[Federal Register Volume 61, Number 183 (Thursday, September 19, 1996)]
[Rules and Regulations]
[Pages 49237-49248]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-23951]


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FEDERAL RESERVE SYSTEM

12 CFR Part 226

[Regulation Z; Docket No. R-0927]


Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board is publishing revisions to Regulation Z (Truth in 
Lending). The revisions implement the Truth in Lending Act Amendments 
of 1995, which establish new creditor-liability rules for closed-end 
loans secured by real property or dwellings and consummated on or after 
September 30, 1995. The 1995 Amendments create several tolerances for 
accuracy in disclosing the amount of the finance charge, and creditors 
have no civil or administrative liability if the finance charge and 
affected disclosures are within the applicable tolerances. The 
amendments also clarify how lenders must disclose certain fees 
connected with mortgage loans. In addition, the Board is publishing a 
new rule regarding the treatment of fees charged in connection with 
debt cancellation agreements, which is similar to the existing rule for 
credit insurance premiums and provides for more uniform treatment of 
these fees.

DATES: This rule is effective October 21, 1996.

FOR FURTHER INFORMATION CONTACT: James A. Michaels, Senior Attorney, or 
Natalie E. Taylor or Michael L. Hentrel, Staff Attorneys, Division of 
Consumer and Community Affairs, Board of Governors of the Federal 
Reserve System, at (202) 452-3667 or 452-2412; users of 
Telecommunications Device for the Deaf (TDD) only, contact Dorothea 
Thompson at (202) 452-3544.

SUPPLEMENTARY INFORMATION:

I. Background

    The purpose of the Truth in Lending Act (TILA) (15 U.S.C. 1601 et 
seq.) is to promote the informed use of consumer credit by requiring 
disclosures about its terms and cost. The act requires creditors to 
disclose the cost of credit as a dollar amount (the ``finance charge'') 
and as an annual percentage rate (the ``APR''). Uniformity in 
creditors' disclosures is intended to assist consumers in comparison 
shopping.

[[Page 49238]]

The TILA requires additional disclosures for loans secured by a 
consumer's home and permits consumers to rescind certain transactions 
that involve their principal dwelling. The act is implemented by the 
Board's Regulation Z (12 CFR part 226).

II. Regulatory Provisions

    On September 30, 1995, the Congress enacted the Truth in Lending 
Act Amendments of 1995 (1995 Amendments), Pub. L. 104-29, 109 Stat. 
271. The 1995 Amendments address the concerns of mortgage lenders 
stemming from a 1994 court decision, Rodash v. AIB Mortgage Co., 16 
F.3d 1142 (11th Cir. 1994). In that case, the U.S. Court of Appeals 
affirmed a district court opinion that allowed a consumer to rescind a 
home mortgage loan and recover all fees and finance charges that had 
been paid, based in part on errors in the creditor's TILA disclosures. 
Subsequently, a number of class action lawsuits were filed, involving 
thousands of mortgage loans, alleging similar violations and seeking 
the remedy of rescission.
    In response to mortgage lenders' concerns about their potential 
liability for finance charge violations that they viewed as minor, the 
Congress enacted a temporary moratorium on such litigation, which has 
now been replaced by the 1995 Amendments. The Amendments establish new 
liability rules for loans consummated before and after September 30, 
1995, establish a new rule that includes mortgage broker fees in the 
finance charge disclosure, and clarify the proper treatment of other 
fees. In May 1996, the Board published proposed regulations to 
implement the amendments with respect to loans made after September 30 
(61 FR 26126).
    The Board is also amending Regulation Z to provide a rule 
addressing the treatment of fees charged in connection with debt 
cancellation agreements, which serve purposes similar to credit 
insurance. A specialized form of debt cancellation agreement, known as 
guaranteed automobile protection or ``GAP,'' is also covered by the new 
rule. In response to public comments, the final rule has been modified 
slightly from the May 1996 proposal.
    Finally, the Board is making a technical amendment to the 
definitions of ``business day'' in Regulation Z, 12 CFR 226.2(a)(6). 
For clarity, the Board has amended the definitions of ``business day'' 
to include a specific reference to subpart E.
    Under the 1995 Amendments, the statutory provision treating 
mortgage broker fees as finance charges becomes effective on September 
30, 1996. The other provisions of the 1995 Amendments became effective 
upon the law's enactment on September 30, 1995. The Board believes that 
revisions to Regulation Z do not impose any additional disclosure 
requirements beyond those already required under the statute, as 
amended. Accordingly, the revisions to Regulation Z will become 
effective on October 21, 1996.
    The new rule on debt cancellation fees will also become effective 
on October 21. The rule imposes no additional disclosure requirements. 
Creditors must continue to treat debt cancellation fees as finance 
charges; when the new rule becomes effective creditors will have the 
option of excluding voluntary debt cancellation fees from the finance 
charge if they meet the specified requirements.

III. Section-by-Section Analysis

Subpart A--General

Section 226.2--Definitions and Rules of Construction
2(a) Definitions
2(a)(6)
    Paragraph (2)(a)(6) is adopted as proposed. For purposes of the 
Board's rules implementing the Home Ownership and Equity Protection Act 
of 1994 in Subpart E of Regulation Z, the ``business day'' definition 
for rescission applies. The Board has also updated the list of legal 
public holidays to include the Birthday of Martin Luther King, Jr.
Section 226.4--Finance Charge
4(a)(1) Charges by Third Parties
    Paragraph 4(a)(1) reflects the general rule for third party charges 
currently contained in comment 4(a)-3 of the Official Staff Commentary. 
A slight modification has been made for clarity. In general, amounts 
charged by third parties are included in the finance charge if the 
creditor requires the use of the third party or retains any portion of 
the charge (in which case the portion retained is included as a finance 
charge).
4(a)(2) Special Rule; Closing Agent Charges
    Paragraph 4(a)(2) incorporates the substance of section 2(a) of the 
1995 Amendments, and is consistent with the existing interpretation in 
comment 4(a)-4 of the Official Staff Commentary. Under the rule, a fee 
charged by a third-party closing agent is included in the finance 
charge only if the creditor requires the imposition of the charge or 
the provision of the service, or retains any portion of the charge. 
Accordingly, a courier fee charged by a third-party closing agent is 
only a finance charge if the creditor requires the use of the courier 
(or to the extent the creditor retains a portion of the charge). The 
rule only applies to the third-party serving as the closing agent with 
respect to that loan. The final rule has also been modified slightly to 
clarify the term ``closing agent.''
4(a)(3) Special Rule; Mortgage Broker Fees
    Paragraph 4(a)(3) contains a new rule regarding the treatment of 
mortgage broker fees, to implement section 106(a)(6) of the TILA (15 
U.S.C. 1605(a)(6)), which becomes effective on September 30, 1996. The 
rule requires that all fees charged by a mortgage broker and paid 
directly by the consumer be included in the finance charge, whether the 
fee is paid to the broker or to the lender for delivery to the broker. 
A fee charged by a mortgage broker will be excluded from the finance 
charge only if it is the type of fee that would also be excluded when 
it is charged by the creditor. In the case of application fees charged 
by a mortgage broker, such fees may be excluded from the finance charge 
if the mortgage broker charges the fee to all applicants for credit, 
whether or not credit is actually extended.
    Several commenters questioned the basis for requiring creditors to 
disclose, as finance charges, fees that the creditor neither imposes 
nor requires. They also expressed concern about creditors' duty for 
including brokers' fees in Truth in Lending disclosures when the 
existence or amount of such fees may not be known to the creditor.
    The new rule is mandated by the 1995 Amendments. Under the Real 
Estate Settlement Procedures Act (RESPA) (12 U.S.C. 2601 et seq.), 
amounts paid by a consumer directly to a mortgage broker or through the 
lender for delivery to the mortgage broker are already required to be 
disclosed to the borrower at the loan closing on the HUD-1 or HUD-1A. 
See 24 CFR part 3500 appendix A, appendix B para.12. The Board believes 
that the new TILA disclosure requirement should not pose a significant 
additional burden, and that it is reasonable to require creditors to 
use the information from the HUD forms in calculating the finance 
charge. Accordingly, the Board expects that creditors will adopt 
practices and procedures consistent with their affirmative obligation 
to obtain the relevant information from the parties involved.
    In the May proposal, the Board noted that fees paid by the funding 
party to a broker as a ``yield spread premium,''

