The Small Servicer Exemption to the Consumer Financial Protection Bureau’s Mortgage Servicing Rules
This year ushered in new mortgage servicing rules promulgated by the Consumer Financial Protection Bureau (“Bureau”). The rules implement certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), which was passed in 2010 to protect consumers from perceived abuses in the financial services industry.
By now, most bankers are familiar with the rules, but questions are still raised about the exemptions. Specifically, which of the mortgage servicing rules apply to my bank? This article focuses on the exemptions, and in particular, the small servicer exemption.
The mortgage servicing rules are found in either Regulation Z - Truth in Lending Act or Regulation X - Real Estate Settlement Procedures Act. Exemptions can occur in a variety of ways, e.g., by definition or by an affirmative statement that certain loans are exempt. The new mortgage servicing rules created a new exemption category, called the “Small Servicer” exemption.
Creating the Small Servicer Exemption
Dodd-Frank tasked the Bureau with considering potential costs and benefits of the proposed regulations, and in particular, the impact on smaller financial institutions. Dodd-Frank also gave the Bureau authorization to create exemptions where appropriate.
The Bureau’s analysis of the proposed mortgage servicing rules considered the business model that has evolved for servicing high volumes of mortgage loans, which the Bureau distinguished from servicers that rely on local reputation and are therefore motivated to provide what the Bureau considered higher quality servicing. Generally, the latter are community banks and credit unions that service only loans they originate, build relationships with their customers and depend upon repeat business. Beginning with this premise, and with input from its Small Business Review Panel, the Bureau concluded that an exemption to the mortgage servicing rules was appropriate for servicers that (i) service a relatively small number of loans and (ii) originate the loans and retain either ownership or servicing rights.
Defining the Small Servicer
(12 C.F.R. 1026.41(e)(4))
The final regulations define a Small Servicer as one that, (i) together with affiliates, services 5,000 or fewer mortgage loans, (ii) for which the servicer or affiliate is the creditor or assignee. Both prongs must be met to qualify as a Small Servicer. A servicer (or affiliate) is a creditor or assignee if it currently owns or originated the loan.
Only closed-end consumer credit transactions secured by a dwelling are considered, both for counting the number of loans and for qualifying status as creditor or assignee. Open-end lines of credit are excluded. Also excluded are reverse mortgages and loans secured by a timeshare plan. For example, if the servicer (with affiliate) services 5,200 mortgage loans, but 300 of them are reverse mortgages, the servicer may qualify as a Small Servicer because the 300 reverse mortgages are not included in the loan count.
If the servicer is not the creditor or assignee for one or more of the mortgage loans it services, the servicer cannot qualify as a Small Servicer regardless of how many loans it services. For example, if a servicer services 4,500 loans, but neither the servicer nor an affiliate is a creditor or assignee for 100 of those loans, the servicer cannot qualify as a Small Servicer, even if the servicer has mortgage servicing rights for those 100 loans.
If the servicer services 4,000 loans and its affiliate services 2,000 loans, the servicer cannot qualify as a Small Servicer because the total exceeds 5,000. Mortgage loans acquired by a servicer or affiliate as part of a merger or acquisition are considered loans for which the servicer or affiliate is the creditor.
Small Servicer status is not lost by retaining a subservicer, but a subservicer does not gain Small Servicer status by subservicing for a Small Servicer. Both master servicer and subservicer must meet the threshold qualifications. Further, a subservicer can be a Small Servicer only if the master servicer is a Small Servicer. Generally, the subservicer is not able to qualify as a Small Servicer unless it is an affiliate of the qualifying master servicer because the subservicer is not a creditor or assignee of the loans it services.
