Pending Suitability Regulations Leave Mortgage Lenders Exposed to Potential Violations

Current and proposed regulations require lenders to select loans that are suitable to borrowers and watch out for their best interest

Claims that loan originators have failed to consider the interests of their customers have proliferated over the last few years, particularly in the subprime arena. The result is a wave of proposed and enacted laws mandating lenders to ensure that certain types of residential mortgage loans benefit borrowers, in states that include New York, Massachusetts, Maine, Ohio, Minnesota and North Carolina. So far, “duty of care” or suitability regulations—those that mandate lenders to act in the borrower’s interest—are currently imposed at the state level, but that may change as Congress continues to consider federal regulations focused on mortgage loan reform.

“Suitability has become a big focus for 2008, but as many lenders are finding, it’s hard to implement and enforce,” explains Larry Platt, a Washington DC-based attorney with K&L Gates who specializes in residential mortgage lending law. “Regulators want to ensure that borrowers are not put into loans that aren’t good for them. Suitability can mean different things to different people. In this case, regulators want to ensure that the mortgage loan provided to the borrower offers a net tangible benefit to the borrower; that the loan originator hasn’t been steering or directing a borrower into a loan program that’s not as beneficial to the borrower as it could be; and that the borrower has a reasonable ability to repay the loan. Depending on the law in question, failure to satisfy legal requirements could result in monetary damages and in some cases, rescission of the loan.”

In the majority of instances, mortgage loans are selected for the borrower based on the borrower’s stated preferences and the loan officer’s personal evaluation, which is not the optimum way to find the best, most suitable loan for the borrower. “Regulators want loan originators to question a borrower’s judgment, because borrowers don’t always know each product on the market, and won’t always know what’s best for them,” explains Platt. “Suitability is in the eyes of the beholder and requires a subjective judgment for which there is no legal certainty. Establishing a good faith, objective evaluation method can only help reduce the risk of a legal violation because it gives lenders a uniform way of making a decision, so there’s more consistency and less of a margin for error.”

Lenders face a multi-faceted challenge in addressing the policies underlying the current suitability regulations, as well as in preparing for pending changes. In order to meet these challenges, lenders need to adjust their assessment methods away from evaluating loans based on the borrower’s or loan officer’s choosing. First, lenders must quantify net tangible benefits and distribute these calculations enterprise-wide to insure consistent application; second, they should use a completely transparent automated decisioning process to determine the borrower’s ability to repay; and third, lenders must begin evaluating each borrower against all available loan products and pricing so that they can get an objective determination of which loan is best suited for the given borrower.

“Most lenders follow a loan origination process that pushes the decisioning process—or decisioning iterations—towards the end of the mortgage cycle,” says Linda Simmons, senior vice president of business development for Overture Technologies, the mortgage industry’s leading developer of decisioning technology. “This approach puts the emphasis on the three suitability criteria days and weeks after the borrower initiates the process, which is not good because these delays can interfere with those criteria being achieved. However, a decision-centric approach—where the decisioning is moved up to the front of the lending process and drives the process—better supports the good faith evaluation method. Decisioning technology can support net benefit and ability to repay calculations while facilitating a level of transparency and consistency that work for both the borrower and the lender. Implementing objective loan evaluation practices and staying one step ahead of regulations is a wise idea. The last thing lenders need is to be unprepared in the face of change.”

Certain technologies, such as Overture’s Mozart Decisioning Suite, work to help lenders with their suitability challenges. Using a decision-centric approach, Mozart can evaluate the borrower’s loan application against every available lender program, rather than merely trying to match the borrower’s application to the loan program that the borrower or loan officer deems best. Additionally, Mozart also tracks all loans presented, as well as all decisions considered, adding to the transparency and consistency the suitability legislation demands. Mozart provides sophisticated English-language rules-writing capabilities for net benefit and ability to repay calculations. It is also well suited to interface directly with compliance solutions that specialize in the relevant calculations.

In short, technologies such as Mozart serve to take subjectivity out of the equation and provide the lender with an objective ranking of the loans that are best for the borrower. “Using technology to identify suitable loans is no longer an option, it’s a necessity,” adds Simmons.

About Overture Technologies

Overture Technologies is a Mortgage Technology magazine Top 50 service provider and the mortgage industry’s leader in decisioning solutions for loan sourcing, aggregation and investor delivery. Overture’s solutions automate decisioning and re-decisioning throughout the various stages of the loan cycle from point of sale through secondary, turning time-consuming processes into automated tasks that are completed in seconds. Established in 2000, Overture’s products include the Mozart Suite, the mortgage industry’s premier non-conforming automated underwriting and pricing system; the Mozart Portals, the credit decision engine which both aggregates data and interprets multi-investor complex risk rules; Tape Cracker, which leverages industry standard formats for data interpretation and management for multiple asset classes. For further information, please contact Overture Technologies at (301) 492-2140 or visit www.OvertureTechnologies.