[[Page 49239]]

and already included in the finance charge as interest or as points 
should not be double counted. Several commenters sought further 
clarification, noting that brokers may be compensated by the lender 
under various arrangements. The proposal's reference to ``yield spread 
premiums'' was only intended to be one example of lender-paid 
compensation that must be separately disclosed on the HUD-1 under the 
current RESPA rules, but should not be double counted because it is 
already included as part of the finance charge.
4(b) Example of Finance Charge
4(b)(10) Debt Cancellation Fees
    Debt cancellation agreements serve a purpose similar to credit 
insurance, even though the products are not identical in all respects. 
Paragraph 4(b)(10) clarifies that fees charged by creditors for debt 
cancellation coverage that is written in connection with a credit 
transaction are considered finance charges. Conditions under which 
voluntary debt cancellation fees may be excluded from the finance 
charge are set forth in paragraph 4(d)(3).
    Comments by some insurance providers noted that the term ``debt 
cancellation agreement'' is not commonly used in reference to GAP 
agreements. For purposes of Regulation Z, however, the term ``debt 
cancellation agreement'' is used generically to refer to a contract 
between a debtor and creditor providing for satisfaction of all or part 
of the debt when a specified event occurs. This definition includes GAP 
agreements, even though GAP agreements only cancel the portion of the 
debt remaining after the application of property insurance benefits.
    Some commenters disagreed with the notion that voluntary debt 
cancellation fees may be considered finance charges, although they 
generally supported the Board's approach in paragraph 4(d)(3), 
excluding such fees when appropriate disclosures are provided. Other 
commenters believed that debt cancellation agreements are an integral 
part of the loan agreement and argue that such fees are necessarily 
charged as an incident to the extension of credit, making them finance 
charges.
    The Board believes that a debt cancellation fee charged by the 
creditor satisfies the definition of a finance charge because it is 
part of the cost of the credit. The TILA defines a finance charge to 
include any charge imposed as an incident to the extension of credit. 
The Board has interpreted this definition to include any fee charged by 
the creditor in connection with the loan, if it is not charged in 
comparable cash transactions and is not subject to an express 
exemption. The Board has generally taken a case-by-case approach in 
determining whether particular fees are ``finance charges,'' and does 
not interpret Regulation Z to automatically exclude all ``voluntary'' 
charges from the finance charge. As a practical matter, most voluntary 
fees are excluded from the finance charge under the separate exclusion 
for charges that are payable in a comparable cash transaction, such as 
fees for optional maintenance agreements or fees paid to process motor 
vehicle registrations. In the case of debt cancellation agreements, 
however, the voluntary nature of the arrangement does not alter the 
fact that debt cancellation coverage is a feature of the loan affecting 
the total price paid for the credit.
    Thus, even though a lender may not require a particular loan 
feature, the feature may become a term of the credit if it is included. 
For example, borrowers obtaining variable-rate loans may have an option 
to convert the loan to a fixed interest rate at a subsequent date. Even 
though the lender does not require that particular feature, when it is 
included for an additional charge (either paid separately at closing or 
paid in the form of a higher interest rate or points), that amount 
properly represents part of the finance charge for that particular 
loan, even though less costly loans may be available without that 
feature. This is also the case with debt cancellation coverage, which 
alters the fundamental nature of the borrower's repayment obligation. 
Although the same loan may be available without that feature, with 
respect to a loan that has been structured in this manner, the debt 
cancellation fee is one that has been imposed as an incident to that 
particular extension of credit. The same rationale applies to premiums 
for voluntary credit insurance, which generally are finance charges 
under the TILA but may be excluded if specified disclosures are given.
    Creditors have reported significant difficulty in determining the 
proper treatment of debt cancellation fees under Regulation Z, 
particularly GAP fees. Because the status of these agreements under 
state insurance laws and regulations is often unclear, creditors have 
been unsure whether they may apply the TILA rules excluding certain 
credit insurance premiums from the finance charge. Those rules permit 
the cost of credit insurance to be excluded if the purchase is 
voluntary and certain disclosures are made regarding the terms of the 
coverage. For the reasons discussed below, the Board has determined 
that similar treatment for debt cancellation fees is appropriate. 
Accordingly, paragraph 4(d)(3) provides that debt cancellation fees may 
be excluded from the finance charge if the disclosures and requirements 
in that paragraph are satisfied.
4(c) Charges Excluded From the Finance Charge
4(c)(7)  Real-Estate Related Fees
4(c)(7)(ii)
    Paragraph 4(c)(7)(ii) is revised to implement the amendment to 
section 106(e)(2) of the TILA (15 U.S.C. 1605(e)(2)). The Board 
believes that the amendment does not represent a substantive change 
from the current rule.
4(c)(7)(iii)
    Paragraph 4(c)(7)(iii) is revised by deleting the reference to 
appraisal fees, which is addressed separately in revised paragraph 
4(c)(7)(iv).
4(c)(7)(iv)
    Former paragraph 4(c)(7)(iv) is redesignated as 4(c)(7)(v). A new 
paragraph 4(c)(7)(iv) implements section 106(e)(5) of the TILA (15 
U.S.C. 1605(e)(5)), which clarifies that fees related to property 
inspections conducted prior to closing for pest infestation or flood 
hazard determinations, may be excluded from the finance charge. In 
response to commenters' suggestions, the language has been modified to 
reflect that the same rule applies to other types of property 
inspections conducted as part of the lender's credit decision to assess 
the value or condition of the property. The revision is consistent with 
comment 4(c)(7)-3 of the Official Staff Commentary, which states that 
excluded fees are those charged solely in connection with the initial 
decision to extend credit. The exclusion does not apply to fees for 
inspections or services to be performed periodically during the term of 
the loan.
4(d) Insurance and Debt Cancellation Coverage
4(d)(1) Voluntary Credit Insurance Premiums
    Paragraph 4(d)(1)(i) is modified consistent with existing comment 
4(d)-1 of the Official Staff Commentary, to clarify that a disclosure 
that insurance coverage is not required by the creditor must be in 
writing.

[[Page 49240]]

