loans aren’t being made because of the economic climate. We asserted in our August 2006 article that the Database Law would materially delay and complicate loan closings and give the state government unfettered access to the personal financial information of its citizens. Unfortunately, that still may be the case. Perhaps the Anti-Predatory Lending Database website (www.ilapld.com) will address many of the technical kinks of its predecessor.

In addition to revising HB 4050’s Database Law, SB 1167 imposes statewide anti-predatory lending standards on licensees under the Residential Mortgage License Act (the “RMLA”), including additional disclosure requirements, ability to repay restrictions, prepayment fee limitations, expanded duty of care for brokers, and liability for compliance failures. SB 1167 also amends the Illinois Interest Act’s prepayment penalty provisions. The new statewide standards are effective June 1, 2008. As noted above, the Cook County portions are effective July 1, 2008.

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I. Cook County Anti-Predatory Lending Database Law

Background

When HB 4050 was signed into law in 2005, it established an anti-predatory lending database for residential mortgage loans located in a pilot program area that covered ten specific zip codes in Cook County, Illinois. Under that law, brokers and originators of all residential mortgage loans in the pilot program area submitted required borrower information to the predatory lending database, managed by the Department of Financial and Professional Regulation (the “Department”). The Department compared the information to its adopted credit counseling standards and determined whether the borrower was required to seek credit counseling. An independent HUD-certified credit counselor would then provide its determination concerning the borrower’s fitness for a loan. The loan could not close until the required counseling was completed and the counselor submitted required information to the database. Title insurance companies and closing agents were also required to submit specific information to the database.

HB 4050 became effective on September 1, 2006, but only a few months later (in January 2007), the Governor suspended the controversial program in its entirety because of the widespread criticism and apparent resulting negative impact on lending in the impacted communities.

Summary of Amended Cook County Anti-Predatory Lending Database Law

The Database Law, as amended by SB 1167, requires brokers, originators, counselors, title insurance companies and closing agents to submit specific borrower and loan information to an Anti-Predatory Lending Database managed by the Department (“Database”) for all loans in Cook County, not just loans in certain zip codes. SB 1167 also makes the program permanent by removing the “pilot program” status. The program applies to mortgage applications that are made or taken on or after July 1, 2008. However, according to recent guidance issued by the Department, for mortgage loan applications taken prior to July 1, 2008 but closed after July 1, 2008, a certificate of exemption will need to be recorded with the mortgage.

The Department will “recommend” (which effectively means “require”) pre-loan counseling if the borrowers are first-time homebuyers or refinancing a primary residence and the loan has any of the following features: interest only payments, negative amortization, a prepayment penalty, an ARM loan, or total points and fees payable by the borrower at or before closing that will exceed 5 percent. As under the prior law, the loan cannot close until required counseling is completed and the counselor submits required information to the Database. None of this comes without costs of course. In fact, the broker or originator must pay costs of no more than $300 associated with required counseling, and there is no provision permitting the lender to pass these costs on to the borrower. Nor does this come without potential delays to closing. The entire Database submission and counseling process may take more than a month from application to closing – and that assumes no changes are made to the loan terms. If there are changes to the loan terms after the broker or originator submits information to the Database, the process restarts from scratch.

We discuss SB 1167 in more detail below, starting with a loan origination timeline based on the requirements of the Database Law. We also provide details regarding the applicability of the law, specific information that each type of entity subject to the law must submit to the Database, the standards used to determine whether counseling is required, and penalties for violations of the law. Finally, we address SB 1167’s potential impact on borrowers and the industry.

Loan Origination Timeline

•�Ten�Days�from�Application—Within ten (10) days from application, the broker or originator submits required information (described below) to the Database.

•�Seven� Days� from� Receipt� of� Information—Within seven (7) days of receiving the information from the broker or originator, the Department will compare that information against housing counseling standards (described below) and determine whether counseling is “recommended.” Note that the law does not set a time frame for the Department to notify the broker or originator and borrower of its recommendation. If counseling is “recommended,” the borrower must obtain counseling; it cannot be waived. The Department must notify the borrower

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of all participating HUD-certified counseling agencies in Illinois and direct the borrower to interview with a counselor associated with any of those agencies.

•��Change�of�Information—Extends�Time�Frame—If the broker or originator changes the terms of the loan or issues a new commitment to the borrower after having submitted the required information, the broker or originator must re-submit all of the required information within five (5) days of the change. The Department will go through its process again within four (4) days of receiving the new information from the broker or originator and issue a new determination of whether re-counseling is “recommended.” The Department must require re-counseling if the loan terms have been modified to meet another housing counseling standard or if the broker increased the interest rate by more than 200 basis points. The law again sets no time frame for the Department to notify the broker or originator and borrower of its recommendation. And again if counseling is “recommended,” the borrower must obtain counseling; re-counseling cannot be waived. The Department must notify the borrower of all participating HUD-certified counseling agencies in Illinois and direct the borrower to interview with a counselor associated with any of those agencies.

•�Ten�Days�from�Notice�of�Required�Counseling—The borrower must select a counseling agency and interview with a counselor associated with that agency within ten (10) days after receiving the names of participating HUD-certified counseling agencies. The law is silent on what happens if there are no available counseling agencies, but it does provide for telephone counseling if there is a hardship (i.e., the borrower is confined to his or her home due to medical conditions verified in writing by a physician, or the borrower resides 50 or more miles from the nearest participating counseling agency). The broker or originator must pay reasonable and customary costs of no more than $300 (with an annual inflation adjustment) associated with this mandatory counseling.

•�Seven�Days�from�Interview—The counselor must submit required information (described below) to the Database within seven (7) days of interviewing the borrower. The law does not require the counselor to share its recommendations with either the borrower or the broker/originator.

