On July 1, 2024, the Consumer Financial Protection Bureau (“CFPB”)—the primary federal watchdog of the consumer finance industry—along with several other federal agencies, approved a new rule to regulate the use of automated valuation models (“AVMs”) affecting the mortgage industry. The new rule, set to take effect on July 1, 2025, requires covered businesses to enact policies, procedures, practices, and control systems designed to: (1) ensure a high level of confidence in the estimates produced; (2) protect against the manipulation of data; (3) avoid conflicts of interest; (4) require random sample testing and reviews; and (5) comply with applicable nondiscrimination laws. While the rule gives covered businesses the autonomy to fashion their own policies and procedures to comply with the rule, that flexibility does not immunize covered businesses from potential fines, penalties, or enforcement actions if they fail to sufficiently comply.
What You Need to Know:
- The CFPB is the primary federal agency responsible for regulating the consumer finance industry.
- Given the recent uptick in reliance on AVMs to estimate the value of a mortgaged property, the CFPB and other federal agencies have taken efforts to regulate these AVMs to ensure they are accurate and help foster a fair mortgage market where consumers and industry participants can be confident relying on AVMs.
- The new rule, set to take effect on July 1, 2025, requires businesses that utilize AVMs to enact their own policies and procedures to further various initiatives proposed by the CFPB and other federal agencies.
I. Rise and prevalence of computer-based valuation platforms.
For many Americans, their primary residence remains their largest financial investment. Even putting aside the down payment, a consumer’s mortgage principle and interest, taxes and insurance, homeowners’ association payments, and any payments for necessary repairs or upgrades comprise the bulk of monthly expenses for millions of households. Given that many of these expenses are tied to the value of that residence, the method by which a primary residence is valued is a critical factor directly affecting many Americans’ monthly cash flow. While professional appraisers are still tapped to provide valuation opinions in connection with real estate sale transactions, many Americans also rely on valuations developed and supplied by companies utilizing technology that analyzes publicly available data, including many online providers. These platforms, referred to as AVMs, use complex algorithms (including some that are now incorporating newer artificial intelligence technologies) compiling a variety of details and factors to provide an estimate of a home’s present value. According to the CFPB, many Americans now heavily rely on these estimated values in deciding their next home purchase, in determining their net worth, in deciding at what price to list their current home for sale, and in making other decisions with significant financial impact on their lives. Fannie Mae and Freddie Mac both also use their own proprietary AVMs in their home valuation processes. While these AVMs offer various benefits by making up-to-date market data readily available and lowering costs and shortening turnaround times for property valuations, according to the CFPB, they also introduce the potential for a litany of problems across the real estate and mortgage industries.
II. The AVM Rule.
Recently, the CFPB, together with the Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and Federal Housing Finance Agency (which, collectively, comprise the Federal Financial Institutions Examination Council) issued a new rule to address these concerns and provide a framework for AVMs to follow in developing estimated home values. The agencies issued the regulations pursuant to section 1473 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (12 U.S.C. § 3354). The rule is titled “Automated valuation models used to estimate collateral value for mortgage lending purposes” and has an anticipated effective date of July 1, 2025.
According to a joint statement from CFPB Director Rohit Chopra and CFPB Deputy Director Zixta Martinez, the rule “requires companies that use these algorithmic appraisal tools to put safeguards into place to ensure a high level of confidence in the home value estimates, protect against the manipulation of data, avoid conflicts of interest, and comply with applicable nondiscrimination laws.”[1] With these guiding principles in mind, the CFPB seeks to ensure that the home appraisal system is fair, nondiscriminatory, and free of improper conflicts of interest through requiring affected businesses to adopt policies, practices, procedures, and control systems[2] to ensure that AVMs used in determining the value of a homeowner’s principal dwelling adhere to quality control standards designed to achieve the CFPB’s goals.
The rule requires that companies that use AVMs—defined as “any computerized model used by mortgage originators and secondary market issuers to determine the collateral worth of a mortgage secured by a consumer’s principal dwelling” (12 U.S.C. § 3354(d))—in connection with making a credit decision adopt policies, practices, procedures, and control systems to ensure that AVMs used in certain credit decisions or covered securitization determinations adhere to quality control standards designed to (1) ensure a high level of confidence in the estimates produced; (2) protect against the manipulation of data; (3) avoid conflicts of interest; (4) require random sample testing and reviews; and (5) comply with applicable nondiscrimination laws. Notably, the rule only applies to AVMs involved in making a credit decision or covered securitization determination regarding a mortgage. For purposes of the rule, the term “credit decision” is defined as a decision regarding whether and under what terms to originate, modify, terminate, or make other changes to a mortgage. A “covered securitization determination” means a determination regarding (1) whether to waive an appraisal requirement for a mortgage origination in connection with its potential sale or transfer to a secondary market issuer, or (2) structuring, preparing disclosures for, or marketing initial offerings of mortgage-backed securitizations.
The rule generally applies to mortgage originators, brokers, and servicers, as well as secondary market issuers (including government-sponsored entities like Fannie Mae and Freddie Mac) regarding their decisions surrounding originating a mortgage, modifying the terms of an existing loan, and renewing, increasing, or terminating a home equity line of credit, but only to the extent these actions involve a credit decision or covered securitization determination. Moreover, the rule applies whether the underlying mortgage loan is for consumer or commercial purposes and whether the credit sought is open- or close-ended.
The rule does not apply, however, to the use of AVMs in simply monitoring the quality of performance of mortgages or mortgage-backed securities. The rule also excludes from its scope instances where a licensed appraiser might use an AVM in the development of an appraisal, likely because licensed appraisers are already required to follow certain criteria set forth in the Uniform Standards of Professional Appraisal Practice that already—on their own—serve the same interests sought via enaction of the instant rule.
III. Impacts on financial services companies.
In order to comply with the new rule, affected businesses will need to closely review the inner workings of their AVMs (whether developed internally or obtained from a third-party) to ensure compliance with the rule’s obligations. Notably, in lieu of prescribing specific, stringent requirements about what exactly covered businesses need to do, the CFPB and other regulatory agencies instead drafted the rule so as to give covered businesses flexibility and autonomy in enacting their own policies, procedures, practices, and control systems to serve the rule’s general purposes. This flexibility and autonomy should not be taken for granted, however, especially given the recent uptick in CFPB enforcement actions and President Biden’s well-publicized efforts to closely scrutinize all consumer financial services companies. Accordingly, it is imperative that any business utilizing AVMs review the new rule and ensure their compliance in order to avoid fines, penalties, and enforcement actions.
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The Consumer Financial Services practice at Saul Ewing will continue to monitor these and other related developments in the consumer finance industry.
[1] https://www.consumerfinance.gov/about-us/blog/cfpb-approves-rule-to-ensure-accuracy-and-accountability-in-the-use-of-ai-and-algorithms-in-home-appraisals/.
[2] Defined as “the functions (such as internal and external audits, risk review, quality control, and quality assurance) and information systems that are used to measure performance, make decisions about risk, and assess the effectiveness of processes and personnel, including with respect to compliance with statutes and regulations.”