4(d)(3) Voluntary Debt Cancellation Fees
    The Board is amending Regulation Z by adding a provision on fees 
charged for debt cancellation agreements, which serve a purpose similar 
to credit insurance. The new rule allows creditors to exclude fees for 
voluntary debt cancellation coverage from the finance charge when 
specified disclosures are made. In disclosing debt cancellation fees, 
creditors may not use the model forms for insurance premiums unless 
debt cancellation coverage constitutes insurance under state law.
    Under a debt cancellation agreement, the creditor agrees to cancel 
all or part of any remaining debt in the event of an occurrence, such 
as the death, disability or unemployment of the borrower. The creditor 
may or may not purchase insurance to cover this risk. A specific form 
of debt cancellation known as guaranteed automobile protection, or 
``GAP,'' is sold in connection with motor vehicle loans. GAP agreements 
cancel the remaining debt when the vehicle securing the loan is stolen 
or destroyed and the settlement payment made by the consumer's primary 
automobile insurance is insufficient to pay the loan balance.
    Previously, debt cancellation fees have not been specifically 
addressed in Regulation Z. In December 1995, the Board proposed to 
issue its first written interpretation on the proper treatment of debt 
cancellation fees under then existing rules. The December 
interpretation recognized that debt cancellation fees are finance 
charges paid as an incident to the extension of credit. In some states, 
debt cancellation coverage may be considered insurance, thus the 
proposed interpretation noted that in some cases the fees might be 
excluded from the finance charge in accordance with the existing rules 
in Sec. 226.4(d) for certain types of insurance premiums. For example, 
the Board noted that in a state where debt cancellation agreements are 
considered or regulated as insurance, Sec. 226.4(d)(1) would allow such 
fees to be excluded from the finance charge if the agreement insures 
against the death, disability, or loss of income of the borrower and 
certain disclosures are given. On the other hand, fees for GAP coverage 
not protecting against the types of risk covered in Secs. 226.4(d) (1) 
and (2) were to be included in the finance charge, as were other types 
of debt cancellation fees in states where the agreements are not 
considered to be insurance. The proposed interpretation also noted that 
charges for insurance protecting the creditor against credit loss are 
finance charges under section 226.4(b)(5) and may not be excluded under 
Sec. 226.4(d).
    The comments received in response to the proposed December 
interpretation were mostly negative. Commenters expressed particular 
concern about the need to make a state-by-state determination of 
whether such agreements are considered insurance contracts. They noted 
that reliance on state law would not create a uniform rule for 
measuring the cost of credit, contrary to the purpose of the TILA. 
Creditors in some states could quote a lower APR for the same product, 
which would not assist consumers in comparison shopping. Even within a 
state that treats debt cancellation agreements as insurance, debt 
cancellation fees would not be treated uniformly under Regulation Z, 
which excludes such fees from the finance charge only if the agreement 
covers loss of life, disability, or unemployment, but not if the 
agreement covered other contingencies, as in the case of GAP 
agreements. Moreover, debt cancellation fees and credit insurance 
premiums would be treated differently for purposes of cost disclosures 
even though they served a similar purpose to the consumer.
    Commenters also expressed concern about the potential compliance 
risks associated with making a determination about the status of debt 
cancellation agreements, including GAP, in states where the insurance 
laws are unclear. Commenters stated that some creditors have refused to 
make or purchase loans with GAP coverage due to the uncertainty about 
how fees must be disclosed under the TILA. Several lawsuits have 
challenged creditors' practices of excluding voluntary GAP fees from 
the finance charge, although some courts have held that these fees are 
not finance charges in the absence of a contrary ruling by the Board.
    In April 1996, the proposed interpretation was withdrawn to allow 
the Board to consider amending Regulation Z to provide a separate rule 
that would explicitly address GAP and other debt cancellation fees. In 
May 1996, the Board proposed such a rule. The proposed rule did not 
mirror the withdrawn interpretation which had largely addressed the 
fees based on the application of the rules for insurance premiums. 
Instead, the Board proposed to treat debt cancellation agreements in a 
uniform manner, without regard to their status under state insurance 
law.
    The Board believes that it is important for Regulation Z to promote 
uniformity in the disclosure of similar credit cost features to assist 
consumers and to facilitate creditor compliance. Accordingly, the Board 
is adopting a new rule to specifically address debt cancellation 
agreements, including GAP agreements. Pursuant to its authority under 
section 105 of the TILA, the Board is authorized to issue regulations 
containing such differentiations or exceptions for any class of 
transactions as in the Board's judgment are proper to effectuate the 
purposes of the TILA or facilitate compliance with the act. The Board 
has determined that the rule being adopted, which allows voluntary debt 
cancellation fees to be excluded from the finance charge when certain 
disclosures are given, will effectuate the TILA's purpose of providing 
uniform disclosures to promote comparison shopping and the informed use 
of credit. The new rule also addresses creditors' difficulties with the 
existing rules and facilitates compliance with the act.
    Comments from credit insurance providers questioned the Board's 
authority to issue the rule based on a section 106(d)(4) of the 
original TILA, which was deleted in the Truth in Lending Simplification 
and Reform Act of 1980 (``Simplification Act''). Section 106 defines 
the term ``finance charge'' for purposes of the TILA and former section 
106(d)(4) authorized the Board to issue regulations excluding from the 
finance charge any ``type of charge which is not for credit'' (emphasis 
added). Insurance providers asserted that the deletion of section 
106(d)(4) curtailed the Board's general authority to exclude items from 
the finance charge by regulation. The Board disagrees with the 
insurance providers' interpretation.
    The Board has express authority to issue the rule on debt 
cancellation fees under section 105 of the TILA. To the extent that the 
former section 106(d)(4) may also have provided more specific 
authority, its deletion merely eliminated an alternate source of 
authority. The Board believes, however, that these commenters have 
misinterpreted the purpose of section 106(d)(4) and the reason for the 
changes made by the Simplification Act. The Simplification Act sought 
to clarify the statutory definition of a ``finance charge'' and did so 
by adding language to expressly exclude from the finance charge, all 
charges ``payable in a comparable cash transaction.'' This new 
statutory exclusion made it unnecessary for the Board to exclude 
noncredit charges on an individual basis by regulation. Thus, the 
authority originally granted in section 106(d)(4) became obsolete.
    There is nothing to suggest that the Simplification Act's revision 
to section 106 was intended to limit the Board's

[[Page 49241]]

general regulatory authority under section 105. Section 106(d)(4) 
established the Board's authority to exclude charges that were not for 
credit. The Board's broader authority under section 105 to make 
exceptions also applies to credit-related charges, and was not affected 
by the Simplification Act. Debt cancellation fees are credit-related 
charges that are not payable in comparable cash transactions, and would 
not have been the type of fees governed by section 106(d)(4).
    New paragraph 4(d)(3) closely parallels the existing rule 
pertaining to credit insurance in Sec. 226.4(d)(1), and excludes fees 
paid for similar types of debt cancellation agreements, as well as GAP 
agreements, from the finance charge if the specified conditions are 
met. Paragraph 4(d)(3) applies whether or not the debt cancellation 
agreement is considered to be insurance under state law. The language 
of paragraph 4(d)(3) has been modified in the final rule to clarify 
that it applies only to specific types of debt cancellation agreements.
    Under the final rule, fees for GAP coverage must be disclosed 
according to paragraph 4(d)(3) rather than the provisions in paragraph 
4(d)(2) for property insurance. Even though GAP coverage is triggered 
by the loss of or damage to property, GAP agreements do not insure 
against such loss or damage. Instead, GAP agreements typically cover 
the remaining balance due on the obligation after traditional property 
insurance benefits are exhausted.
    Comments from credit insurance providers expressed concern that 
consumers will be unaware that debt cancellation agreements differ from 
credit insurance. According to these commenters, the differences are 
significant and stem largely from the fact that insurance is heavily 
regulated while, to date, debt cancellation agreements are largely 
unregulated. They also noted that debt cancellation coverage may 
require consumers to pay taxes that would not apply to credit insurance 
policies. The insurance providers believed that, in the past, the 
different treatment afforded to debt cancellation fees and credit 
insurance premiums under Regulation Z has protected consumers from the 
creditors' utilization of unregulated debt cancellation agreements, but 
that the new rule would promote their use. These commenters asserted 
that if the TILA cost disclosures are identical for insurance and non-
insurance products, consumers will be misled or misinformed; they 
believe that even though greater consumer protection is afforded by the 
regulated insurance products, this difference will not be apparent to 
consumers.
    The Board is mindful that debt cancellation agreements and 
traditional insurance products are not identical in all respects. From 
the consumer's standpoint, however, both products are available to 
satisfy the consumer's liability for the debt in full measure if the 
specified contingency occurs. The fact that debt cancellation 
agreements may be subject to less oversight by state regulators or 
different tax rules is not sufficient in the Board's judgment to 
suggest that the fees paid must necessarily be included in the finance 
charge and APR for purposes of the TILA's cost disclosures. Whatever 
degree of regulation may be appropriate for debt cancellation coverage, 
Regulation Z does not affect the ability of appropriate governmental 
authorities to implement such protections. The TILA cost disclosures 
are not intended to deter creditors from offering unregulated products.
    While the TILA seeks to provide uniform disclosures about the cost 
and terms of credit to promote comparison shopping, the ultimate task 
of assessing the relative value of two different products that are 
similarly priced rests with the consumer. Where voluntary credit 
insurance and debt cancellation agreements cover the identical 
contingency for the same price, requiring the fee to be included in the 
finance charge and APR in one loan but not in the other does not fairly 
inform the borrower about the relative cost of the two loans. Consumers 
are unlikely to become better informed about the distinctions between 
these products simply by having the TILA disclosures make one loan 
appear costlier than the other. The new rule allows the cost to be 
excluded from the finance charge and APR in both cases, so long as the 
cost for the initial term of coverage is disclosed along with other 
specified items. Consumers are likely to find comparison shopping 
easier under this rule to the extent they will have similar cost 
disclosures for both products and will not have to account for 
different treatment in the finance charge or APR disclosures.
    Likewise, consumers comparing loans offered by lenders in two 
different states will be able to comparison shop based on these cost 
disclosures without considering the impact state insurance laws might 
have on the disclosed finance charge or APR. Some commenters suggested 
that uniformity could be achieved just as easily if all voluntary debt 
cancellation fees were simply included in the finance charge rather 
than excluded. Uniformity would not be achieved by the adoption of such 
a rule, however, given that in states where debt cancellation coverage 
is considered insurance the statutory exclusion for credit insurance 
premiums would still allow creditors to exclude some debt cancellation 
fees from the finance charge.
    The Board believes that treating debt cancellation fees and credit 
insurance premiums similarly for purposes of cost disclosure should not 
in itself create confusion about the nature of the parties' contractual 
relationship or the degree to which that relationship is regulated by 
state insurance agencies. The Board agrees that some confusion could 
result if creditors use the Board's existing model forms for disclosing 
insurance premiums to also disclose debt cancellation fees. Although 
the new rule allows both types of charges to be excluded from the 
finance charge under similar conditions, it does not authorize 
creditors to characterize debt cancellation fees as insurance premiums 
for TILA purposes. Creditors can comply with Sec. 226.4(d)(3) by 
providing a disclosure that refers to debt cancellation coverage 
whether or not the agreement is considered insurance. Creditors may use 
the Board's existing credit insurance disclosure forms only if the debt 
cancellation coverage constitutes insurance under state law.
4(e) Certain Security-Interest Charges
4(e)(3) Taxes on Security Instruments
    Paragraph 4(e)(3), which implements section 106(d)(3) of the TILA 
(15 U.S.C. 1605(d)(3)) is consistent with comment 4(e)-1(i) of the 
Official Staff Commentary. The new provision provides that taxes levied 
on security instruments or on documents evidencing indebtedness 
(``intangible property taxes''), that must be paid to record the 
security instrument, are excluded from the finance charge. The language 
has been modified slightly from the proposal, to clarify that the 
exclusion applies when payment of the tax is a requirement for 
recording the instrument, regardless of when the fee is paid.

