How to address compliance risk in loan sale due diligence
Minimizing assignee liability risks in residential mortgage loan sales
WHITE PAPER |
Purchasers of residential mortgage loans need to investigate more than the credit risk of those loans when conducting due diligence. Provisions of the Truth in Lending Act (TILA), the Real Estate Settlement Procedures Act (RESPA) and the Home Ownership and Equity Protection Act (HOEPA), as well as the Dodd-Frank Act and recent provisions to TILA and RESPA, create significant assignee liability risks for the purchasers of such loans. In some cases, regulatory failures by the original lender can grant the borrower the right to rescind the loan. If the consumer receives inaccurate or incomplete disclosures, the rescission right can last for up to three years after the consummation of the transaction or until three days after the inaccuracy or incompleteness is resolved, whichever comes first.
Nor are recession rights the only concern. Assignees can also face civil actions from borrowers or enforcement actions by any of the various regulatory agencies for TILA violations that are apparent on the face of the disclosure statement, as defined in the regulations, unless the assignment of the loan was involuntary. Lenders or assignees subject to a civil action face statutory and actual damages plus finance charges not less than $400 but not more than $4,000 for credit secured by real property or dwellings in addition to return of interest and principal payments and other charges and assessments paid by the borrower. Under a class action, the creditor may be liable up to the lesser of $1 million or 1 percent of the creditor’s net worth. Statutory damages are distinct from actual damages, which are available in all private suits under TILA if the violation caused actual harm to the borrower, and from attorneys’ fees, which are available in any successful action for liability under TILA.
In a typical loan sale due diligence, the objectives are to:
Validate reported loan level data against available information in the loan file
Confirm whether the value of the underlying property is supportable
Verify that loans were underwritten according to the stated underwriting guidelines
Determine if loans were originated in accordance with laws and regulations
Information gathered during this process is then used to measure risks in the transaction. Risks of the transaction that have been identified are addressed and a plan to mitigate such risks is conceived by the buyer. Financial and economic risks are primarily mitigated through pricing. Legal and compliance risks are provided for in the purchase and sale agreement through representations and warranties, put options or other measures.
RSM’s white paper, Addressing compliance risks in loan sale due diligence, offers further insights into the risks and due diligence remedies when purchasing residential mortgage loans.