The 5 Keys to Multi-State Mortgage Lending

The 5 Keys to Multi-State Mortgage Lending Multi-state mortgage lending is a heavily regulated industry that can, at times, be intimidating and confusing.

These 5 keys will help you determine the most efficient way for you to originate loans across the country with resources to guide you through the process.

KEY #1: FEDERAL REGULATIONS AND STATE LICENSING Federal Regulations Let’s set out some ground rules. First, you need to know what kind of loan product you intend to generate. If you intend to originate consumer purpose loans (loans which are primarily for personal, family, or household use) secured by the borrower’s primary residence, such as the purchase or remodel of a person’s home, then read no further. You will need to obtain a mortgage loan originator license in every single state before you can continue. Do not pass go, do not collect $200.

However, if you are in the business of originating business purpose loans (loans which are NOT primarily for personal, family, or household use, but are for business, commercial, or agricultural purposes) then the loan is exempt from two of the most onerous federal regulations: Truth in Lending Act (TILA) and Real Estate Settlement Procedures Act (RESPA). Practically speaking, that means you do not need to: (i) comply with federal requirements to verify the borrower’s ability to repay the loan, (ii) issue TRID disclosures, or (iii) comply with RESPA’s loan servicing requirements.

There may be additional federal regulations your business purpose loans are subject to, including HMDA and ECOA. For a full analysis on the federal “consumer” regulations that apply to business purpose loans, check out this article which provides an in depth analysis.

State Licensing You know that you are only going to be making business purpose loans. GREAT! We know that most federal consumer lending laws no longer apply. But what about the state in which you are planning on lending? You may believe that business purpose loans are exempt from lender licensing in all states, but that is not the case. There are 13 states that currently require a license to originate business purpose loans.

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Of these 11 states, five of them require a license to make loans secured by any type of property:

•1 Arizona

•4 North Dakota (if borrower resides in ND)

•2 California

•5 South Dakota

•3 Nevada

•6 Vermont

Then, there are five states which will only require you to be licensed as a mortgage lender if the collateral securing your loan is a 1-4 family residential property:

•1 Idaho

•4 Utah

•2 Minnesota

•5 Virginia

•3 Oregon In Florida, a lending license is necessary if: (i) the property securing the loan is a residential multifamily containing 5 or more units or commercial real property, and (ii) the borrower or any guarantor is an individual OR the lender is not an accredited investor or an organization solely owned by accredited investors.

Finally, there is North Carolina.

In North Carolina, you will need to register with the Secretary of State if you originate less than $1,000,000.00 in loans secured by real property in the state of North Carolina.

There may be other states which require a license to lend a business purpose loan. Typically, if you are making loans in an amount greater than $75,000 and that are non-owner occupied you are out of the woods. But if you plan to make small loans or make business purpose loans secured by the borrower’s primary residence, make sure you reach out to confirm whether there is an additional restriction in that state.

Beyond lending licenses, you will want to make sure that you do not need to separately be licensed as a mortgage broker or mortgage loan servicer, as the rules vary in each state for those licenses as well. For example, in Hawaii you would need to be licensed as a loan servicer even if you are only servicing business purpose loans, and even though you do not need to be licensed as a mortgage lender if you are only originating business purpose loans. Similarly, New York would require you to be licensed a broker to arrange business purpose loans, even though you do not need to be licensed as a mortgage lender to make business purpose loans.

Lender Foreign Registration The last hurdle lenders will want to be aware of when entering into new markets is whether a state will require entity lenders organized under the laws of one state to register as a foreign entity in the property state prior to making a loan.

Many states clearly exempt lenders who are making loans secured by real property from foreign registration requirements, such as California. Other states, like Alabama, do not have an explicit exemption from registration, so prudent lenders will register their entities in those states. There are also states like Indiana, which require registration for corporations, but not for limited liability companies.

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Check in with your lending counsel prior to exploring new markets to make sure your lending entity does not need to be registered in order to make your loan.