Subpart C--Closed-end Credit

Section 226.17--General Disclosure Requirements
17(a) Form of Disclosures
17(a)(1)
    Footnote 38 in paragraph 17(a)(1) is revised to include the 
disclosures relating to debt cancellation agreements among those that 
may be made together with or separately from the other required 
disclosures.

[[Page 49242]]

17(c) Basis of Disclosures and Use of Estimates
17(c)(2)
    Paragraph 17(c)(2) is redesignated as 17(c)(2)(i) and modified 
slightly to reflect the general rule that disclosures must be based on 
the best information reasonably available to the creditor at the time 
the disclosures are provided to the consumer.
17(c)(2)(ii)
    Paragraph 17(c)(2)(ii) reflects the 1995 amendment to section 
121(c) of the TILA (15 U.S.C. 1631(c)), which deals with the disclosure 
of per-diem interest charges collected at loan consummation.
    Per-diem interest, also known as ``odd-days interest,'' is the 
interest that will accrue between consummation and the first regularly-
scheduled payment. A disclosure affected by the amount of per-diem 
interest collected at consummation will be considered accurate if the 
disclosure is based on the information known to the creditor at the 
time the disclosure is prepared, even if the actual charge differs by 
the time disclosures are provided to the borrower. Creditors should 
exercise reasonable diligence in ascertaining the correct information 
when preparing disclosures.
    Several commenters requested clarification on how the new $100 
finance charge tolerance for mortgage loans applies when the per-diem 
interest charges disclosed prior to consummation are inaccurate. Under 
the new rule, if finance charge disclosures are affected by per-diem 
interest, creditors may rely on the charges known at the time the 
disclosures are prepared, and the disclosures will be deemed to be 
accurate without regard to the amount of per-diem charges actually paid 
at closing. In that case, the $100 finance charge tolerance would not 
be needed. If in the same transaction, other components of the finance 
charge were understated, the creditor would still have the benefit of 
the full $100 tolerance.
    As commenters noted, this provision does not have any applicability 
in open-end credit transactions.
17(f) Early Disclosures
    Paragraph 17(f) is revised to clarify the creditor's duty to 
provide new disclosures, which is determined by comparing the APR at 
the time of consummation to the APR disclosed earlier.
Section 226.18--Content of Disclosures
18(d) Finance Charge
    Section 106(f) of the TILA (15 U.S.C. 1605(f)) establishes a new 
tolerance for accuracy in disclosing the finance charge for closed-end 
loans secured by real property or dwellings. Section 226.18(d) has been 
revised and reorganized to incorporate this change. Commenters 
generally supported the regulatory provisions implementing the new 
tolerances.
18(d)(1) Mortgage Loans
    Paragraph 18(d)(1) provides a new finance charge tolerance 
applicable to mortgage loans consummated on or after September 30, 
1995. For covered transactions, the disclosed finance charge will be 
considered accurate if it is understated by $100 or less or if the 
finance charge is overstated. The new tolerance applies to the 
disclosed finance charge as well as any disclosure affected by the 
finance charge, including the APR. The effect of the new finance charge 
tolerance on the disclosed APR is explained in more detail under 
paragraph 22(a).
    Consumer groups expressed concern that the new statutory tolerance 
might be viewed as an opportunity for creditors to intentionally charge 
consumers up to $100 more than the finance charge stated in the TILA 
disclosures and they refer to the legislative history, which suggests 
that the new law was not intended to give lenders the right to pad 
fees. They argued that the new tolerances should apply, therefore, only 
to creditor errors made in good faith. Although this principle might 
appear sound, the Board notes that the existing tolerances in 
Regulation Z are not limited to good-faith errors and that application 
of a ``good faith'' rule would necessitate a case-by-case determination 
of how a particular error occurred, complicating the broad relief 
intended by the Congress. The Board believes that imposing a good-faith 
standard would be inconsistent with the purpose of the 1995 Amendments, 
which is to reduce potential litigation over disclosure errors. 
Moreover, with the new $100 tolerance, a creditor making intentional 
misstatements would leave little or no margin for making bona fide 
errors, risking the type of potential liability that led to enactment 
of the 1995 Amendments.
18(d)(2) Other Credit
    The existing tolerance for finance charge disclosures, currently in 
footnote 41, continues to apply to all closed-end loans other than 
mortgage loans, and has been moved into paragraph 18(d)(2).
18(n) Insurance and Debt Cancellation Agreements
    Paragraph 18(n) has been revised to include disclosures made in 
connection with debt cancellation agreements.
Section 226.19--Certain Residential Mortgage and Variable Rate 
Transactions
19(a)(2)   Redisclosure Required
    Paragraph 19(a)(2) has been further revised for clarity and 
consistency with paragraph 17(f).
Section 226.22--Determination of Annual Percentage Rate
22(a)  Accuracy of Annual Percentage Rate
    Paragraph 22(a) is revised to add new paragraphs (a)(4) and (a)(5). 
For closed-end loans secured by real property or dwellings, the new 
provisions establish two additional tolerances for accuracy in 
disclosing the APR when the disclosed finance charge is within the 
tolerances established by the 1995 Amendments.
    The TILA contains tolerances for the APR, of either one-quarter or 
one-eighth of 1 percent, depending on the type of transaction. These 
existing statutory APR tolerances were not altered by the 1995 
Amendments, although the amendments create a tolerance for the finance 
charge disclosed for mortgage loans as well as ``any disclosure 
affected by the finance charge.'' Consumer groups argued that the 
Congress intended the new tolerances to apply only to numerical 
disclosures other than the APR (such as the ``amount financed'' and the 
``total of payments''), for which there is currently no regulatory or 
statutory tolerance. The Board believes, however, that the APR is one 
of the ``affected disclosures.'' Otherwise, transactions in which the 
disclosed finance charge is misstated but considered accurate under the 
new tolerance would remain subject to legal challenge based on the 
disclosed APR, which seems inconsistent with the legislative intent. 
There was broad support for this approach among creditors who commented 
on the rule.
22(a)(4) Mortgage Loans
    Paragraph 22(a)(4) provides an additional tolerance for APR 
disclosures in transactions where the finance charge is understated or 
overstated but is considered accurate under the 1995 Amendments. For 
example, in a secured home-improvement loan, if a creditor improperly 
omits a $100 fee from the