Legally Binding Action—The borrower and broker or originator must not take any legally binding action in connection with the loan transaction until the later of the following:

(a) The Department issues a determination not to recommend counseling for the borrower; or

(b) The Department issues a determination that counseling is recommended for the borrower and the counselor submits all required information to the Database.

•��Upon�Recording�and�Ten�Days�from�Closing—The title insurance company or closing agent must submit required information (described below) to the Database within ten (10) days after closing. Although the statute is ambiguous, this appears to be required regardless of whether the broker or originator is required to submit information to the Database or the borrower is required to obtain counseling. The title insurance company or closing agent must attach to the mortgage a Database-generated certificate of compliance with the above requirement. A mortgage may not be recorded without this certificate or a certificate of exemption, as applicable.2 Also, to record any notice of pending suit (lis pendens) for foreclosure on a property within Cook County, the foreclosing party must simultaneously record a certificate of service affirming that a copy of the lis pendens was filed with the Department. Otherwise, the lis pendens is not recordable.

Who Must Submit Information of Which Loans to the Database?

Any broker3 or originator4 that takes mortgage loan applications on residential real property located in Cook County must submit information to the Database, unless exempt. All brokers, and many, but not all, originators, that are exempt from licensing under the RMLA are also exempt from the program. Originators or brokers who are exempt from both the RMLA and the Database Law include state or federally chartered banks, savings and loan associations, credit unions or insurance companies authorized to do business in Illinois. Additional exemptions are available for brokers, but not for originators.5

Essentially any consumer purpose residential mortgage loans are subject to the program. There is, however, an exemption applicable to reverse mortgage loans under

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FHA programs that require HUD-certified counseling. As discussed further below, these borrowers may comply with the program by submitting their HUD counseling certificate at closing.

What Information Should Brokers or Originators Submit to the Database?

For each loan for which the originator takes an application, the broker or originator must submit all of the following information within ten (10) days of application:

•��Identifying� Information—The borrower ’s name, address, social security number or taxpayer identification number, date of birth, and income and expense information contained in the mortgage application.

•��Security�Information—The address, permanent index number and a description of the collateral and information about the loan or loans being applied for.

•��Loan�Terms—The loan terms, including the amount of the loan, the rate and whether the rate is fixed or adjustable, amortization or loan period terms and any other material terms.

�•��Credit�Score—The borrower’s credit score6 at the time of application.

•���Originator�Information—Information about the originator and the company for which the originator works, including the originator’s license number and address, fees being charged, whether the fees are being charged as points up front, the yield spread premium payable outside of closing, and other charges made or remuneration required by the broker or originator or its affiliates or the broker’s or originator’s employer or its affiliates for the mortgage loans.

•��Affiliate�Information—Information about affiliated or third party service providers, including the names and addresses of appraisers, title insurance companies, closing agents, attorneys, and realtors who are involved with the transaction and the broker or originator and any moneys received from the broker or originator in connection with the transaction.

•��Disclosure�Information—All information indicated on the Good Faith Estimate and Truth in Lending

statement disclosures given to the borrower by the broker or originator.

•��Tax�Information—Annual real estate taxes for the property, together with any assessments payable in connection with the property to be secured by the collateral and the proposed monthly principal and interest charge of all loans to be taken by the borrower and secured by the property of the borrower.

•���Source�Information—Information concerning how the broker or originator obtained the client and the name of its referral source, if any.

•��Notices�Required�by�Law—Information concerning the notices provided by the broker or originator to the borrower as required by law and the date those notices were given.

•��Sale� and� Leaseback—Information concerning whether a sale and leaseback is contemplated and the names of the lessor and lessee, seller and purchaser.

•��Previous�Financing—Any and all financing by the borrower for the property within the 12 months prior to the application date.

•��Additional�Loan�Information—The interest rate, term, purchase price, down payment, closing costs, and prepayment penalty (if any).

•��Counseling� Standards� Information—Whether the buyer is a first-time homebuyer or refinancing a primary residence and whether the loan: (i) permits interest only payments; (ii) may result in negative amortization; (iii) includes total points and fees exceeding 5% payable by the borrowers at or before closing; (iv) includes a prepayment penalty, and if so, the terms of the penalty; and (v) is an ARM loan (as defined below).

As you can see, this will require additional time investments on the part of the originator, which ultimately translates into an even longer time between application and closing.

What Are the Standards for Recommending (Requiring) Counseling?

SB 1167 specifies that counseling is required only if the borrower or borrowers are:

• First-time homebuyers or

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• Refinancing a primary residence;

and the mortgage loan meets at least one of the following criteria:

• Permits interest only7 payments;

• May result in negative amortization;8

• Total points and fees9 payable at or before closing exceed 5%;

• Includes a prepayment penalty; or

• Is an ARM loan (defined as a closed-end mortgage that allows interest rate adjustments during the first 3 years of the loan term).

Unlike the previous iteration of the law, the counseling recommendation is not based on the borrower’s FICO score.

The Illinois Legislature and Department have not provided any guidance regarding training or expertise standards that counselors must meet when making recommendations to the borrowers under the program, apart from requiring that the counselors be “HUD-certified”.

What Information Should Counselors Submit to the Database?

Counselors are required to submit the following information to the Database within seven (7) days of interviewing the borrower:

• The following information that brokers and loan originators also must submit to the Database (see descriptions in list provided above): Identifying Information, Disclosure Information, Notices Required by Law, Previous Financing, Additional Loan Information and Counseling Standards Information.

• Any information from the borrower that confirms or contradicts the information called for above.

• The name of the counselor and address of the HUD-certified housing counseling agency that employs the counselor.

• Information pertaining to the borrower’s monthly expenses that assists the counselor in determining whether the borrower can afford the loan or loans for which the borrower is applying.

• A list of the disclosures furnished to the borrower, as seen and reviewed by the counselor, and a comparison of that list to all disclosures required by law.

