CBA Publications >> CBA Regulatory Compliance Bulletin >> Vol 2001 No. 19, December 21, 2001

Vol 2001 No. 19, December 21, 2001

Federal Reserve Revises High Cost Loan Rules

The Federal Reserve Board has amended its Truth in Lending Act (TILA) regulations, codified at 12 CFR Section 226.32 (Regulation Z) relating to high cost loans covered under the Home Ownership and Equity Protection Act (HOEPA). Section 32 of Regulation Z, which implements HOEPA, provides heightened consumer protections in connection with loans secured by the borrower's residence where the rates or fees exceed established thresholds. These protections include, among others, additional disclosures, extended rescission periods, and restrictions on balloon payments and prepayment penalties.

Introduction

The amended rules are the result of the Board's extended comment process that included public hearings held across the country on ways to curb predatory lending practices. In contrast to state and local laws and ordinances passed since the Board embarked on this effort, including bills passed this year in California, the Board's Regulation Z amendments are modest. As with the existing rules, the amended rules do not apply to purchase money residential loans, and the reduced rate trigger of eight percentage points (from 10) applies only to loans secured by a first lien and not to subordinate lien loans. The 8% fees trigger was not changed; however, the fees trigger now includes premiums paid for optional credit insurance.

In contrast, the new California predatory lending bills, AB 489 and AB 344, cover all loans secured by the borrower's residence, and feature a rate trigger of 8% and a points and a fee trigger of 6% of the total loan amount. (See CBA Bulletin no. 11.) Thus, any loan made in California that is covered by HOEPA must also comply with the new state laws.

Summary of Key Provisions

Rate and fee thresholds. The Board has adjusted the APR threshold or trigger for first-lien mortgage loans from 10 percentage points to eight percentage points above the rate for Treasury securities having a comparable maturity. The APR trigger for subordinate-lien loans remains at 10 percentage points. The Board reasoned that most abusive practices involve a first lien loan, and that second lien loans are already covered under HOEPA at a higher rate because they feature higher interest rates.

The fee-based trigger remains at the greater of 8 percent of the total loan amount or $465 (adjusted to $480 beginning in January 1, 2002), but now the fees will include amounts paid at closing for optional credit life, accident, health, or loss-of-income insurance and other debt-protection products, irrespective of whether they constitute insurance under state law. Regulation Z already requires inclusion of mandatory insurance as finance charges, and thus as a component of the fees trigger. Such items must be included whether or not they are paid in cash or financed. In contrast, the new California laws flatly prohibit the financing of credit insurance premiums in a covered loan.

Comment 32(a)(ii)-1 provides guidance on determining the total loan amount: from the amount financed, as determined according to 226.18(b), deduct any cost listed in 226.32(b)(1)(iii) and 226.32(b)(1)(iv) that is both included as points and fees under § 226.32(b)(1) and financed by the creditor. An example is provided.

Loan flipping. Loan flipping refers to the frequent refinancing of home loans which results in the churning of loan fees and thus the stripping of equity from the borrower's home. To address this form of abuse, the amended rules provide that if a creditor had made a HOEPA-covered loan to a borrower in the preceding twelve months, the creditor is prohibited from refinancing the loan with another HOEPA-covered loan, unless the loan is "in the borrower's interest." This prohibition also applies to an originator who does not hold the loan in portfolio and to an assignee that services or purchases a HOEPA loan. Thus, during the first year after a HOEPA loan is made, the originator, assignee, and servicer are not permitted to refinance the loan with another HOEPA loan. Please see the example provided at paragraph 34(a)(3)-2, reprinted below.

The Board decided not to provide specific guidance on the "in the borrower's interest" standard, but noted that, given the short period in which the prohibition applies (12 months after origination), the exception would be narrowly construed. Staff commentary section 34(a)(3)-1 provides that a borrower statement to the effect that "this loan is in my interest" would not meet the standard. However, a refinancing would be in the borrower's interest if needed for a "bona fide personal financial emergency," which is a standard presently applied in certain consumer waivers under TILA (e.g., waiver of the rescission period for certain home equity loans under §226.23(e)). When a refinancing provides additional funds to the borrower, consideration would be given to whether the loan fees and charges are commensurate with the amount of new funds advanced, and whether the real estate-related charges are bona fide and reasonable in amount.

The amended rules do not specifically state that an affiliate of the creditor is treated as the same entity as the creditor for purposes of the flipping prohibition. However, Section 226.34(a)(3) states that loans made by an affiliate are prohibited if the creditor engages in a pattern or practice of arranging for the refinancing of its own loans with an affiliate (or other third party) to evade the flipping prohibition or other provisions of the amended rules.