[[Page 49243]]

finance charge, the understated finance charge will now be considered 
accurate under Sec. 226.18(d)(1). Under paragraph 22(a)(4), the APR 
resulting from the understated finance charge will also be considered 
accurate, even if the disclosed APR falls outside of the existing 
tolerance of one-eighth of 1 percent provided under section 107(c) of 
the TILA. For purposes of determining a borrower's right to rescind a 
mortgage loan, an APR resulting from a finance charge that is 
considered accurate in accordance with the applicable rule in 
Sec. 226.23(g) or (h)(2) will also be considered accurate. The language 
has been modified slightly to clarify that new tolerances apply in 
addition to the existing tolerances in paragraphs 22(a)(2) and (3).
22(a)(5) Additional Tolerance for Mortgage Loans
    In light of the new APR tolerance established under the 1995 
Amendments, the Board has adopted an additional APR tolerance (not 
provided in the statute) in Sec. 226.22(a)(5). The purpose is to avoid 
the anomalous result of imposing liability on a creditor for a 
disclosed APR that is incorrect but is closer to the actual APR than 
the APR that would be considered accurate under the statutory tolerance 
in paragraph 22(a)(4).
    For instance, if the omission of a $100 fee from the finance charge 
results in an understatement of the finance charge and a disclosed APR 
that is understated by one-half of 1 percent, that APR will be 
considered accurate under paragraph 22(a)(4), even though it is outside 
of the existing APR tolerance of one-eighth of 1 percent. Under 
paragraph 22(a)(5), the disclosed APR is considered accurate if it is 
understated by less than one-half of 1 percent. Thus, if the actual APR 
in this example is 9.00 percent and the $100 omission results in an APR 
of 8.50 percent that is considered accurate under paragraph 22(a)(4), a 
disclosed APR of 8.75 percent will be within the tolerance in paragraph 
22(a)(5). Similarly, if an overstated finance charge results in an 
overstated APR, the creditor will not be liable for an overstatement 
that is closer to the actual APR.
    Under section 105 of the TILA, the Board is authorized to adopt 
exceptions to the TILA that will facilitate compliance. Paragraph 
22(a)(5) treats as accurate, a disclosed APR that is more accurate than 
the one resulting from a misstated finance charge that is considered 
accurate under the 1995 Amendments. The Board believes that this rule 
will facilitate compliance with the TILA, and prevent disputes over 
errors that have no greater effect on consumers beyond the effects 
already contemplated by the statutory tolerances. The Board recognizes 
that this rule might allow a creditor to disclose an inaccurate APR 
that is not derived from either the actual or the disclosed finance 
charge. Presumably, this situation will not be common. On balance, 
however, the Board believes the rule is consistent with the intent of 
the 1995 Amendments.
    The language in the proposed rule has been modified slightly to 
clarify that the new tolerance is in addition to and not in lieu of the 
existing tolerance.
Section 226.23--Right of Rescission
23(b) Notice of Right To Rescind
    Paragraph 23(b)(2) clarifies that use of the appropriate model form 
approved by the Board, or a comparable form, is required for compliance 
with the regulation for those disclosures.
    Model form H-9 was revised to ease compliance and to clarify that 
it may be used in loan refinancings with the original creditor, whether 
or not the creditor is the holder of the note at the time of 
refinancing. Some commenters requested further clarification on the 
proper use of the form, noting that it does not address the situation 
where the original note and mortgage are extinguished and new documents 
are executed to cover both the outstanding debt and the amount borrowed 
in the new transaction. The form has been revised in order to address 
these concerns.
23(g) Tolerances for Accuracy
    Paragraph 23(g) implements section 106(f)(2) of the TILA (15 U.S.C. 
1605(f)(2)). The Board is applying the rescission tolerances in section 
106(f)(2) in addition to, rather than in lieu of, the general 
tolerances in section 106(f)(1). The Board believes this is consistent 
with the statutory language; it is unlikely that the Congress intended 
to allow the rescission remedy to be invoked when the disclosures would 
otherwise be considered accurate under the rules for civil and 
administrative liability. Most commenters supported these 
interpretations. Consumer groups expressed the view that the new 
rescission tolerances should only be applied to creditor errors made in 
good faith. For the reasons already discussed, the Board believes such 
an interpretation would be inconsistent with the legislative intent of 
the amendments.
    Several commenters sought clarification of what constitutes a loan 
where ``no new money is advanced'' for purposes of Sec. 226.23(g)(2). 
The rule has been modified for consistency and now refers to a 
refinancing in which there has been ``no new advance.'' This phrase 
applies to loans for which the new amount financed does not exceed the 
unpaid principal balance plus any earned unpaid finance charge on the 
existing debt, and amounts attributed solely to the costs of the 
refinancing. This is consistent with section 226.23(f)(2) and the 
language used in comment 23(f)-4 of the Official Staff Commentary.
23(h) Special Rules for Foreclosures
    Paragraph 23(h) implements section 125(i)(2) of the TILA (15 U.S.C. 
1635(i)(2)), which provides special rescission rules after a 
foreclosure action has been initiated. Most commenters supported the 
proposal, although consumer groups believed that the foreclosure rules 
should apply to both open- and closed-end mortgage transactions.
    The Board proposed to apply the new foreclosure rules only to 
closed-end mortgages since there appeared to be no basis for applying 
them to open-end lines of credit. The Board believes the Congress 
clearly intended to provide additional consumer protections once 
foreclosure has been initiated. For example, the statute allows a 
consumer to rescind a closed-end loan in foreclosure if the finance 
charge is understated by more than $35, even though a larger tolerance 
would otherwise apply. Because open-end home equity loans have no 
general tolerance for finance charge errors, applying the $35 tolerance 
to open-end loans in foreclosure would actually result in less 
protection for consumers. The Board believes this would be inconsistent 
with the intent of the special foreclosure rules. Accordingly, the 
Board interprets the foreclosure tolerances to apply only to closed-end 
loans.
    The 1995 Amendments also allow a consumer to rescind a loan in 
foreclosure if a mortgage broker fee was not properly disclosed, 
without regard to the dollar amount involved. Consumer groups commented 
that this aspect of the new foreclosure rules should be applied to 
open-end transactions. Because broker fees are not generally associated 
with open-end lines of credit, it seems unlikely that this was the 
legislative intent. There is also no basis for reading this portion of 
the foreclosure rules more broadly than the foreclosure tolerances 
which apply only to closed-end transactions.
    The new rules covering consumers' right to rescind a loan in 
foreclosure

[[Page 49244]]

only apply to transactions that were originally subject to the right of 
rescission. Consequently, the new rules do not apply to purchase money 
loans.

Subpart E--Special Rules for Certain Mortgage Transactions

Section 226.31--General Rules
31(d) Basis of Disclosures and Use of Estimates
    Paragraph 31(d) is revised and reorganized, consistent with the 
revisions made to Sec. 226.17(c).
31(d)(3)
    Paragraph 31(d)(3) incorporates the new rule regarding the 
disclosure of per-diem interest charges, consistent with the amendment 
in section 226.17(c)(2)(ii). In preparing disclosures, creditors are 
expected to exercise reasonable diligence in ascertaining the necessary 
information. Paragraph 31(d)(3) has been modified slightly to clarify 
that the rule applies to a disclosure made pursuant to Subpart E (such 
as the APR) that would be affected by the per-diem interest charge.
31(g) Accuracy of Annual Percentage Rate
    Paragraph 31(g) is intended to clarify that for purposes of 
determining whether a transaction is covered under Sec. 226.32(a) and 
in making the disclosures required by Sec. 226.32(c), a creditor may 
rely on its APR calculations if they are considered accurate according 
to the APR tolerances provided in Sec. 226.22. For this purpose, the 
APR tolerances in paragraph 22(a) (4) and (5) apply only if the finance 
charge is considered accurate under Sec. 226.18(d)(1); the rescission 
tolerances in Sec. 226.23 (g) or (h) do not apply.
    Consumer groups expressed the view that the new tolerances should 
not apply in determining whether a loan is covered under 
Sec. 226.32(a). The language of the 1995 Amendments suggests that the 
new tolerances apply to all closed-end mortgage loans. The Board does 
not believe such an interpretation would be consistent with the 
legislative intent of the statute.
Appendix H to Part 226--Closed-End Model Forms and Clauses
H-9 Rescission Model Form
    The 1995 Amendments clarify that creditors will not be liable for 
the form of rescission notice they give to the consumer if the creditor 
uses the appropriate form published by the Board or a comparable 
notice. In order to ease compliance, model form H-9 has been revised 
slightly to clarify that it may be used in loan refinancings with the 
original creditor, without regard to whether the original creditor is 
the holder of the note at the time of refinancing. Creditors may, 
however, continue to use the original forms H-8 and H-9 as appropriate.
Supplement I--Official Staff Interpretations
    The revisions would conform the Official Staff Commentary 
consistent with the amendments to Regulation Z.