• Whether the borrower provided tax returns to the broker or originator or to the counselor, and, if so, who prepared the tax returns.

• A statement of the counselor’s recommendations that indicates the counselor’s response to each of the following statements:

(a) The loan should not be approved due to indicia of fraud;

(b) The loan should be approved; no material problems noted;

(c) The borrower cannot afford the loan;

(d) The borrower does not understand the transaction;

(e) The borrower does not understand the costs associated with the transaction;

(f) The borrower’s monthly income and expenses have been reviewed and disclosed;

(g) The rate of the loan is above market rate;

(h) The borrower should seek a competitive bid from another broker or originator;

(i) There are discrepancies between the borrower’s verbal understanding and the originator’s completed form;

(j) The borrower is precipitously close to not being able to afford the loan;

(k) The borrower understands the true cost of debt consolidation and the need for credit card discipline;

(l) The information that the borrower provided the originator has been amended by the originator.

Although the statute does not obligate the credit counselor to share his or her recommendation with the originator, it is expected that lenders will not process a loan without first receiving a copy of the recommendation. Moreover, the majority of the recommendations are negative ones, which raises the question of what a lender should do if it receives a negative recommendation. Changing any of the loan terms in response to a negative recommendation will

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trigger a new round of required credit counseling. If, however, the borrower and lender disagree with the counselor’s recommendation and want to proceed with the originally contemplated transaction, can they do that? There is no legal prohibition on making a loan following a negative recommendation. In fact, the statute specifically provides that it is not intended “to prevent a borrower from making his or her own decision as to whether to proceed with the transaction.” But that begs the issue of whether the loan would be eligible for sale to many secondary market investors.

The Database Law also provides that counselors may not suggest that a borrower contact another specific company for any reason related to the specific mortgage transaction, but they may generally suggest that the borrower seek another opinion. A counselor or housing counseling agency that in good faith provides counseling will not be liable to a broker, originator or borrower unless there is “willful or wanton misconduct” by the counselor in providing the counseling.

What Information Should Title Insurance Companies or Closing Agents Submit to the Database?

Within ten (10) days after closing, the title insurance company10 or closing agent11 must submit certain information for inclusion in the Database.

•��Identifying� Information—The borrower ’s name, address, social security number or taxpayer identification number, date of birth, and income and expense information contained in the mortgage application.

•��Security�Information—The address, permanent index number and a description of the collateral and information about the loan or loans being applied for.

•��Loan�Terms—The loan terms, including the amount of the loan, the rate and whether the rate is fixed or adjustable, amortization or loan period terms and any other material terms.

•��Tax�Information—Annual real estate taxes for the property, together with any assessments payable in connection with the property to be secured by the collateral and the proposed monthly principal and interest charge of all loans to be taken by the borrower and secured by the property of the borrower

as well as any required escrows and the amounts paid monthly for those escrows.

•��Disbursement�Information—All itemization and descriptions set forth in the RESPA settlement statement including items to be disbursed, payable outside closing “POC” items noted on the statement, and a list of payees and the amounts of their checks.

•��Title� Insurance� Company/Closing� Agent�Information—The name and license number of the title insurance company or closing agent together with the name of the agent actually conducting the closing.

•��Parties�at�Closing—The names and addresses of all originators, brokers, appraisers, sales persons, attorneys, and surveyors that are present at the closing.

•��Additional�Closing� Information—The date of closing, a detailed list of all notices provided to the borrower at closing and the date of those notices, and all information indicated on the Truth in Lending statement and Good Faith Estimate disclosures.

The title insurance company or closing agent must attach to the mortgage a Database-generated certificate of compliance with the law’s requirements. A mortgage cannot be recorded without this certificate. Informal guidance issued by the Department12 indicates that an entity not required to be licensed under RMLA, such as banks and other depository institutions, are exempt entities under the Database Law. Exempt entities are not required to enter information into the Database but, according to the Department, must obtain a certificate of exemption from the closing agent to record their mortgages. If any exempt entity chooses to close its own loans, it must register as a closer.��While real property laws are not generally subject to federal preemption, when the real property requirement is styled as part of an anti-predatory lending law it could be challenged as an impermissible burden on federally chartered lenders.

Also, if any notice of pending suit for foreclosure is recorded on the property within Cook County, a certificate of service must be simultaneously recorded that affirms that a copy of the lis pendens was filed with the Department. If not, the lis pendens is not recordable.

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As a condition to making a first lien, residential mortgage loan, virtually all lenders require a title policy insuring the validity and priority of the lien. By definition, a valid, first lien on the property presupposes that the security instrument is recorded on the real property records. As noted above, a security instrument will not be eligible for recordation in the Cook County land records unless the Department issues a certificate of compliance or exemption. Thus, a title company or closing agent will not be in a position to issue a clean title policy unless and until it receives a certificate of compliance or exemption issued by the Department.

There is the possibility that a title company may seek to issue an exception to its policy relating to compliance with the Database Law in issuing its policy. It would do this based on the possibility that claims will arise regarding the legitimacy of the information submitted to the Database. Such claims may call into question the propriety of the certificate of compliance and thus the original eligibility of the loan for recordation in the real property records. While we think this is unlikely (given that clean title policies were provided when HB 4050 was in effect), title companies may impose additional requirements and costs on lenders as a condition to issuing a clean policy without exception for loans subject to the Database Law.

Penalties for Violations

A violation of the Database Law is an “unlawful practice” under the Fraud Act. (Please see discussion of Fraud Act penalties under “Penalties for Violations of New RMLA Provisions,” below.) Because the Database Law is codified in the Residential Real Property Disclosure Act, similar penalties may also be available under that Act for an action commenced within one year from the earlier of the date of possession, occupancy or recording the instrument of conveyance. There is no express assignee liability under the law, as amended, although the court has latitude to provide equitable relief.