KEY #2: USURY Usury Usury laws are usually traced back to prohibitions on loan sharking. Many of the usury laws can be found in the constitutions of each state. They are archaic, disputed heavily, and one of the most misunderstood areas we come across. Some states like Washington, Arizona, and Utah exempt business purpose loans from usury, so you’re in the clear. Some states have usury limitations for business purpose loans, but have large available exemptions.

For example, in California, there is currently a usury cap of 10% for business purpose loans (and consumer loans). However, any loan that is arranged by a licensed real estate broker and secured by real property, or is made by a licensed California Finance Lender, is exempt from usury in California.

Other states will look to the loan amount to determine what the usury rate is. For example, in Texas, if a loan is less than $250,000 then there is an 18% usury cap, and a 28% cap for loans greater than $250,000. Similarly, Florida has a usury cap of 18% for loans less than $500,000, and a 25% cap for loans greater than $500,000.

In an extreme example, Tennessee has a cap of 4% above the current prime offering rate (7.25% as of this writing). Tennessee exempts certain licensed lenders from this harsh usury cap; however, no license is required to make a business purpose loan in Tennessee, so unless you happen to be licensed, you will be bound by Tennessee’s usury restriction.

To complicate matters, states are all over the place as to what gets included in the usury calculation. For example, California does not consider default interest or late charges to be part of the usury calculation because these are considered to be elections by the borrower; whereas Florida will consider default interest as part of the usury calculation as they are more interested in an APR style analysis to determine usury.

As an example, in Florida the usury cap is 18% for loans less than $500,000. This may not provide much pause for a lender because the interest rate is only 10% in the Note. However, once late charges, default interest, and origination fees are factored in, the loan may easily exceed the usury cap.

So, what do you do?

You are a lender in the state of Utah which has no usury limitation and you want to lend in Tennessee, but you would like to charge more than 7.25%. Thankfully, Tennessee has codified its acceptance of choice of law in a foreign jurisdiction, which means that the Promissory Note can be governed by another state’s law so long as there is a reasonable relationship to the state. Since you as a lender are located in Utah, providing you with a reasonable relationship to the state, your note can take advantage of Utah’s usury exemption.

Other states like Florida have not codified a choice of law acceptance into statutory law, but its courts have ruled that a foreign governing law provision is acceptable so long as the lender is domiciled in that that state. But beware, since the purpose of usury laws are to protect consumers, some states will refuse to accept a foreign jurisdiction’s governing law, even with explicit choice of law provisions in the Note. For example, courts in the state of Montana have stated that public policy requires the state to protect its citizens from foreign predatory lenders and will not permit a lender to use another state’s laws to avoid usury.

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As you can see, usury is complicated, and you will want to make sure you understand the usury landscape prior to making a loan.

KEY #3: LATE CHARGES AND CONSTRUCTION CONCERNS Late Charges States generally regulate late charges and require a minimum grace period before a late charge can be assessed. States like California have complex late charge regimes which change based on what type of license the lender possesses and the type of collateral securing the loan. The key here is to understand what the restrictions are in your state as you may forfeit any late charges based on technicalities, such as not providing a sufficient grace period under your Note. Typically, a ten-day grace period and a 10% charge on a missed installment payment is acceptable nationwide. That said, Texas does not allow for a charge greater than 5% on a missed installment payment. In addition, many states state that a late charge on a balloon payment is unenforceable. The key here is to understand the landscape where you are lending to make sure any late charges are permissible.

Construction Concerns The primary concern in a construction loan is whether a mechanic’s lien will take priority over the lender’s lien. States like New York are so friendly to mechanic lien claimants that it is wise to create a first and second mortgage structure in New York with the First funds used to purchase the property, and the construction holdback funds disbursed in a second position loan. The reasoning is that a mechanic lien claimant would only be able to claim priority over the second position lien, leaving the purchase funds secured. Similarly, Michigan is a particularly mechanic lien claimant-friendly state, and it is recommended to have the title company manage the draw process and obtain proper lien releases as funds are administered.