IV. Regulatory Flexibility Analysis

    In accordance with section 3(a) of the Regulatory Flexibility Act 
(5 U.S.C. 603), the Board's Office of the Secretary has reviewed the 
amendments to Regulation Z. Overall, the amendments are not expected to 
have any significant impact on small entities. The regulatory revisions 
required to implement the 1995 Amendments clarify the existing 
disclosure requirements and ease compliance by providing new 
tolerances. Under the existing rules, fees charged in connection with 
debt cancellation agreements are generally treated as finance charges; 
the final rule allows creditors to exclude these fees from the finance 
charge if additional disclosures are provided to the consumer.

V. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3501 et seq.), the Board has reviewed the amendments to Regulation Z 
under the authority delegated to the Board by the Office of Management 
and Budget. 5 CFR part 1320 appendix A.1.
    The respondents are individuals or businesses that regularly offer 
or extend consumer credit. The purpose of the TILA and Regulation Z is 
to promote the informed use of consumer credit by requiring creditors 
to disclose its terms and cost. Creditors must retain records of 
compliance for 24 months. The revisions to the requirements in this 
regulation are found in 12 CFR 226.4, 226.17, 226.18, 226.19, 226.23, 
and 226.31.
    The disclosures made by creditors to consumers under Regulation Z 
are mandatory pursuant to the Truth in Lending Act (15 U.S.C. 1601 et 
seq.). Since the Federal Reserve does not collect any information, no 
issue of confidentiality under the Freedom of Information Act arises. 
Disclosures relating to specific transactions or accounts are not 
publicly available.
    The Board's Regulation Z applies to all types of creditors, not 
just state member banks. Under the Paperwork Reduction Act, however, 
the Federal Reserve accounts for the paperwork burden associated with 
Regulation Z only for state member banks. Any estimates of paperwork 
burden for institutions other than state member banks that would be 
affected by the amendments would be provided by the federal agency or 
agencies that supervise those lenders.
    There are 1,042 state member banks with an average frequency of 
136,294 responses per bank each year. The current estimated burden for 
Regulation Z ranges from 5 seconds per response (for disclosures prior 
to opening a credit card account) to 30 minutes per response (for 
inclusion of information in an advertisement). The combined annual 
burden for all state member banks under Regulation Z is estimated to be 
1,975,605 hours (an average of 1,896 hours per state member bank).
    As stated in the notice of proposed rulemaking, the changes to the 
regulation are not expected to increase the ongoing annual burden of 
Regulation Z. The Federal Reserve also estimated the associated startup 
cost to be $160 per respondent for changing disclosures (or disclosure-
producing software) to include disclosures relating to voluntary debt 
cancellation agreements.
    The Federal Reserve received comments on the burden estimates from 
a multi-bank holding company and from a bank and its affiliated 
mortgage company. Both believed that the Federal Reserve's estimate of 
the cost of revising the disclosures was too low. However, some 
activities cited by the commenters, such as recordkeeping, filing, 
auditing, and monitoring, should be ongoing under the current rule. The 
burden for these activities is included in the figures above, estimated 
to be 1,896 hours per state member bank per year. Also, under the 
Paperwork Reduction Act, some activities, while associated with 
complying with the regulation, are not considered paperwork burden. 
Nonetheless, the Federal Reserve is revising its estimate of the 
typical startup cost at a state member bank to $3,000 to include the 
cost of additional legal services.
    An agency may not collect or sponsor the collection or disclosure 
of information, and an organization is not required to collect or 
disclose information unless a currently valid OMB control number is 
displayed. The OMB control number for the Recordkeeping and Disclosure 
Requirements in Connection with Regulation Z is 7100-0199.
    Send comments regarding the burden estimate, or any other aspect of 
this collection of information, including

[[Page 49245]]

suggestions for reducing the burden, to: Secretary, Board of Governors 
of the Federal Reserve System, 20th and C Streets, NW., Washington, DC 
20551; and to the Office of Management and Budget, Paperwork Reduction 
Project (7100-0199), Washington, DC 20503.

List of Subjects in 12 CFR Part 226

    Advertising, Banks, banking, Consumer protection, Credit, Federal 
Reserve System, Mortgages, Reporting and recordkeeping requirements, 
Truth in lending.

    For the reasons set forth in the preamble, the Board amends 12 CFR 
Part 226 as follows:

PART 226--TRUTH IN LENDING (REGULATION Z)

    1. The authority citation for part 226 continues to read as 
follows:

    Authority: 12 U.S.C. 3806; 15 U.S.C. 1604 and 1637(c)(5).

    2. Section 226.2 is amended by revising paragraph (a)(6) to read as 
follows:


Sec. 226.2  Definitions and rules of construction.

    (a) Definitions. * * *
* * * * *
    (6) Business day means a day on which the creditor's offices are 
open to the public for carrying on substantially all of its business 
functions. However, for purposes of rescission under Secs. 226.15 and 
226.23, and for purposes of Sec. 226.31, the term means all calendar 
days except Sundays and the legal public holidays specified in 5 U.S.C. 
6103(a), such as New Year's Day, the Birthday of Martin Luther King, 
Jr., Washington's Birthday, Memorial Day, Independence Day, Labor Day, 
Columbus Day, Veterans Day, Thanksgiving Day, and Christmas Day.
* * * * *
    3. Section 226.4 is amended as follows:
    a. Paragraph (a) is revised;
    b. New paragraph (b)(10) is added;
    c. A heading is added to paragraph (c)(7), the introductory text to 
paragraph (c)(7) is republished, paragraphs (c)(7)(ii) and (c)(7)(iii) 
are revised, paragraph (c)(7)(iv) is redesignated as paragraph 
(c)(7)(v) and republished, and a new paragraph (c)(7)(iv) is added;
    d. The paragraph (d) heading is revised, the paragraph (d)(1) 
heading and introductory text are revised, paragraph (d)(1)(i) is 
revised, and a new paragraph (d)(3) is added.
    e. A new paragraph (e)(3) is added.
    The revisions and additions are to read as follows:


Sec. 226.4  Finance charge.

    (a) Definition. The finance charge is the cost of consumer credit 
as a dollar amount. It includes any charge payable directly or 
indirectly by the consumer and imposed directly or indirectly by the 
creditor as an incident to or a condition of the extension of credit. 
It does not include any charge of a type payable in a comparable cash 
transaction.
    (1) Charges by third parties. The finance charge includes fees and 
amounts charged by someone other than the creditor, unless otherwise 
excluded under this section, if the creditor:
    (i) requires the use of a third party as a condition of or an 
incident to the extension of credit, even if the consumer can choose 
the third party; or
    (ii) retains a portion of the third-party charge, to the extent of 
the portion retained.
    (2) Special rule; closing agent charges. Fees charged by a third 
party that conducts the loan closing (such as a settlement agent, 
attorney, or escrow or title company) are finance charges only if the 
creditor:
    (i) Requires the particular services for which the consumer is 
charged;
    (ii) Requires the imposition of the charge; or
    (iii) Retains a portion of the third-party charge, to the extent of 
the portion retained.
    (3) Special rule; mortgage broker fees. Fees charged by a mortgage 
broker (including fees paid by the consumer directly to the broker or 
to the creditor for delivery to the broker) are finance charges even if 
the creditor does not require the consumer to use a mortgage broker and 
even if the creditor does not retain any portion of the charge.
    (b) Example of finance charge * * *
* * * * *
    (10) Debt cancellation fees. Charges or premiums paid for debt 
cancellation coverage written in connection with a credit transaction, 
whether or not the debt cancellation coverage is insurance under 
applicable law.
    (c) Charges excluded from the finance charge. * * *
* * * * *
    (7) Real-estate related fees. The following fees in a transaction 
secured by real property or in a residential mortgage transaction, if 
the fees are bona fide and reasonable in amount:
* * * * *
    (ii) Fees for preparing loan-related documents, such as deeds, 
mortgages, and reconveyance or settlement documents.
    (iii) Notary and credit report fees.
    (iv) Property appraisal fees or fees for inspections to assess the 
value or condition of the property if the service is performed prior to 
closing, including fees related to pest infestation or flood hazard 
determinations.
    (v) Amounts required to be paid into escrow or trustee accounts if 
the amounts would not otherwise be included in the finance charge.
* * * * *
    (d) Insurance and debt cancellation coverage.--(1) Voluntary credit 
insurance premiums. Premiums for credit life, accident, health or loss-
of-income insurance may be excluded from the finance charge if the 
following conditions are met:
    (i) The insurance coverage is not required by the creditor, and 
this fact is disclosed in writing.
* * * * *
    (3) Voluntary debt cancellation fees. (i) Charges or premiums paid 
for debt cancellation coverage of the type specified in paragraph 
(d)(3)(ii) of this section may be excluded from the finance charge, 
whether or not the coverage is insurance, if the following conditions 
are met:
    (A) The debt cancellation agreement or coverage is not required by 
the creditor, and this fact is disclosed in writing;
    (B) The fee or premium for the initial term of coverage is 
disclosed. If the term of coverage is less than the term of the credit 
transaction, the term of coverage also shall be disclosed. The fee or 
premium may be disclosed on a unit-cost basis only in open-end credit 
transactions, closed-end credit transactions by mail or telephone under 
Sec. 226.17(g), and certain closed-end credit transactions involving a 
debt cancellation agreement that limits the total amount of 
indebtedness subject to coverage;
    (C) The consumer signs or initials an affirmative written request 
for coverage after receiving the disclosures specified in this 
paragraph. Any consumer in the transaction may sign or initial the 
request.
    (ii) Paragraph (d)(3)(i) of this section applies to fees paid for 
debt cancellation coverage that provides for cancellation of all or 
part of the debtor's liability for amounts exceeding the value of the 
collateral securing the obligation, or in the event of the loss of 
life, health, or income or in case of accident.
    (e) Certain security interest charges. * * *
* * * * *
    (3) Taxes on security instruments. Any tax levied on security 
instruments or on documents evidencing indebtedness if the payment of 
such taxes is a requirement for recording the