As mentioned above, a counselor or housing counseling agency that in good faith provides counseling will not be liable to a broker, originator, or borrower unless there is “willful or wanton misconduct” by the counselor in providing the counseling.

Potential Impact of Amended Law on Originators

It is clear that the Database reporting requirements will continue to impose a burden on brokers, originators, counselors and closing agents. However, it is difficult to estimate exactly how much time, personnel, and financial resources will have to be spent complying with the law.

Collecting substantial volumes of borrowers’ personal credit information raises obvious privacy concerns. Apart from the general discomfort many borrowers may have with allowing a state government to collect their personal financial information, a more tangible consumer concern is the recent rise of identity theft from large databases. The amended Database Law still does not impose any specific security requirements or structure to protect borrowers’ information residing in the Database, apart from clarifying that the information will not be subject to disclosure under the Freedom of Information Act and that any information or documents the Department’s employees obtain in the course of maintaining and administering the Database are deemed confidential and must not be disclosed. Any request for production of information from the Database must be referred to the Department. However, there still is no guidance on how long the state will retain the Database information.

The amended law still makes no effort to determine whether the counseling agencies have the requisite ability to make the evaluations required in the statutes at all or with any uniformity, among the various approved agencies. Whether a housing counseling agency is HUD-certified continues to be the only eligibility requirement under the law for an agency to be able to assume the responsibility to determine a borrower’s fitness for a loan. Yet, HUD’s only substantive requirement in its final rule published on September 28, 2007 relating to technical proficiency is that the agency employ staff trained in housing counseling and at least half the counselors have at least six months experience in the job they will perform in the agency’s housing counseling program.13 That’s it! We do not question the desire of HUD-approved housing counseling agencies to do the right thing by their clients. Whether they have the technical expertise to do so, however, is not an explicit legal requirement imposed by HUD. By continuing to rely solely on HUD approval as a proxy for expertise, Illinois has

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adopted a system that imposes no material eligibility criteria on the counselors who are empowered to determine the borrower’s eligibility for a loan.

In addition, the counseling recommendations are not binding on a borrower, but does that mean that it is acceptable for a lender to disregard a recommendation?

Potential Impact of Amended Law on Secondary Market

It is not clear how the secondary market will react to the amended Database Law. Purchasers are not subject to the law, and there is no explicit assignee liability for violations of the law. Obviously, if a loan is ineligible for recordation because it is not accompanied by the requisite certificate of compliance (or exemption) from the title company or closing agent, it will not be eligible for sale or securitization under standard purchase criteria. If, however, the loan is recorded, does the secondary market have any reason to worry?

With the previous version of the Database Law, at least one purchaser stated it would not purchase or underwrite the securitization of any loans secured by residential property subject to the law unless the loan seller provided the following documents in the related mortgage file prior to the sale: (i) a certificate of compliance issued by the Department (or certificate of exemption, if applicable); (ii) a clean title policy without any exception relating to HB 4050; and (iii) either written evidence of the Department’s conclusion that the mortgagor did not need credit counseling or, if recommended, a written statement of the credit counselor’s recommendation. That investor further provided that it would reject for purchase or securitization any loan if the recommendations of the credit counselor included any of the negative recommendations that a credit counselor could issue (as set forth above). These requirements may be replicated by purchasers in connection with the amended version of the Database Law.

Among the amended law’s many remaining flaws is the absence of any requirement that the housing counselor’s recommendations be shared with the broker or originator. We assume that originators and purchasers will condition the making and purchasing of any loan on the receipt of the counselor’s recommendation and its retention in the loan file. Assuming a purchaser can review the recommendation,

what does it do with the information? Recall that there is a range of recommendations that the housing counselor may make, almost all of which are negative recommendations. What if the loan closes with a recommendation in the file that “the borrower does not understand the transaction,” “the borrower should seek a competitive bid from another broker or originator,” “there are discrepancies between the borrower’s verbal understanding and the originator’s completed form,” and “the borrower is precipitously close to not being able to afford the loan”? Would a purchaser want a loan with such a recommendation in its possession?

II. New Requirements Applicable to Licensees Under the RMLA

SB 1167 also amends several provisions of the RMLA applicable to licensees under that Act and a prepayment penalty provision applicable to entities subject to the Interest Act. These requirements are becoming common in newly enacted mortgage lending laws in other states. Below we discuss the following six categories of amendments: (1) verification of the borrower’s ability to repay the loan; (2) mortgage broker’s agency relationship with the borrower and additional duties; (3) limitations on prepayment penalties; (4) disclosure requirements; (5) additional requirements; and (6) penalties for violations of the new provisions.

Ability to Repay

A licensee cannot make, provide or arrange for a residential mortgage loan without verifying the borrower’s reasonable ability to repay the loan, including principal and interest, real estate taxes, homeowner’s insurance, assessments, and mortgage insurance premiums, if applicable. For an adjustable rate loan, the licensee must determine the borrower’s ability based on a fully indexed rate, calculated by using the index rate at the time of origination plus the margin that will apply when calculating the adjustable rate under the terms of the loan, assuming a fully amortizing repayment schedule based on the loan term. If the loan allows for negative amortization, the licensee must calculate the principal amount of the loan by including the maximum amount the principal balance may increase due to negative amortization under the terms of the loan.

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The ability to make stated income loans will be extremely limited. The lender or broker must verify the borrower’s income and financial resources by tax receipts, payroll receipts, bank records, or other reasonably reliable methods, based on the circumstances of the proposed loan. A borrower’s mere statement of income and resources will not be deemed sufficient to establish the existence of the income or resources when verifying the reasonable ability to repay.

Notwithstanding the above, a licensee may rely on criteria other than the borrower’s income and financial resources to establish the borrower’s ability to repay, but the licensee must verify the other criteria through reasonably reliable methods and documentation. This leaves open the question of what other criteria will be deemed reasonably reliably methods. For example, could a licensee rely on criteria such as the borrower’s credit history obtained through one of the credit reporting agencies?

