California Higher-Priced Mortgage Loan Audits

UPDATED: July 9, 2010 (Revisions are highlighted in yellow.)

California Assembly Bill 260, which was signed into law on October 11, 2009, established a new category of California "higher-priced mortgage loans" ("HPML"). AB 260 amends the California Financial Code by adding Division 1.9 (commencing with Section 4995) (the "California HPML Law") and becomes effective for all higher-priced mortgage loans originated on or after July 1, 2010. This article describes some of the features of, and the audits DocMagic is implementing in connection with, the new California HPML Law.

California Higher-Priced Mortgage Loans Defined

California Financial Code Section 4995(a) defines a "higher-priced mortgage loan" by referring to the provisions under Regulation Z that apply to higher-priced mortgage loans. Section 4995(a) provides:

"Higher-priced mortgage loan" has the meaning set forth in Part 226 of Title 12 of the Code of Federal Regulations.

Accordingly, as a higher-priced mortgage loan in California is essentially a federal higher-priced mortgage loan that is secured by covered property in California, the process by which a California higher-priced mortgage loan determination is made is identical to the process by which a Federal higher-priced mortgage loan determination is made (also referred to as a "Section 35" loan (§226.35)). To review our prior discussion of Federal HPML regulations and DocMagic's process for determining whether a loan is a Federal HPML, please click here.

Applicability & Coverage:

Occupancy: The California HPML Law applies only to owner-occupied dwellings. The occupancy status for a California HPML loan stems from Reg. Z §226.35(a), which provides that a [federal] higher-priced mortgage loan is a "consumer credit transaction secured by the consumer's principal dwelling." "Consumer credit" is defined in Regulation Z as, "[C]redit offered or extended to a consumer primarily for personal, family, or household purposes" (§226.2(a)(12)).
Property Type: The California HPML Law covers condominiums, cooperatives, mobile homes and trailers that are used as a residence. A "dwelling" is defined in Regulation Z as "[a] residential structure that contains one to four units, whether or not that structure is attached to real property. The term includes an individual condominium unit, cooperative unit, mobile home, and trailer, if it is used as a residence." (§226.2(a)(19)).
Loan Purpose and Lien Type: The California HPML Law covers both purchase money and refinance loans, regardless of lien position, and applies to conventional loans, construction-to-perm loans, government loans (i.e., FHA, VA and USDA loans), and any other loan with a term greater than 12 months. Construction loans (bridge loans with terms of 12 months or less), reverse mortgage loans, and home equity lines of credit are excluded from coverage under the California HPML Law.
APR & Lock-in Rate: As with Federal HPML regulations, a California HPML loan will exist if the loan's annual percentage rate exceeds the average prime offer rate by 1.50% for first mortgages or 3.50% for subordinate (junior) mortgages. The average prime offer rate will be determined by applying the published rate for a comparable term at the time the interest rate is set (the lock-in date). The "average prime offer rate" is defined by reference to the average prime offer rates published by the Board of Governors of the Federal Reserve. The average prime offer rates are a survey-based estimate of APRs currently offered on prime mortgage loans of a comparable type. The Board publishes two separate tables, one for fixed rate loans (the "Average Prime Offer Rates - Fixed" accessible here) and another for adjustable rate loans (the "Average Prime Offer Rates - Adjustable" accessible here). Average prime offer rates are published on a weekly basis on Friday, effective as of the following Monday. Additional information about the average prime offer rates is available here and here.