Small Servicer determination is made each year, as of January 1. If the servicer ceases to qualify as a Small Servicer after January 1, it will have the later of 6 months or until the following January 1 to comply with the mortgage servicing regulations from which it was previously exempted. For example, let’s say a servicer qualifies as a Small Servicer on January 1, 2015, but increases the mortgage loans it services to more than 5,000 as of February 1, 2015, and still services more than 5,000 mortgage loans as of January 1, 2016. The servicer loses its Small Servicer status as of January 1, 2016. If the same Small Servicer were, instead, to increase the loans it services to more than 5,000 as of October 1, 2015 and still services more than 5,000 loans as of January 1, 2016, the servicer would lose its Small Servicer status on April 1, 2016, 6 months after October 1, 2015. If the same Small Servicer increased the loans it services to more than 5,000 as of February 1, 2015, but services less than 5,000 loans on January 1, 2016, it would still qualify as a Small Servicer on January 1, 2016.
Last, the final rule added State Housing Finance Agencies to the definition of a Small Servicer, without regard for the number of loans serviced or status as creditor or assignee. The Bureau, based on comments received in response to the proposed rules, and taking into consideration the protections provided by such agencies’ lending practices and their mission to provide safe and affordable financing, determined that the exemption for Housing Finance Agencies was necessary and proper.
The mortgage servicing rules cover nine different mortgage servicing functions:
- Periodic Statements (Reg. Z – § 1026.41)
- Force-Placed Insurance (Reg. X – § 1024.37)
- Servicing Policies and Procedures (Reg. X – § 1024.38)
- Interest Rate Adjustment Notices (Reg. Z – § 1026.20(c) and (d)
- Payment Crediting and Payoff Statements (Reg. Z – § 1026.36)
- Error Resolution and Information Requests (Reg. X – § 1024.35 and .36)
- Early Intervention with Delinquent Borrowers (Reg. X – § 1024.39)
- Continuity of Contact with Delinquent Borrowers (Reg. X – § 1024.40)
- Loss Mitigation Procedures (Reg. X – § 1024.41)
There are no exemptions to the regulations pertaining to payment crediting and error resolution. Adjustable rate mortgages with a term of less than 1 year are the only exemption to the interest rate adjustment notices regulation.
Small Servicers, servicers of reverse mortgages and servicers of loans secured by timeshares are exempt from the periodic statement regulation. Small Servicers, servicers of reverse mortgages and servicers of mortgage loans where the servicer is a qualified lender under the Farm Credit Act of 1971 (“Farm Credit Loans”) are exempt from the regulations for servicing policies and procedures; early intervention; and continuity of contact.
Small Servicers have a partial exemption to the force-placed insurance and loss mitigation procedures regulations. The force-placed insurance regulation, among other things, prohibits a servicer from obtaining force-placed insurance when the borrower has an escrow account for payment of insurance premiums – even if the servicer would have to advance funds to the escrow account to pay the force-placed insurance premium. The Small Servicer is exempt from this provision so long as the force-placed insurance purchased is less expensive to the borrower than the amount the Small Servicer would have to advance to maintain insurance.
The Small Servicer, servicers of reverse mortgages and servicers of Farm Credit Loans are exempt from the loss mitigation procedures regulation with two exceptions: (i) the Small Servicer may not make the first foreclosure notice or filing until a borrower is more than 120 days delinquent and (ii) the Small Servicer may not foreclose if the borrower is performing under a loss mitigation agreement.
The consequences of relying on the Small Service exemption when the servicer does not qualify can be severe. A servicer that violates Reg. Z or Reg. X can be liable for actual damages, statutory damages, plus attorneys’ fees and costs. In addition, there are potential regulatory actions or fines.
Consequently, it is imperative that the Small Servicer and its affiliate maintain accurate records of the number of loans serviced, the types of loans serviced, and its relationship to the loans it services, i.e., as creditor or assignee. The data must be available throughout the year (not just January 1) to monitor compliance.
Last, it may be advisable for the Small Servicer to comply with the regulations to the extent possible – even though not required – in the event the regulations become a “best practices” standard for mortgage servicing.
The foregoing is not intended to be legal advice, but only a general overview of the Bureau’s mortgage servicing rules exemptions. The advice of counsel should be sought if there are questions regarding the regulations or the exemptions.