Despite strong verification language to support the borrower’s ability to repay, stated income loans are not per se illegal. The law expressly provides that “stated income should be accepted only if there are mitigating factors that clearly minimize the need for direct verification of the borrower’s ability to repay.” No guidance is provided on the types of mitigating factors that would be acceptable.

Broker’s Agency Relationship and Duties

A licensed mortgage broker is considered to have an agency relationship with the borrower in all cases. The broker also has specific duties; the broker must:

• Act in the borrower’s best interest and in good faith toward the borrower.

• Disclose any compensation or remuneration that the broker accepts, gives, charges or realizes, through direct or indirect means, for the broker’s benefit on an expenditure made for the borrower.

• Carry out all lawful instructions that a borrower gives to the broker.

• Disclose all “material facts” of which the broker has knowledge which might reasonably affect the borrower’s rights, interests, or ability to receive the borrower’s intended benefit from the loan, but not facts that are reasonably susceptible to the knowledge of the borrower. Material facts are not defined in the

statute. We hope regulations under the RMLA will clarify this point.

• Use reasonable care in performing duties.

• Account to a borrower for all the borrower’s money and property received as an agent.

A broker is not required to obtain a loan containing terms or conditions that are not available to the broker in the usual course of business or a loan from a lender with whom the broker does not have a business relationship. A mortgage broker also is not prohibited from contracting for or collecting a fee for services rendered and which had been disclosed to the borrower in advance of the provision of those services (however, existing regulations require broker fees collected prior to closing be placed in escrow).14

Prepayment Fees

The following prepayment fee restrictions apply to loans made, refinanced, renewed, extended, or modified on or after June 1, 2008.

A RMLA licensee may not make, provide or arrange a loan with a prepayment penalty unless the licensee makes a written offer to the borrower for a loan without the penalty, and the borrower declines by initialing the offer. The licensee must also disclose the discount in the rate received in consideration for the loan with the penalty.

If the borrower declines the offer, the licensee may impose a penalty for no more than the first three years or the first change date or rate adjustment of a variable rate mortgage, whichever comes first. If prepayment is made during the fixed rate period, the licensee may charge no more than:

• 3% of the total loan amount for prepayment within the first 12-month period;

• 2% of the total loan amount for prepayment within the second 12-month period; or

• 1% of the total loan amount for prepayment within the third 12-month period, if the fixed rate extends 3 years.

Notwithstanding the above, prepayment penalties are prohibited in connection with the sale or destruction of a dwelling secured by a residential mortgage loan.

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Illinois is one of only a handful of states that will apply its prepayment fee restrictions not only to lenders, but also to brokers. Brokers should take note of this requirement; otherwise a broker might be subjected to the penalties described below.

SB 1167 also amends the prepayment penalty provisions in Section 4.1a of Illinois’s Interest Act, which appear to apply to all lenders (whether or not licensed under the RMLA) that make “nonexempt residential mortgage loans” as defined in the RMLA. As amended, the Act provides that in the case of those loans, a lender may charge a prepayment penalty that extends no longer than the fixed rate period of a variable rate mortgage. The same “sliding scale” percentage-based thresholds discussed above apply if prepayment is made during the fixed rate period for the first three years.)

Unlike the amendments to the prepayment fee provision in the RMLA, the amendments to the Interest Act do not offer the alternative of charging the penalty in the first three years or the first change date or rate adjustment of a variable rate mortgage, whichever comes first. Thus, it is unclear whether Section 4.1a of the Interest Act permits a nonlicensee under RMLA to impose a prepayment fee in connection with a fixed-rate residential mortgage loan, or in connection with a loan with a fixed-rate period that extends beyond three years. Further, it remains unclear what Section 4.1a of the Interest Act means when referring to a “nonexempt” loan. While the new provision refers to a “nonexempt residential mortgage loan” as defined in the RMLA, the RMLA does not define “nonexempt residential mortgage loan.” It defines “residential mortgage loan” generally as a loan to a natural person made primarily for personal, family, or household use, primarily secured by a mortgage on residential real property located in Illinois, but does not offer any guidance, other than sheer speculation, as to the meaning of “nonexempt.”

A separate provision in the Interest Act, Section 4, does not appear to be affected by SB 1167, and continues to provide that except for certain loans, whenever the rate of interest exceeds 8% per annum on any loan secured by a mortgage on residential real estate, “it shall be unlawful to provide for a prepayment penalty or other charge for prepayment.” Thus, it appears that the Interest Act continues to prohibit prepayment penalties

on loans for which the interest rate exceeds 8% per year (both for licensees and nonlicensees).

Disclosure and Re-Disclosure Requirements

The law imposes the following four categories of additional disclosure requirements:

•��Notice�of�Change� in�Loan�Terms – A licensee must provide “timely” notice to the borrower of any material change in the terms of the loan prior to closing. A “material change” is: (i) a change in the type of loan offered (e.g., fixed or variable rate, balloon); (ii) a change in the loan term, as reflected in the number of monthly payments due before a final payment is scheduled; (iii) an increase in the interest rate of more than 0.15%, or an equivalent increase in the amount of discount points charged; (iv) a more than 5% increase in the regular monthly payment of principal and interest; (v) a change regarding the requirement or amount of tax or insurance escrow; or (vi) a change regarding the private mortgage insurance requirement and/or payment. A licensee must also provide timely notice to the borrower if any fees payable by the borrower to the licensee increase by more than 10% or $100, whichever is greater.

The licensee must provide the above notices no later than three (3) days after learning of the change or 24 hours before the loan closes, whichever is earlier. Even if the licensee discloses more than three days after learning of the change, it will not be liable for penalties or forfeitures provided it discloses 24 hours prior to closing and the borrower avoids any damage. As is so often the case in these types of statutes, it is not clear whether closing refers to the signing of documents or the disbursement of funds.

