Nearly three years into the Trump Administration, you may think the pendulum for banking regulations — Dodd-Frank rules created after the 2008 crisis — has swung to a more permissive position. President Trump campaigned promising to dial back regulations, and legislators from both parties promised some “recalibration.”
Certainly, some changes have happened. Following the 2018 midterms, Democrats in the House shifted focus to protecting consumers and overseeing fintech. The Republican-led Senate Banking Committee is simplifying rules that weren’t tackled in 2018’s deregulatory bill. Additionally, regulatory agencies overseeing implementation of Dodd-Frank are all led by Trump appointees with authority to limit enforcement.
Although the federal pendulum swung one way, there’s a countervailing force: state authorities regulating lenders inside their borders. Our firm sees this in our market of Maryland, Virginia and D.C., and most states across the country. Currently states focus on payday loans, auto finance and fintech, but we expect them to eventually turn their attention to hard money lenders.
States Flex On Tech
States already flex their regulatory muscle — today they’re the primary regulators of tech companies offering peer-to-peer payments. Probably everyone reading this has used Apple Pay, Google Pay or Amazon, and they have likely offered you credit. So it’s no surprise tech companies including Facebook, Google, Apple and Amazon have money transmitter licenses in over 40 states. Fintech companies like Fundable and Kabbage are also monitored by states.
Why did states jump in? First, because the feds left a vacuum by not regulating tech lenders. Recently there have been conversations with major tech players, but for the past five years, Washington generally took a hands-off approach. Regulators hate vacuums because they increase risks of predatory lending. The second reason is that tech companies pay fat license fees to state treasuries.
Payday Lending, Consumer Finance Under Fire
States also have been actively regulating payday lenders who charge low-income borrowers usurious interest rates and have high defaults. After the Truth in Lending Act (TILA) passed, the Consumer Financial Protection Bureau and state regulators clamped down on payday lenders. State regulators became TILA enforcers, hammering lenders who circumvented usury laws by charging hidden fees.
They’ve taken that TILA hammer to online lenders too. An example from our backyard: Virginia recently sued a company that sells personal loans with interest rates up to 155%. Virginia alleged NetCredit offered residents loans that exceeded its statutory interest rate cap, operated without a state license and used unlawful collection techniques. If the state prevails, the company will face hefty fines and see its business restricted.
Nonbank Mortgages, Consumer Finance Under A Microscope
States scrutinize nonbank mortgage servicers using TILA and RESPA compliance to fill gaps in their own laws around mortgage loan payments. If a lender fails to process payments correctly, taxes and insurance may not get paid on time, leading the state to levy fines and remediation. Here in Maryland, regulators collaborated with other state and federal agencies in a major lawsuit against a nonbank servicer for mismanagement of consumer escrow accounts, and for operating (over the internet) without a state license. In our state alone, that servicer was hit with over $750,000 in penalties.
Is It Our Turn Next?
Many in our industry have a false sense of security, thinking consumer regulations don’t apply because we offer business-purpose loans. But “business-purpose” is not “compliance-exempt.”
For starters, ensure you comply with TILA. Hard money lenders take one of three TILA exemptions. First, loans to corporate entities are exempt, and since it’s easy to set up LLCs, we encourage borrowers to do so. Second, loans primarily for a business purpose, like a fix and flip, are generally exempt, although this is not black and white — you must consider factors to determine “genuine business purpose,” including the borrower’s occupation and how involved they will be.
The third exemption is for non-owner-occupied rental property, deemed a business purpose. The threshold is whether it’s occupied under 15 days a year. But suppose your borrower violates this and a regulator figures that out by examining water bills? That’s another reason we encourage borrowers to form LLCs.
On Top Of TRID And Other Federal Rules
If you make five or more loans annually, stay on top of TILA and RESPA’s Integrated Disclosure Rule (TRID). Whether TRID applies depends on each loan, but it will if proceeds go to personal use. Under TRID, a lender must give clients standardized loan estimates and disclosures within certain time frames, and the loan advances only after execution.
Finally, don’t collect fees other than for a credit report until the borrower signs the forms. TRID rules are meticulously explained in 2,000 pages from the CFPB. State regulators wouldn’t be shy about examining your compliance with the Fair Housing Act, Equal Credit Opportunity Act, Fair Credit Reporting Act and other federal rules, so stay on top of them.
What’s Going On In Your State?
Some states require lenders to be licensed if any loans are secured by residential property, even to corporate borrowers. For example, a bill pending in Florida would end the business-purpose exception. Other states examine business-purpose loans for predatory lending, excessive referral fees or unfair and deceptive acts.
Virginia recently joined 10 states enacting statutes requiring a lender to issue a payoff letter for loans to corporations. These must be clear, detailed and provided upon request by the lender (not your lawyer) to borrowers and title companies.
The Boy Scouts’ motto bears repeating as states take an active hand in regulating lending. Set aside some time, and study which regulations apply. Start with the CFPB, and then go through other sites. Carefully review licensing requirements and enforcement actions for each state where you do business. Finally, put pen to paper to craft your readiness plan. Noncompliance can be severe for originating lenders, purchasers and assignees alike, so a little homework is well worth your time.