Restrictions

California higher-priced mortgage loans will be subject to a number of restrictions and prohibitions, including but not limited to the following:

Negative Amortization: A licensed person covered by the California HPML Law shall not make a higher-priced mortgage loan that contains a provision for negative amortization. Negative amortization, regardless if prescribed by a borrower's choice of multiple payment options or provided by the terms of a loan, is prohibited.
Prepayment Penalty: The maximum prepayment penalty term is 24 months. A penalty, if assessed, may not exceed two percent (2.00%) of the principal balance prepaid during months one through 12 or one percent (1.00%) of the principal balance prepaid during months 13 through 24.
Repayment Ability: While the California HPML provisions do not specifically require a determination of a borrower's repayment ability, it should be noted that provisions in Regulation Z would have applicability if triggered by §226.35(b)(1), or if the loan was also otherwise subject to Section 32 (§226.32). (See Reg. Z §226.34(a)(4)).
Brokerage Services: If a mortgage broker1 receives compensation, including a yield spread premium, fee, commission, or any other compensation, on a California HPML loan with a prepayment penalty provision, the broker would not be allowed to receive a higher amount of compensation than if the same loan was arranged without a prepayment penalty.
HPML Avoidance: A licensed person covered by the California HPML Law shall not split a covered loan into separate parts (e.g., a combined first and second mortgage transaction) or utilize an open-end credit program when an applicant's loan terms create a covered closed-end credit program, for the purpose and with the intent of evading the provisions of the California HPML Law.

Persons and Licensees Subject to California HPML Law

The following licensed persons2 are subject to the California HPML Law:

Mortgage Brokers and Real Estate Brokers subject to the Real Estate Law
Brokers and Lenders subject to the California Finance Lenders Law
Lenders subject to the Residential Mortgage Lending Act
Commercial and Industrial Banks subject to the Banking Law
Savings Associations subject to the Savings Association law
Credit Unions subject to the California Credit Union Law

California Higher-Priced Mortgage Loan Audits

If a loan meets the definition of a California higher-priced mortgage loan, then a warning displays substantially as follows:

WARNING: THIS LOAN IS A CALIFORNIA HIGHER-PRICED MORTGAGE LOAN ("CA HPML") (CA FIN. CODE SECTIONS 4995-4995.6).

To establish whether or not a loan is covered by California HPML, it will be necessary to determine if the interest rate set exceeds the average prime offer rate as of the date the interest rate is set for the comparable type of loan (fixed or ARM) and loan term. In order to make that determination, a rate lock date must be entered in the worksheet, and if absent, then a warning will display substantially as follows:

WARNING: RATE LOCK DATE IS MISSING; DOCMAGIC HAS DEFAULTED TO THE DOCUMENT DATE OF ___ TO RUN THE CA HPML AUDIT.

NOTE: If the Rate Lock Date has not yet been established, we suggest that you simply enter the date on which you are running the audit until such time as the Rate Lock Date is established. If the Rate Lock Date is missing, the DocMagic system will default to the document date.

If a loan meets the definition of a California HPML, includes a prepayment penalty provision, and a broker is a party to the transaction, then a warning displays substantially as follows:

WARNING: THIS LOAN IS A CA HPML LOAN. AS THIS LOAN PROVIDES FOR A PREPAYMENT PENALTY, THE MORTGAGE BROKER CANNOT RECEIVE COMPENSATION THAT EXCEEDS THE COMPENSATION THAT THE BROKER WOULD OTHERWISE RECEIVE FOR ARRANGING A CA HPML WITHOUT A PREPAYMENT PENALTY. (CA FIN. CODE SECTION 4995.2(e)(1)).

If a loan meets the definition of a California HPML, provides for a prepayment penalty, and the prepayment penalty term is greater than 24 months, then a warning displays substantially as follows:

WARNING: MAXIMUM PREPAYMENT PENALTY TERM ON A CA HPML IS 24 MONTHS. (CA FIN. CODE SECTION 4995.1)

If a loan meets the definition of a California higher-priced mortgage loan and contains an excessive prepayment penalty, then a warning displays substantially as follows:

WARNING: THE MAXIMUM CA HPML PREPAYMENT PENALTY ALLOWED IS 2% IN THE FIRST YEAR AND 1% IN THE SECOND YEAR (ON THE PRINCIPAL BALANCE PREPAID) (CA FIN. CODE SECTION 4995.1).