The above notice requirements do not apply to certain loan originator licensees that are limited to soliciting loan applications, so long as the solicitor does not discuss terms and conditions with the potential borrower.

•���Comparable�Monthly�Payment�Quotes – A licensee may not state or imply that monthly loan payments that include amounts escrowed for property taxes and homeowner’s insurance are comparable with monthly loan payments that do not include these amounts.

•��Copy�of�Appraisals – A licensee must provide to the borrower a complete copy of the appraisal or AVM report that the lender obtained for use in underwriting

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the loan. The licensee must provide the copy within 3 business days of receipt, but in no event less than 24 hours prior to the closing date. The licensee may send the copy via first class mail, commercial carrier, facsimile or email (if the borrower supplied an email address).

•��Refinancing�Options – If the licensee that makes, provides or arranges a loan discusses the subject of a future loan, the licensee must disclose the circumstances under which a new loan could be considered, with a clear statement that it is not a contract and that the licensee is not representing or promising that the licensee could or would make the new loan at any time in the future.

Additional Requirements

•��Equity�Stripping�and�Loan�Flipping – A licensee may not engage in equity stripping or loan flipping, as those terms are defined in the Illinois Fairness in Lending Act.15

•���Financing� Certain� Insurance� Premiums – A licensee may not make, provide, or arrange for a loan that finances, directly or indirectly, any credit life, credit disability or credit unemployment insurance. It is not considered prohibited financing if insurance premiums are calculated and paid on a monthly basis.

•��Encouraging� Default – A licensee may not recommend or encourage default or the failure to make timely payments on an existing mortgage loan or debt prior to and in connection with the closing or planned closing of a loan that refinances all or any portion of the existing loan or debt.

Penalties for Violations of New RMLA Provisions

Unlike the state’s existing anti-predatory lending law, the High Risk Home Loan Act, violations of the RMLA’s new provisions are not subject to assignee liability. Such violations, however, are subject to the RMLA’s standard penalty provisions. In addition, a borrower injured by a violation of any of the new provisions of the RMLA has a private right of action for the violation. However, the licensee will not be liable if either: (i) within 30 days of the closing and prior to receiving notice from the borrower of the violation, the licensee makes appropriate restitution to the borrower and adjustments to the loan; or (ii) the violation was

not intentional and resulted from a bona fide error in fact, notwithstanding the licensee’s maintenance of procedures reasonably adopted to avoid such errors, and within 60 days of the discovery of the violation and prior to receiving notice from the borrower of the violation, the licensee notifies the borrower of the violation and makes appropriate restitution to the borrower and adjustments to the loan.

The amended RMLA includes a separate penalty provision in connection with the notice of change in loan terms requirement. If a licensee does not disclose the increase in the total amount of the fee paid by the borrower to the broker, the broker must refund to the borrower the amount by which the fee was increased. If the fee was financed into the loan, the broker must also refund the interest charged to finance the fee.

The Attorney General has the authority to enforce any violation of the Act’s new provisions, other than the prohibition against encouraging default, as an “unlawful practice” under the Consumer Fraud and Deceptive Business Practices Act (the “Fraud Act”). Under the Fraud Act, violators will be subject to: (a) injunctions; (b) revocation, forfeiture or suspension of any license or other evidence of authority to do business in Illinois; (c) appointment of a receiver; (d) dissolution of domestic corporations or association suspension or termination of the right of foreign corporations or associations to do business in Illinois; (e) restitution; and (f) civil penalties of no more than $50,000. If the court finds that the unlawful practice was entered into with the intent to defraud, the court may impose a civil penalty of no more than $50,000 per violation. Additional penalties of $10,000 per violation may be imposed for violations committed against a person 65 years old or older. Any person who suffers actual damage as a result of a violation committed by another person may bring an action against that person within three (3) years after the cause of action accrued. The court may award actual economic damages or any other relief the court deems proper, which could include punitive damages, injunctive relief, costs and attorney’s fees. Class actions may be available.

SB 1167 includes a safe harbor from liability for persons or entities acting in conformity with a written interpretation of the RMLA that is in effect at the time of that act. This safe harbor applies even if the written interpretation is later amended, rescinded, or determined to be invalid for any reason. The law

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expressly authorizes persons or entities to submit a written request to the Department for a written interpretation of the RMLA, which the Department may choose to provide in its sole discretion. A written interpretation is only valid if it is signed by the Secretary, or his or her designated Director of Financial and Professional Regulation, and the Department’s General Counsel. A written interpretation expires two years after the date it was issued.

1 Chaos in Cook County: Precipitously Close to Lending Database [add link].

2 In response to HB 4050, the Cook County Recorder of Deeds in cooperation with the Department required an exemption certificate be used to allow the recording of any exempt mortgage although there was no statutory basis for this requirement. It appears that the Department will continue to require an exemption certificate on exempt loans notwithstanding the lack of statutory authority in SB 1167 for such requirement.

3 A “broker” is defined as a person, partnership, association, corporation, or limited liability company, other than those persons, partnerships, associations, corporations, or limited liability companies exempted from licensing under the RMLA, who performs the following activities: (a) soliciting, processing, placing, or negotiating a residential mortgage loan, which means for compensation or gain, either directly or indirectly, accepting or offering to accept an application for a residential mortgage loan, assisting or offering to assist in the processing of an application for a residential mortgage loan on behalf of a borrower, or negotiating or offering to negotiate the terms or conditions of a residential mortgage loan with a lender on behalf of a borrower including, but not limited to, the submission of credit packages for the approval of lenders, the preparation of residential mortgage loan closing documents, including a closing in the name of a broker; and (b) the act of helping to obtain from another entity, for a borrower, a loan secured by residential real estate situated in Illinois or assisting a borrower in obtaining a loan secured by residential real estate situated in Illinois in return for consideration to be paid by either the borrower or the lender including, but not limited to, contracting for the delivery of residential mortgage loans to a third party lender and soliciting, processing, placing, or negotiating residential mortgage loans. 765 Ill. Comp. Stat. 77/70(a); 205 Ill. Comp. Stat. 635/1-4(c), (o), (p).

