Two risky strategies of the past - high-cost home equity loans made without tax and insurance escrow accounts, and the use of tech platforms siloed between different types of real estate lending - are coming back to bite mortgage lenders via tough new regulations.
On April 1, 2010, a much wider swath of loans, including hundreds of billions of dollars in new home equity loans, will be required by changes in the Truth in Lending Act's Regulation Z to carry escrow accounts, a measure many institutions are not prepared for from a systems perspective.
"First mortgages and products like home equity loans and are often on different platforms. Usually, if a software platform doesn't have mortgage capabilities, it can't manage an escrow account," says Cathy Martin, vp of consumer loan products at Fiserv. "Even though home equity loans are real estate-secured loans, they have been traditionally looked at as consumer products."
That's not good, since new Regulation Z rules for "higher-priced loans" require an escrow account for taxes and insurance on home equity loans. A higher-priced loan is defined as a consumer credit transaction secured by a principal dwelling with an annual percentage rate that's higher than the average prime mortgage offer rate for a comparable transaction on the date the interest rate is set. The triggers will be a rate that's 1.5 percentage points or more above for loans secured by a first lien on a dwelling; or 3.5 percentage points or higher for loans secured by a subordinate lien on a dwelling - the general parameters for subprime mortgages.
Mortgage consultant Richard Beidl says that for institutions that offer both first and second mortgages, compliance could be achieved by integrating the two platforms. But for institutions that offer only second mortgages, or outsource first mortgage processing - two industry subsets that include many community banks - the challenge becomes greater.
The choice is to build internally, or to turn to a hosted or outsourced solution - a more likely option, considering it can cost as much as $3 to $4 million to build an escrow management system. "An escrow management system is not a small undertaking," Beidl says, adding deposit management, payment tracking, keeping track of where and when taxes are due, and managing insurance are just part of the responsibilities inherent in managing escrow accounts.
"The new regs are great news for the Jack Henrys and the Fiservs of the world. Things would be pretty grim for IT spending if it wasn't for these new regs," says Ellen Carney, senior analyst for Forrester, adding more than half of banks say risk and compliance IT strategy is now a high priority.
For some institutions, the new requirement will be the first time they have had to plan for and manage escrow transactions. Martin says Fiserv is offering compliance services for the new rules via a pre-existing single-platform servicing strategy that can manage any type of loan, and about 25 percent of affected clients have migrated to the system.
Dennis Gorges, corporate compliance manager for Jack Henry, says his firm has adjusted its system to add questions to be answered in mortgage documentation to establish escrow accounts. "Even for lenders that escrowed first mortgages before, the people who work on home equity loans may have not have any expertise on managing escrows."
Andrew Turner, svp of product management for business lending solutions for Metavante, says his firm, which has about 800 clients that may be impacted by the change, is offering ComplianceAnalyzer, along with its Loan Origination Studio product. Compliance analyzer IDs compliance violations, while LOS boards those loans including escrow accounts to core banking systems.
Shelley Leonard, svp of product strategy for Lender Processing Services, is offering clients the ability to leverage its mortgage system for home equity lending. "Institutions will have to be able to obtain information on what the insurance is, who the carrier is, what the payment is, so these amounts can be loaded into the system once the [HELOC] loan has closed," Leonard says.
While lenders grapple with changes in Reg Z, both lenders and tech firms await final word on additional changes to RESPA, due in early 2010 - that may require changes to a variety of disclosures - timing of statement notifications and the placements of disclosures on mortgage statements. The tech execs says these regs will require IT changes for both the vendors and banks. Jack Henry's Gorges, for example, says his firm is examining additional fields it may add to respond to new disclosure requirements, but it generally doesn't do formal coding until new regulations are final.