California has strict regulations on mortgage brokers. And at a time when the broker share of originations has been rising, that won’t change. The Golden State’s brokers need to prioritize compliance, not only to protect themselves from fines and additional scrutiny, but also to build strong relationships with lenders, investors and clients.
Although remaining compliant isn’t easy, there is a ready-made, user-friendly source of information available to all brokers. The essential rules and regulations are spelled out in the Department of Real Estate (DRE) Compliance Evaluation Manual.
The manual outlines licensing requirements and a range of rules that affect business operations, including the retention of documents, required reports and disclosures and advertising compliance.
Record retention rules
Brokers are subject to numerous rules regarding the retention of records, required disclosures to clients and regulators, and marketing of their services. In general, brokers must retain all documents involved in the loan for at least three years, but certain documents must be stored for four years.
One type involves records of self-dealing statements that might reveal conflicts of interest, or when a broker has acted in their own interest. Statements made by investors as to their qualifications to fund a hard money loan are another type of record that must be held for an extra year.
Records of evaluations made by private lenders to gauge a loan investor’s financial capacity and suitability for an investment must also be retained for four years.
Brokers also need to comply with several rules on advertising. Brokers can promote their services if their ads and marketing materials are not deceptive or misleading. Ads must include their license number. Depending on the content, additional information might be required, such as the loan’s annual percentage rate, loan amount and loan term.
There is a requirement for brokers to submit various reports, including an annual business activity report and quarterly mortgage call reports that spell out the company’s mortgage activity and financial condition.
Brokers as lenders
Brokers sometimes act as lenders by directly lending funds on certain loans rather than functioning as intermediaries. In general, California requires people to hold a broker license if that person makes eight or more loans using their own funds in a calendar year when the loans are held or resold and secured by a one-to-four unit residential dwelling.
When acting as lenders, brokers must comply with Regulation 2844, which covers risk management, underwriting standards, control systems and consumer protections. They also must file an annual residential mortgage report if they have assets under $10 million or less, regularly fund real estate loans and make 10% or more in interest on a qualified loan. Brokers who file a similar report under Regulation C of the Home Mortgage Disclosure Act (HMDA) may be exempt.
Collecting advance fees
Brokers are also subject to rules when handling funds or collecting advance fees. This includes the proper use of trust accounts and executing advance fee agreements.
Trust accounts are generally used for appraisal or credit report fees that have not been marked up by additional costs added to the original agreement. If the broker has already advanced the fees and is simply being reimbursed, those funds don’t generally need to go into a trust account; however, before the broker is reimbursed, the borrower should provide clear instructions.
An advance fee agreement is a contract where someone pays a fee for a service upfront. For fees that do not fall under appraisal or credit report fees, an advance fee agreement must be executed before accepting funds into a trust account. Even then, funds must stay in the trust account until the agreed-upon services are completed.
In some transactions, brokers are prohibited from collecting advance fees, regardless of whether an agreement is in place, such as in the case of loan modifications and forbearances.
Brokers should review all applicable advance fee regulations before accepting advanced payments. If uncertain, you should consult an attorney familiar with state compliance.
Required loan disclosures
Brokers must provide specific disclosures to borrowers within three days of receiving a loan application and in the primary language used during negotiations. These disclosures must be retained for three years.
Some required disclosures include the mortgage loan disclosure statement; form RE 885 for non-traditional mortgage products, like interest-only loans on one-to-four unit properties, and RE 882 or 883 for all other loans; a privacy policy statement; the Equal Credit Opportunity appraisal disclosure; and the Patriot Act disclosure. Some others include the borrower-authorization form, the disclosure of hazard insurance and the Fair Lending notice.
Disclosures must include the broker’s California DRE license information, anticipated compensation and use of broker-controlled funds. The DRE licensing information telephone number must also be included.
If any costs, expenses or loan terms materially change, brokers must timely update the borrower with revised disclosures.
Additionally, brokers who represent the borrower in the underlying real estate transaction while also arranging the loan must provide an additional written disclosure to all parties involved.
Additional licensing requirements
California brokers may also be subject to additional licensing requirements. For example, if the broker has multiple offices in the state, the broker must obtain a license for each branch location. Also, the broker can’t operate a “doing business as” name unless licensed under that name.
Brokers also need to consider licensing regulations for their employees and contractors, including broker associates, salespersons and independent contractors.
If the employee is involved with negotiations or works independently of the broker, they generally must also hold a real estate license. Only true employees, who aren’t involved in negotiations and whom the broker supervises and exercises direct control over, can proceed without a real estate license.
It is crucial that brokers prioritize compliance. While mastering the regulations isn’t easy, the DRE’s Compliance Evaluation Manual is a good guide and handy reference. Reviewing the rules frequently can prevent brokers from making costly mistakes and give them a leg up on the competition.