4 An “originator” is any natural person who, for compensation or in the expectation of compensation, either directly or indirectly makes, offers to make, solicits, places, or negotiates a residential mortgage loan. 765 Ill. Comp. Stat. 77/70(a); 205 Ill. Comp. Stat. 635/1-4(hh).

5 An “originator” is defined in the Database Law as that term is defined in Section 1-4(hh) of the RMLA (see Endnote iv, above), except the term excludes an “exempt person.” 765 Ill. Comp. Stat. 77/70(a). Under the Database Law, an “exempt person” is defined as that term is defined in Section 1-4(d)(1) and (d)(1.5) of the RMLA. Id. Under Section 1-4(d)(1) and (d)(1.5), an exemption is available for the following: (a)(i) any banking organization or foreign banking corporation licensed by the Illinois Commissioner of Banks and Real Estate (the “Commissioner”) or the United States Comptroller of the Currency (the “OCC”) to transact business in Illinois; (ii) any national bank, federally chartered savings and loan association, federal savings bank, federal credit union; (iii) any pension trust, bank trust, or bank trust company; (iv) any bank, savings and loan association, savings bank, or credit union organized under the laws of Illinois or any other state; (v) any Illinois Consumer Installment Loan Act licensee; (vi) any insurance company authorized to transact business in Illinois; (vii) any entity engaged solely in commercial mortgage lending; (viii) any service corporation of a savings and loan association or savings bank organized under the laws of Illinois or the service corporation of a federally chartered savings and loan association or savings bank having its principal place of business in Illinois, other than a service corporation licensed or entitled to reciprocity under the Real Estate License Act of 2000; or (ix) any first tier subsidiary of a bank, the charter of which is issued under the Illinois Banking Act by the Commissioner, or the first tier subsidiary of a bank chartered by the OCC and that has its principal place of business in Illinois, provided that the first tier subsidiary is regularly examined by the Commissioner or the OCC, or a consumer compliance examination is regularly conducted by the Federal Reserve Board; and (b) any employee of a person or entity mentioned in (a), above. 205 Ill. Comp. Stat. 635/1-4(d)(1), (1.5).

“Broker” is defined under the Database Law as that term is defined in Section 1-4(p) of the RMLA (see Endnote iii, above). 765 Ill. Comp. Stat. 77/70(a). Under the RMLA, the definition of “broker” exempts any person listed under Section 1-4(d)(1) through (6) of the RMLA. 205 Ill. Comp. Stat. 635/1-4(p). Thus, the entities in Section 1-4(d)(1) and (d)(1.5), set forth above, are exempt from the definition of “broker” under the Database Law (and are exempt from licensing under the RMLA). In addition, the following entities, listed in Section 1-4(d)(2) through (6), are exempt from the definition of “broker” under the Database Law (and are exempt from licensing under the RMLA) but appear to remain subject to the requirements in the Database Law when acting as an “originator”: (a) any person or entity that does not originate mortgage loans in the ordinary course of business making or acquiring residential mortgage loans with his or her or its own funds for his or her or its own investment without intent to make, acquire, or resell more than 10 residential mortgage loans in any one calendar year. (b) Any person employed by a licensee to assist in the performance of the activities regulated by the RMLA who is

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compensated in any manner by only one licensee. (c) Any person licensed pursuant to the Real Estate License Act of 2000, who engages only in the taking of applications and credit and appraisal information to forward to a licensee or an exempt entity under the RMLA and who is compensated by either a licensee or an exempt entity under the RMLA, but is not compensated by either the buyer (applicant) or the seller. (d) Any individual, corporation, partnership, or other entity that originates, services, or brokers residential mortgage loans, as those activities are defined in the RMLA, and who or which receives no compensation for those activities, subject to the Commissioner’s regulations with regard to the nature and amount of compensation. (e) A person who prepares supporting documentation for a residential mortgage loan application taken by a licensee and performs ministerial functions pursuant to specific instructions of the licensee who neither requires nor permits the preparer to exercise his or her discretion or judgment; provided that this activity is engaged in pursuant to a binding, written agreement between the licensee and the preparer that: (i) holds the licensee fully accountable for the preparer’s action; and (ii) otherwise meets the requirements of Section 1-4 and the RMLA, does not undermine the purposes of the RMLA, and is approved by the Commissioner. 205 Ill. Comp. Stat. 635/1-4(d)(2)-(6).

6 “Credit score” is defined as “a credit risk score as defined by the Fair Isaac Corporation, or its successor, and reported under such names as ‘BEACON’, ‘EMPIRICA’, and ‘FAIR ISAAC RISK SCORE’ by one or more of the following credit reporting agencies or their successors: Equifax, Inc., Experian Information Solutions, Inc., and TransUnion LLC. If the borrower’s credit report contains credit scores from 2 reporting agencies, then the broker or loan originator shall report the lower score. If the borrower’s credit report contains credit scores from 3 reporting agencies, then the broker or loan originator shall report the middle score.” 765 Ill. Comp. Stat. 77/70(a).

7 “Interest only” is defined as a closed-end loan that permits one or more interest payments without any reduction in the principal balance, excluding the first payment on the loan. Id.

8 “Negative amortization” is “an amortization method under which the outstanding balance may increase at any time over the course of the loan because the regular periodic payment does not cover the full amount of interest due.” Id.