In addition to the prepayment audit outlined above, if we determine that a loan is a California HPML, and the loan provides for a prepayment penalty, we will default in the closing loan package a Prepayment Addendum to Note ("Addendum") and a Prepayment Rider to the Security Instrument ("Rider"). If the loan terms provide for a hard prepayment penalty, the DocMagic file names for the Addendum and Rider are CAPATNHP.PPF and CAPRHP.PPF, respectively. If the loan terms provide for a soft prepayment penalty, the DocMagic file names for the Addendum and Rider are CAPATNHPS.PPF and CAPRHPS.PPF, respectively. Further note that as the California HPML will also constitute a federal higher-priced mortgage loan under Reg. Z Section 226.35, the Higher-Priced Mortgage Loan Addendum to Prepayment Penalty Addendum/Rider ("Addendum") will also return by default in the closing package. To read more about the federal HPML and the Addendum that automatically returns in the closing package, please click here.

If a loan meets the definition of a California higher-priced mortgage loan and contains negative amortization, then a warning displays substantially as follows:

WARNING: NEGATIVE AMORTIZATION IS PROHIBITED ON A CA HPML LOAN (CA FIN. CODE SECTION 4995.2(g).

California Higher-Priced Mortgage Loan Cure Provision

Pursuant to CA Financial Code §4995.2(h):

A licensed person who makes a higher-priced mortgage loan and who, when acting in good faith, fails to comply with this section, shall not be liable if the licensed person establishes either of the following:

(1) Within 90 days of the loan closing and prior to the institution of any action against the licensed person under this section, the licensed person did all of the following:
(A) Notified the borrower of the compliance failure.
(B) Tendered appropriate restitution.
(C) Offered, at the borrower's option, either to make the higher-priced mortgage loan comply with the requirements of this division or change the terms of the loan in a manner beneficial to the borrower so that the loan will no longer be considered a higher-priced mortgage loan subject to the provisions of this division.
(D) Within a reasonable period of time following the borrower's election of remedies, took appropriate action based on the borrower's choice.

(2) (A) The compliance failure was not intentional and resulted from a bona fide error notwithstanding the maintenance of procedures reasonably adopted to avoid those errors, and within 120 days after receipt of a complaint or the discovery of the compliance failure or the licensed person's receipt of written notice of the compliance failure, the licensed person did all of the following:
(i) Notified the borrower of the compliance failure.
(ii) Tendered appropriate restitution.
(iii) Offered, at the borrower's option, either to make the higher-priced mortgage loan comply with the requirements of this division or change the terms of the loan in a manner beneficial to the borrower so that the loan will no longer be considered a higher-priced mortgage loan subject to the provisions of this division.
(iv) Within a reasonable period of time following the borrower's election of remedies, took appropriate action based on the borrower's choice.
(B) For purposes of this subdivision, examples of a bona fide error include clerical, calculation, computer malfunction and programming, and printing errors.

The above audits will be implemented by the California HPML's effective date of July 1, 2010. Please feel free to contact DocMagic's Compliance Department if you have any questions or comments regarding the California HPML audits.

1 "Mortgage broker" means a licensed person who provides mortgage brokerage services. For purposes of this division, a licensed person who makes home loans is a "mortgage broker," and subject to the requirements of this division applicable to mortgage brokers, only with respect to transactions in which the licensed person provides mortgage brokerage services. "Mortgage brokerage services" means arranging or attempting to arrange, as exclusive agent for the borrower or as dual agent for the borrower and lender, for compensation or in expectation of compensation, paid directly or indirectly, a higher-priced mortgage loan made by an unaffiliated third party.

2 "Licensed person" means a real estate broker licensed under the Real Estate Law (Part 1 (commencing with Section 10000) of Division 4 of the Business and Professions Code), a finance lender or broker licensed under the California Finance Lenders Law (Division 9 (commencing with Section 22000)), a residential mortgage lender licensed under the California Residential Mortgage Lending Act (Division 20 (commencing with Section 50000)), a commercial or industrial bank organized under the Banking Law (Division 1 (commencing with Section 99)), a savings association organized under the Savings Association Law (Division 2 (commencing with Section 5000)), and a credit union organized under the California Credit Union Law (Division 5 (commencing with Section 14000)).