[[Page 49246]]

instrument securing the evidence of indebtedness.
* * * * *
    4. Section 226.17 is amended as follows:
    a. In paragraph (a)(1), footnote 38 is revised;
    b. Paragraph (c)(2) is redesignated as paragraph (c)(2)(i) and 
revised, and paragraph (c)(2)(ii) is added;
    c. Paragraph (f) is revised.
    The revisions and additions are to read as follows:


Sec. 226.17  General disclosure requirements.

    (a) Form of disclosures. (1) * * * 38 * * *
---------------------------------------------------------------------------

    \38\ The following disclosures may be made together with or 
separately from other required disclosures: the creditor's identity 
under Sec. 226.18(a), the variable rate example under 
Sec. 226.18(f)(4), insurance or debt cancellation under 
Sec. 226.18(n), and certain security interest charges under 
Sec. 226.18(o).
---------------------------------------------------------------------------

* * * * *
    (c) Basis of disclosures and use of estimates. * * *
    (2)(i) If any information necessary for an accurate disclosure is 
unknown to the creditor, the creditor shall make the disclosure based 
on the best information reasonably available at the time the disclosure 
is provided to the consumer, and shall state clearly that the 
disclosure is an estimate.
    (ii) For a transaction in which a portion of the interest is 
determined on a per-diem basis and collected at consummation, any 
disclosure affected by the per-diem interest shall be considered 
accurate if the disclosure is based on the information known to the 
creditor at the time that the disclosure documents are prepared for 
consummation of the transaction.
* * * * *
    (f) Early disclosures. If disclosures required by this subpart are 
given before the date of consummation of a transaction and a subsequent 
event makes them inaccurate, the creditor shall disclose before 
consummation: 39
---------------------------------------------------------------------------

    \39\ For certain residential mortgage transactions, 
Sec. 226.19(a)(2) permits redisclosure no later than consummation or 
settlement, whichever is later.
---------------------------------------------------------------------------

    (1) any changed term unless the term was based on an estimate in 
accordance with Sec. 226.17(c)(2) and was labelled an estimate;
    (2) all changed terms, if the annual percentage rate at the time of 
consummation varies from the annual percentage rate disclosed earlier 
by more than \1/8\ of 1 percentage point in a regular transaction, or 
more than \1/4\ of 1 percentage point in an irregular transaction, as 
defined in Sec. 226.22(a).
* * * * *
    5. Section 226.18 is amended as follows:
    a. Footnote 41 in paragraph (d) is removed and paragraph (d) 
introductory text is republished;
    b. New paragraphs (d)(1) and (d)(2) are added;
    c. Footnotes 39 and 40 in paragraph (c) are redesignated as 
footnotes 40 and 41 respectively; and
    d. Paragraph (n) is revised.
    The revisions and additions are to read as follows:


Sec. 226.18  Content of disclosures.

* * * * *
    (d) Finance charge. The finance charge, using that term, and a 
brief description such as ``the dollar amount the credit will cost 
you.''
    (1) Mortgage loans. In a transaction secured by real property or a 
dwelling, the disclosed finance charge and other disclosures affected 
by the disclosed finance charge (including the amount financed and the 
annual percentage rate) shall be treated as accurate if the amount 
disclosed as the finance charge:
    (i) is understated by no more than $100; or
    (ii) is greater than the amount required to be disclosed.
    (2) Other credit. In any other transaction, the amount disclosed as 
the finance charge shall be treated as accurate if, in a transaction 
involving an amount financed of $1,000 or less, it is not more than $5 
above or below the amount required to be disclosed; or, in a 
transaction involving an amount financed of more than $1,000, it is not 
more than $10 above or below the amount required to be disclosed.
* * * * *
    (n) Insurance and debt cancellation. The items required by 
Sec. 226.4(d) in order to exclude certain insurance premiums and debt 
cancellation fees from the finance charge.
* * * * *
    6. Section 226.19 is amended by revising paragraph (a)(2) to read 
as follows:


Sec. 226.19  Certain residential mortgage and variable-rate 
transactions.

    (a) * * *
    (2) Redisclosure required. If the annual percentage rate at the 
time of consummation varies from the annual percentage rate disclosed 
earlier by more than \1/8\ of 1 percentage point in a regular 
transaction or more than \1/4\ of 1 percentage point in an irregular 
transaction, as defined in Sec. 226.22, the creditor shall disclose all 
the changed terms no later than consummation or settlement.
* * * * *
    7. Section 226.22 is amended by adding new paragraphs (a)(4) and 
(a)(5) to read as follows:


Sec. 226.22  Determination of annual percentage rate.

    (a) Accuracy of annual percentage rate. * * *
* * * * *
    (4) Mortgage loans. If the annual percentage rate disclosed in a 
transaction secured by real property or a dwelling varies from the 
actual rate determined in accordance with paragraph (a)(1) of this 
section, in addition to the tolerances applicable under paragraphs 
(a)(2) and (3) of this section, the disclosed annual percentage rate 
shall also be considered accurate if:
    (i) The rate results from the disclosed finance charge; and
    (ii)(A) The disclosed finance charge would be considered accurate 
under Sec. 226.18(d)(1); or
    (B) For purposes of rescission, if the disclosed finance charge 
would be considered accurate under Sec. 226.23(g) or (h), whichever 
applies.
    (5) Additional tolerance for mortgage loans. In a transaction 
secured by real property or a dwelling, in addition to the tolerances 
applicable under paragraphs (a)(2) and (3) of this section, if the 
disclosed finance charge is calculated incorrectly but is considered 
accurate under Sec. 226.18(d)(1) or Sec. 226.23(g) or (h), the 
disclosed annual percentage rate shall be considered accurate:
    (i) If the disclosed finance charge is understated, and the 
disclosed annual percentage rate is also understated but it is closer 
to the actual annual percentage rate than the rate that would be 
considered accurate under paragraph (a)(4) of this section;
    (ii) If the disclosed finance charge is overstated, and the 
disclosed annual percentage rate is also overstated but it is closer to 
the actual annual percentage rate than the rate that would be 
considered accurate under paragraph (a)(4) of this section.
* * * * *
    8. Section 226.23 is amended as follows:
    a. Paragraphs (b)(1) through (b)(5) are redesignated as paragraphs 
(b)(1)(i) through (b)(1)(v);
    b. The introductory text of paragraph (b) is redesignated as (b)(1) 
and republished;
    c. A new paragraph (b)(2) is added; and
    d. New paragraphs (g) and (h) are added.
    The revisions and additions are to read as follows:

[[Page 49247]]

Sec. 226.23  Right of rescission.