9 “Points and fees” means: (i) all items that are disclosed as points and fees under the 2000 version of Section 226.32 of Regulation Z (“HOEPA”); (ii) the premium of any single premium credit life, credit disability, credit unemployment or any other life or health insurance that is financed directly or indirectly into the loan; and (iii) all compensation paid directly or indirectly to a mortgage broker, including a broker that originates a loan in its own name in a table funded

transaction, not otherwise included in (i) above (regulators take the position this includes yield spread premiums). See id.; 815 Ill. Comp. Stat. 137/10.

The 2000 version of HOEPA requires the following items be disclosed as points and fees: (i) all items disclosed as finance charges under Section 226.4(a) and (b) except for interest or the time-price differential; (ii) all front-end compensation paid to mortgage brokers; and (iii) all items disclosed under 12 C.F.R. Section 226.4(c)(7) (other than the amounts held for future payment of taxes), unless the charge is reasonable, the creditor receives no direct or indirect compensation in connection with the charge, and the charge is not paid to an affiliate of the creditor.

10 A “title insurance company” is defined as “any domestic company organized under the laws of [Illinois] for the purpose of conducting the business of guaranteeing or insuring titles to real estate and any title insurance company organized under the laws of another State, the District of Columbia, or a foreign government and authorized to transact the business of guaranteeing or insuring titles to real estate in [Illinois].” 765 Ill. Comp. Stat. 77/70(a).

11 A “closing agent” is defined as “an individual assigned by a title insurance company or a broker or originator to ensure that the execution of documents related to the closing of a real estate sale or the refinancing of a real estate loan and the disbursement of closing funds are in conformity with the instructions of the entity financing the transaction.” Id.

12 See “Anti-Predatory Lending Database Program Fact Sheet available at www.idfpr.com/finlit101/sb1167.asp,

13 See 24 C.F.R.§ 214.103(g)(2).

14 Ill. Admin. Code tit. 38 § 1050.1335; see also id. §1050.440

15 “Equity stripping” means “to assist a person in obtaining a loan secured by the person’s principal residence for the primary purpose of receiving fees related to the financing when (i) the loan decreased the person’s equity in the principal residence and (ii) at the time the loan is made, the financial institution does not reasonably believe that the person will be able to make the scheduled payments to repay the loan.” 815 Ill. Comp. Stat. 120/2(d). The term does not include reverse mortgages (defined in Section 5a of the Illinois Banking Act, Section 1-6a of the Illinois Savings and Loan Act of 1985, or Section 46(3) of the Illinois Credit Union Act). Id. “Loan flipping” means “to assist a person in refinancing a loan secured by the person’s principal residence for the primary purpose of receiving fees related to the refinancing when (i) the refinancing of the loan results in no tangible benefit to the person and (ii) at the time the loan is made, the financial institution does not reasonably believe that the refinancing of the loan will result in a tangible benefit to the person.” Id. 120/2(e).

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Mortgage Banking & Consumer Credit Alert

K&L Gates’ Mortgage Banking & Consumer Finance practice provides a comprehensive range of transactional, regulatory compliance, enforcement and litigation services to the lending and settlement service industry. Our focus includes first- and subordinate-lien, open- and closed-end residential mortgage loans, as well as multi-family and commercial mortgage loans. We also advise clients on direct and indirect automobile, and manufactured housing finance relationships. In addition, we handle unsecured consumer and commercial lending. In all areas, our practice includes traditional and e-commerce applications of current law governing the fields of mortgage banking and consumer finance.

For more information, please contact one of the professionals listed below.

LAWYERS Boston

R. Bruce Allensworth bruce.allensworth@klgates.com +1.617.261.3119 Irene C. Freidel irene.freidel@klgates.com +1.617.951.9154 Stephen E. Moore stephen.moore@klgates.com +1.617.951.9191 Stanley V. Ragalevsky stan.ragalevsky@klgates.com +1.617.951.9203 Nadya N. Fitisenko nadya.fitisenko@klgates.com +1.617.261.3173 Brian M. Forbes brian.forbes@klgates.com +1.617.261.3152 Andrew Glass andrew.glass@klgates.com +1.617.261.3107 Phoebe Winder phoebe.winder@klgates.com +1.617.261.3196

Los Angeles

Thomas J. Poletti thomas.poletti@klgates.com +1.310.552.5045

Miami

Paul F. Hancock paul.hancock@klgates.com +1.305.539.3378 Melissa Sanchez melissa.sanchez@klgates.com +1.305.539.3373

New York

Elwood F. Collins elwood.collins@klgates.com +1.212.536.4005 Steve H. Epstein steve.epstein@klgates.com +1.212.536.4830 Drew A. Malakoff drew.malakoff@klgates.com +1.216.536.4034

San Francisco

Jonathan Jaffe jonathan.jaffe@klgates.com +1.415.249.1023 Erin Murphy erin.murphy@klgates.com +1.415.249.1038

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Holly K. Towle holly.towle@klgates.com +1.206.370.8334

Washington, D.C.

Costas A. Avrakotos costas.avrakotos@klgates.com +1.202.778.9075 Melanie Hibbs Brody melanie.brody@klgates.com +1.202.778.9203 Eric J. Edwardson eric.edwardson@klgates.com +1.202.778.9387 Steven M. Kaplan steven.kaplan@klgates.com +1.202.778.9204 Phillip John Kardis II phillip.kardis@klgates.com +1.202.778.9401 Rebecca H. Laird rebecca.laird@klgates.com +1.202.778.9038 Laurence E. Platt larry.platt@klgates.com +1.202.778.9034 Phillip L. Schulman phil.schulman@klgates.com +1.202.778.9027 H. John Steele john.steele@klgates.com +1.202.778.9489 Ira L. Tannenbaum ira.tannenbaum@klgates.com +1.202.778.9350 Nanci L. Weissgold nanci.weissgold@klgates.com +1.202.778.9314

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Mortgage Banking & Consumer Credit Alert

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