"Spurious" open-end credit. HOEPA covers only closed- end loans. In order to prevent creditors from treating a mortgage loan as an open-end credit line for the purpose of evading HOEPA's requirements, the amended rules would subject creditors and assignees to enhanced liability if a loan that otherwise would be covered by HOEPA is structured as an open-end loan but does not meet the TILA definition of open-end credit. For example, a high- cost mortgage could not be structured as a home-secured line of credit if the consumer did not apply for such a line and there is no reasonable expectation that repeat transactions will occur under a reusable line.

If a loan that meets the rate or fees trigger is documented as open-end credit but the terms or other circumstances demonstrate that it does not meet the definition of open-end credit, the loan will be subject to the HOEPA rules (and to open-end credit rules generally). Comment 34(b)-1 notes that the individual facts and circumstances should be reviewed to determine the amount financed and the principal loan amount of a loan that is improperly structured as an open-end credit. Factors to be considered include the amount of money the consumer originally requested, the amount of the first advance or the highest outstanding balance, and the amount of the credit line. If it is reasonable to expect that the consumer might use the full amount of the credit, then the loan amount would be the full amount of the credit.

"Due-on-demand" provisions. A creditor may not exercise a "due-on-demand" or "call" provision in a HOEPA loan except where the borrower has committed fraud or had made a material misrepresentation with respect to the loan, the borrower has defaulted, or if the borrower's action or failure to act adversely affects the creditor's security. Examples of the latter include transferring title to the property without the creditor's permission, failure to pay taxes or insurance, committing waste, and the filing of a senior lien.

Ability to repay. Under existing rules, a creditor may not engage in a pattern or practice of making HOEPA loans based on the equity in the borrower's home without regard to the borrower's ability to repay. The board cites the difficulty of enforcing this prohibition because creditors are not required to document that they had considered the borrower's ability to repay. Under the amended rule, a creditor's routine failure to verify and document borrowers' current or expected income, current obligations, and employment, could give rise to a presumption of such pattern or practice.

Whether a creditor has engaged in a pattern or practice depends on the "totality of the circumstances." While a pattern or practice is not established by isolated, random, or accidental acts, it can be established without the use of a statistical process. In addition, a creditor acting under a lending policy (whether written or unwritten) could be the basis of a pattern or practice of making loans without regard to the borrower' ability to repay.

In transactions where the initial interest rate is adjusted during the term of the loan, Comment 34(a)(4)-3 clarifies that creditors are required to consider the consumer's ability to repay assuming the non-discounted or fully-indexed rate rather than the introductory rate. A creditor may consider any expected income except equity income that would be realized from collateral. For example, a creditor may consider gifts, expected retirement payments, or income from self-employment. See Comment 34(a)(4)-1. Also, Comment 34(a)(4)-4 provides guidance on verifying and documenting the ability to repay.

Enhance disclosures. In addition to the usual Regulation Z disclosures, creditors offering HOEPA loans must provide additional disclosures before the loan is closed informing borrowers that they are not obligated to complete the transaction and that they could lose their home if they fail to make payments. Also, the APR, monthly payments, and other information must be provided. The amended rules require the HOEPA disclosure to be made in a conspicuous type size, and add several items.

The creditor must disclose the total amount borrowed, as reflected on the face of the note. The intent is to alert consumers that the total amount of the debt is increased by the financing of points, fees, and other charges. The disclosure of both the amount borrowed and regular payments is deemed accurate if the disclosed amount varied no more than $100 from the actual amount borrowed. As discussed above, if premiums or other charges for optional credit insurance or debt-cancellation coverage are financed, the disclosure must so specify, and such voluntary items may be included in the regular payment disclosure only if the consumer had previously agreed to the amounts. The result is that the consumer will note that the total loan amount, as calculated, may be less than what was requested.

Redisclosure. Section 226.31(c)(1) requires a three-day waiting period between the time the consumer is furnished with disclosures required under Section 226.32 and the time the consumer becomes obligated under the loan. If the creditor changes any terms that make the disclosures inaccurate, new disclosures must be given and another three-day waiting period is triggered.

A new comment Section 226.31(c)(1)(i)-2 is added to address the practice of offering credit insurance at closing which, if the premiums are financed, would make the disclosures inaccurate. The comment clarifies that in such instance, redisclosure is required and a new three-day waiting period applies.

Assignee liability. Comment 34(a)(2)-3 is added to clarify that the existing provision making purchasers or assignees of HOEPA loans subject to claims and defenses that the borrower could assert against the creditor is not limited to violations of TILA. Such claims could include, for example, those based on common law fraud and misrepresentation.

The amended rules are effective upon publication in the Federal Register (not published yet as of the printing of this Bulletin), but compliance is optional until October 1, 2002. For further information, please contact Minh-Duc T. Le, Daniel G. Lonergan, or Jane E. Ahrens of the Federal Reserve at (202) 452-3667 or 452-2412.