One of the first goals an institution will have to achieve as a HMDA reporter is to ensure all reportable loans are included in their Loan/Application Register (LAR). However, this first step can be harder than it looks. As a HMDA auditor, I commonly find omissions - a loan that should have been included does not show up on the LAR - and chief among these, refinancings are disproportionately omitted from HMDA reporting in error. What is it about refis that makes them so susceptible to falling through the cracks? Some concrete examples may help illustrate the problem.
As you consider the cases below, remember that the definition of a reportable refinance, as found in 12 CFR 1003.2, is a new obligation that satisfies and replaces an existing obligation by the same borrower, where both the existing obligation and the new obligation are secured by liens on dwellings. (Notice that there is no “purpose” component stated in this definition.)
In one recent audit, we noted that an institution originated a home equity loan which the borrower used to pay off two commercial loans. Both the home equity loan and the commercial loans were secured by a mortgage on the borrower’s residence. The new loan had not been reported on the LAR, although it met Reg C’s definition of a reportable refinance.
In another audit, an institution received an application for a consumer loan to pay off a mortgage on a mobile home with land and refinance a car loan. The new consumer loan would be secured by the mobile home. Again, the application met the definition of a refinance, but was not reported on the institution’s LAR.
One factor that sets refinancings apart from the other HMDA reportable loans is loan purpose. An institution can reliably identify potentially HMDA reportable home purchase or home improvement loans by referring to the purpose of the loan. However, a refinancing can be for any purpose. If an institution is scrubbing its loan system for HMDA reportable loans by purpose, they could easily miss a refi with a stated purpose of commercial loan payoff, auto refinance, or debt consolidation. Additionally, there is no specific loan type that a HMDA-reportable refi must be. As long as it is secured by a dwelling and replaces a prior dwelling-secured loan to the same borrower, a HMDA-reportable refi could just as easily be a first mortgage, home equity loan, or commercial loan. Without a strong HMDA compliance program in place, tailored to the institution’s risk and activity, it is easy to see how an ad hoc approach may miss some outlying loans.
So what can an institution do to ensure no refinancings fall through the cracks, before an audit or an exam finds omissions from their LAR?
Luckily, the answer is no different than any other compliance area: the unified compliance management system model provides an excellent road map for HMDA compliance. Many institutions have a policy stating they will comply with the requirements of Reg C, but successful institutions don’t stop there. These institutions will establish a procedure that provides detailed instructions on how the responsible individuals will achieve the compliance goals stated in the policy. A good procedure establishes controls that are designed for the institution’s specific activity and risk factors. In my experience, institutions that successfully avoid omissions from their LAR will have appropriate preventive controls in place from the very beginning of the lending process: whether a manual worksheet completed with each loan application to determine HMDA reportability in a low-volume reporter, or strict rules for loan classification and frequent training in a higher-volume reporter. Successful controls are systemic, baked into the lending process, and applied consistently.
After that, monitoring becomes a matter of testing whether the existing controls are working as intended, rather than a first line of defense against LAR omissions. A regular review of reported and non-reported applications will point to where the controls are strong, or areas where current controls are in need of improvement.
On the Continuity platform, several RegControls™ are available to help our clients automate the entire HMDA compliance lifecycle. For institutions whose procedure calls for a detailed review of potentially reportable applications, the “Identify a HMDA Reportable Application” control is a great way to standardize and document this review. Our “Monitor Accuracy of the HMDA-LAR” control can be scheduled to fit within the existing process for LAR updates and monitoring, and walks users through verifying that all reportable originations and adverse actions are included on the LAR, as well as verifying accuracy of the reported information.
Sadly, in too many institutions quarterly monitoring, or even a yearly audit, are considered the first opportunity to ensure all reportable loans are included on the LAR. Take a moment to look at your own HMDA compliance program today. At what point in the process is a given loan identified as HMDA reportable? How confident are you that your working LAR contains all applications that meet the Reg C definition of a home purchase loan, home improvement loan, or refinancing?