* * * * *
    (b)(1) Notice of right to rescind. In a transaction subject to 
rescission, a creditor shall deliver two copies of the notice of the 
right to rescind to each consumer entitled to rescind. The notice shall 
be on a separate document that identifies the transaction and shall 
clearly and conspicuously disclose the following:
    (i) The retention or acquisition of a security interest in the 
consumer's principal dwelling.
    (ii) The consumer's right to rescind the transaction.
    (iii) How to exercise the right to rescind, with a form for that 
purpose, designating the address of the creditor's place of business.
    (iv) The effects of rescission, as described in paragraph (d) of 
this section.
    (v) The date the rescission period expires.
    (2) Proper form of notice. To satisfy the disclosure requirements 
of paragraph (b)(1) of this section, the creditor shall provide the 
appropriate model form in Appendix H of this part or a substantially 
similar notice.
* * * * *
    (g) Tolerances for accuracy.--(1) One-half of 1 percent tolerance. 
Except as provided in paragraphs (g)(2) and (h)(2) of this section, the 
finance charge and other disclosures affected by the finance charge 
(such as the amount financed and the annual percentage rate) shall be 
considered accurate for purposes of this section if the disclosed 
finance charge:
    (i) is understated by no more than \1/2\ of 1 percent of the face 
amount of the note or $100, whichever is greater; or
    (ii) is greater than the amount required to be disclosed.
    (2) One percent tolerance. In a refinancing of a residential 
mortgage transaction with a new creditor (other than a transaction 
covered by Sec. 226.32), if there is no new advance and no 
consolidation of existing loans, the finance charge and other 
disclosures affected by the finance charge (such as the amount financed 
and the annual percentage rate) shall be considered accurate for 
purposes of this section if the disclosed finance charge:
    (i) is understated by no more than 1 percent of the face amount of 
the note or $100, whichever is greater; or
    (ii) is greater than the amount required to be disclosed.
    (h) Special rules for foreclosures.--(1) Right to rescind. After 
the initiation of foreclosure on the consumer's principal dwelling that 
secures the credit obligation, the consumer shall have the right to 
rescind the transaction if:
    (i) A mortgage broker fee that should have been included in the 
finance charge was not included; or
    (ii) The creditor did not provide the properly completed 
appropriate model form in Appendix H of this part, or a substantially 
similar notice of rescission.
    (2) Tolerance for disclosures. After the initiation of foreclosure 
on the consumer's principal dwelling that secures the credit 
obligation, the finance charge and other disclosures affected by the 
finance charge (such as the amount financed and the annual percentage 
rate) shall be considered accurate for purposes of this section if the 
disclosed finance charge:
    (i) is understated by no more than $35; or
    (ii) is greater than the amount required to be disclosed.
    9. Section 226.31 is amended by revising paragraphs (d) and (g) to 
read as follows:


Sec. 226.31  General rules.

* * * * *
    (d) Basis of disclosures and use of estimates--(1) Legal 
Obligation. Disclosures shall reflect the terms of the legal obligation 
between the parties.
    (2) Estimates. If any information necessary for an accurate 
disclosure is unknown to the creditor, the creditor shall make the 
disclosure based on the best information reasonably available at the 
time the disclosure is provided, and shall state clearly that the 
disclosure is an estimate.
    (3) Per-diem interest. For a transaction in which a portion of the 
interest is determined on a per-diem basis and collected at 
consummation, any disclosure affected by the per-diem interest shall be 
considered accurate if the disclosure is based on the information known 
to the creditor at the time that the disclosure documents are prepared.
* * * * *
    (g) Accuracy of annual percentage rate. For purposes of 
Sec. 226.32, the annual percentage rate shall be considered accurate, 
and may be used in determining whether a transaction is covered by 
Sec. 226.32, if it is accurate according to the requirements and within 
the tolerances under Sec. 226.22. The finance charge tolerances for 
rescission under Sec. 226.23(g) or (h) shall not apply for this 
purpose.
    10. In Part 226, Appendix H is amended by revising the H-9 
Rescission Model Form and the contents listing at the beginning of 
Appendix H to read as follows:
Appendix H to Part 226--Closed End Model Forms and Clauses
H-1--Credit Sale Model Form (Sec. 226.18)
H-2--Loan Model Form (Sec. 226.18)
H-3--Amount Financed Itemization Model Form (Sec. 226.18(c))
H-4(A)--Variable-Rate Model Clauses (Sec. 226.18(f)(1))
H-4(B)--Variable-Rate Model Clauses (Sec. 226.18(f)(2))
H-4(C)--Variable-Rate Model Clauses (Sec. 226.19(b))
H-4(D)--Variable-Rate Model Clauses (Sec. 226.20(c))
H-5--Demand Feature Model Clauses (Sec. 226.18(I))
H-6--Assumption Policy Model Clause (Sec. 226.18(q))
H-7--Required Deposit Model Clause (Sec. 226.18(r))
H-8--Rescission Model Form (General) (Sec. 226.23)
H-9--Rescission Model Form (Refinancing With Original Creditor) 
(Sec. 226.23)
H-10--Credit Sale Sample
H-11--Installment Loan Sample
H-12--Refinancing Sample
H-13--Mortgage with Demand Feature Sample
H-14--Variable-Rate Mortgage Sample (Sec. 226.19(b))
H-15--Graduated Payment Mortgage Sample
H-16--Mortgage Sample (Sec. 226.32)
* * * * *

H-9--Rescission Model Form (Refinancing with Original Creditor)

NOTICE OF RIGHT TO CANCEL

Your Right to Cancel

    You are entering into a new transaction to increase the amount 
of credit previously provided to you. Your home is the security for 
this new transaction. You have a legal right under federal law to 
cancel this new transaction, without cost, within three business 
days from whichever of the following events occurs last:
    (1) the date of this new transaction, which is ________________; 
or
    (2) the date you received your new Truth in Lending disclosures; 
or
    (3) the date you received this notice of your right to cancel.
    If you cancel this new transaction, it will not affect any 
amount that you presently owe. Your home is the security for that 
amount. Within 20 calendar days after we receive your notice of 
cancellation of this new transaction, we must take the steps 
necessary to reflect the fact that your home does not secure the 
increase of credit. We must also return any money you have given to 
us or anyone else in connection with this new transaction.
    You may keep any money we have given you in this new transaction 
until we have done the things mentioned above, but you must then 
offer to return the money at the address below.

[[Page 49248]]

    If we do not take possession of the money within 20 calendar 
days of your offer, you may keep it without further obligation.

How To Cancel

    If you decide to cancel this new transaction, you may do so by 
notifying us in writing, at

----------------------------------------------------------------------
(Creditor's name and business address).

    You may use any written statement that is signed and dated by 
you and states your intention to cancel, or you may use this notice 
by dating and signing below. Keep one copy of this notice because it 
contains important information about your rights.
    If you cancel by mail or telegram, you must send the notice no 
later than midnight of

----------------------------------------------------------------------

(Date)-----------------------------------------------------------------

(or midnight of the third business day following the latest of the 
three events listed above).
    If you send or deliver your written notice to cancel some other 
way, it must be delivered to the above address no later than that 
time.

I WISH TO CANCEL

----------------------------------------------------------------------
Consumer's Signature
----------------------------------------------------------------------
Date

    11. In Supplement I to Part 226, under Section 226.4--Finance 
Charge, under 4(a) Definition, paragraph 3.ii. is removed.
    12. In Supplement I to Part 226, under Section 226.17--General 
Disclosure Requirements, under 17(c) Basis of disclosures and use of 
estimates, paragraph 17(c)(2) is redesignated as paragraph 17(c)(2)(i):
Supplement I--Official Staff Interpretations
* * * * *

Section 226.17--General Disclosure Requirements

* * * * *

17(c) Basis of Disclosures and Use of Estimates

* * * * *
    Paragraph 17(c)(2)(i).
* * * * *
    13. In Supplement I to Part 226, under Section 226.18--Content of 
Disclosures, under 18(d) Finance charge, paragraph 2 is removed.
    14. In Supplement I to Part 226, under Section 226.23--Right of 
Rescission, under 23(b) Notice of right to rescind, the first sentence 
of paragraph 3 is revised to read as follows:

Section 226.23--Right of Rescission.

* * * * *

23(b) Notice of right to rescind

* * * * *
    3. Content. The notice must include all of the information 
outlined in Section 226.23(b)(1)(i) through (v). * * *
* * * * *
    By order of the Board of Governors of the Federal Reserve 
System, September 13, 1996.
William W. Wiles,
Secretary of the Board.
[FR Doc. 96-23951 Filed 9-18-96; 8:45 am]
BILLING CODE 6210-01-P