Additionally, certain states may have regulations which govern how the funds are loaned out in a construction loan. For example, California-licensed Real Estate Brokers must comply with an exhaustive regulation which requires a licensed 3rd party funds control, the use of a licensed appraiser, inspections by licensed general contractors, and certain other safeguards put in place for the benefit of 3rd party investors and the borrower. You can read our article on California construction loans here. New York requires the filing of a building loan agreement with the Building Loan Department. The practical implication is that you will want to make sure that you understand the construction regulations in each state you lend in.

KEY #4: TITLE AND CLOSING Title and Closing Some states rarely use attorneys in the closing process. For example, California has independent escrows which manage the flow of funds along with the preparation of settlement statements, and transfers documents along with coordinating with the title company to ensure proper title is being provided. Whereas in New York, title is represented by its own attorneys, the lender typically has its own attorney acting in the settlement capacity, and the borrower has their own attorney as well.

First, you will need to know who the closing agent will be and what their responsibilities are in the state you are lending in. You will want to verify that they are properly licensed and insured. You will separately want to confirm the title company (or its agent) is licensed with the insurance commission in each state.

Then you will need to understand what kind of title policy is available in the state. The most common type of title policy throughout the country is a 2006 ALTA Lender’s policy. The vast majority of states will permit you to obtain the policy, with the large exception in Texas, which has its own specific form of title policies. Additionally, you will find considerable variation with the endorsements available in each state. Many states will accept the standard ALTA endorsements available to an ALTA policy, including access, same as survey,

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unrecorded matters, and other common endorsements. However, some states such as New York and Florida will only permit limited endorsements to a title policy. A practical point here is to provide the ALTA endorsement number to the title underwriter as soon as possible prior to closing so they can determine if a similar endorsement is available in the state.

Finally, it’s worth noting that states have different recording procedures. For example, in New York, the mortgage may not be recorded until 45 days after loan closing. However, the title policy is issued to the lender at loan closing, insuring the lender that they are in 1st position despite the fact that the mortgage has not yet recorded. Conversely, in California, the Deed of Trust may be recorded the same day as the loan closing, but it may take up to 30 days to receive the title policy.

KEY #5: FORECLOSURE Foreclosure The last key is to understand how default works in the state you want to lend in. People in Texas who get to enjoy a foreclosure process that typically takes less than 30 days are rightfully surprised and concerned when they find out that a foreclosure in New York typically takes 2-3 years.

First, you will need to understand which states utilize a Deed of Trust and which states rely on a Mortgage to create a lien interest in real property. A Deed of Trust is a three-party instrument which has the borrower as the trustor, the lender as the beneficiary, and a third-party trustee which has the right to foreclose on the property without using the courts. This is referred to as a non-judicial foreclosure. Conversely, a Mortgage has no trustee, and the majority of mortgage states require the filing of a foreclosure lawsuit in order to foreclose on the property. This is referred to as a judicial foreclosure.

States which permit a non-judicial foreclosure usually permit a lender to foreclose in six months or less, whereas a non-judicial foreclosure is subject to how backed up the courts are in the jurisdiction where the property is located. Some states permit a fast-track judicial foreclosure, but most do not.

Below is a list of states which primarily use a Deed of Trust and typically permit non-judicial foreclosures: Alaska, Arizona, California, Colorado, D.C., Georgia, Idaho, Maryland, Mississippi, Missouri, Nebraska, Nevada, New Mexico, North Carolina, Oregon, Tennessee, Texas, Utah, Virginia, Washington, and West Virginia.

The remainder of the states primarily use Mortgages and typically require a foreclosure lawsuit to foreclose on the subject property.

If the state you would like to lend in requires judicial foreclosure, we recommend you revise your underwriting criteria and lower your LTV, as the equity cushion could be heavily diminished in a state where there is protracted litigation.

Further, you will most likely want to include a membership pledge of the borrower’s entity so that you can try to circumvent the foreclosure process in the state by foreclosing on the membership interests rather than the property. You’ll still need to complete the foreclosure process after the fact to receive clean title, but at least you will have control over the property while you wait for the process to unfold.

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