[Federal Register Volume 65, Number 248 (Tuesday, December 26, 2000)]
[Proposed Rules]
[Pages 81438-81452]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-32504]


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FEDERAL RESERVE SYSTEM

12 CFR Part 226

[Regulation Z; Docket No. R-1090]


Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Proposed rule.

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SUMMARY: The Board is proposing amendments to the provisions of 
Regulation Z (Truth in Lending) that implement the Home Ownership and 
Equity Protection Act (HOEPA). HOEPA was enacted in 1994, in response 
to evidence of abusive lending practices in the home-equity lending 
market. HOEPA imposes additional disclosure requirements and 
substantive limitations (for example, restricting short-term balloon 
notes) on home-equity loans bearing rates or fees above a certain 
percentage or amount. The amendments would broaden the scope of 
mortgage loans subject to HOEPA by adjusting the price triggers used to 
determine coverage under the act. The rate-based trigger would be 
lowered by two percentage points and the fee-based trigger would be 
revised to include optional insurance premiums and similar credit 
protection products paid at closing. Certain acts and practices in 
connection with home-secured loans would be prohibited, including rules 
to restrict creditors from engaging in repeated refinancings of their 
own HOEPA loans over a short time period when the transactions are not 
in the borrower's interest. HOEPA's prohibition against extending 
credit without regard to consumers' repayment ability would be 
strengthened. Disclosures received by consumers before closing for 
HOEPA-covered loans would be enhanced.

DATES: Comments must be received on or before March 9, 2001.

ADDRESSES: Comments, which should refer to Docket No. R-1090, may be 
mailed to Ms. Jennifer J. Johnson, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW., 
Washington, DC 20551 or mailed electronically to 
[email protected]. Comments addressed to Ms. Johnson may 
also be delivered to the Board's mail room between 8:45 a.m. and 5:15 
p.m. weekdays, and to the security control room at all other times. The 
mail room and the security control room, both in the Board's Eccles 
Building, are accessible from the courtyard entrance on 20th Street 
between Constitution Avenue and C Street, NW. Comments may be inspected 
in room MP-500 in the Board's Martin Building between 9:00 a.m. and 
5:00 p.m., pursuant to the Board's Rules Regarding the Availability of 
Information, 12 CFR part 261.

FOR FURTHER INFORMATION CONTACT: Kyung Cho-Miller, Counsel, or Jane E. 
Ahrens, Senior Counsel, Division of Consumer and Community Affairs, at 
(202) 452-3667 or 452-2412; for the hearing impaired only, contact 
Janice Simms, Telecommunication Device for the Deaf, (202) 872-4984.

SUPPLEMENTARY INFORMATION:

I. Background

    Much attention has been focused on ``predatory lending practices'' 
in connection with mortgage loans. The term encompasses a variety of 
practices. Homeowners in certain communities oftentimes are targeted 
with offers of high-cost credit, particularly the elderly, minorities, 
and women. In the case of elderly homeowners, they may be living on 
fixed incomes and have little or no home-secured debt. The loans may be 
based on consumers' equity in their homes and not their ability to make 
the scheduled payments. When homeowners have trouble repaying, they are 
often encouraged to refinance the loan into another unaffordable, high-
fee loan that increases the loan amount owed primarily due to financed 
fees and decreases the consumers' equity in their homes. (This practice 
is referred to as ``loan flipping'' or ``equity stripping.'') The loan 
transactions also may involve fraud, misrepresentations, and other 
deceptive practices.

The Home Ownership and Equity Protection Act

    In response to the anecdotal evidence about abusive practices 
involving high-cost home-secured loans, in 1994 the Congress enacted 
the Home Ownership and Equity Protection Act (HOEPA), contained in the 
Riegle Community Development and Regulatory Improvement Act of 1994, 
Public Law 103-325, 108 Stat. 2160, as an amendment to the Truth in 
Lending Act (TILA), 15 U.S.C. 1601 et seq. TILA is intended 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. 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.
    HOEPA does not prohibit creditors from making any type of home-
secured loan, nor does it limit or cap rates that creditors may charge. 
Instead, HOEPA identifies a class of high-cost mortgage loans through 
rate and fee triggers, and it provides consumers entering into these 
transactions with special protections. A loan is covered by HOEPA if 
(1) the APR exceeds the rate for Treasury securities with a comparable 
maturity by more than 10 percentage points, or (2) the points and fees 
paid by the consumer exceed the greater of 8 percent of the loan amount 
or $400. The $400 figure is adjusted annually based on the Consumer 
Price Index; for 2001 it is $465. 65 FR 70465, Nov. 24, 2000.
    HOEPA is implemented in Sec. 226.32 of the Board's Regulation Z, 
effective in October 1995. 60 FR 15463, March 24, 1995. HOEPA also 
amended TILA to require additional disclosures for reverse mortgages, 
that are contained in `` Sec. 226.33 of Regulation Z. For purposes of 
this notice of proposed rulemaking, however, the term ``HOEPA-covered 
loan'' or ``HOEPA loan'' generally refers only to mortgages covered by 
`` Sec. 226.32 that meet HOEPA's rate or fee-based triggers.
    Creditors offering HOEPA-covered loans must give consumers an 
abbreviated disclosure statement at least three business days before 
the loan is closed, in addition to the disclosures generally required 
by TILA before or at closing. The HOEPA disclosure informs consumers 
that they are not obligated to complete the transaction and could lose 
their home if they take the loan and fail to make payments. It includes 
a few key cost disclosures, including the APR. In loans where consumers 
have three business days after closing to rescind the loan, the HOEPA 
disclosure affords consumers a minimum of six business days to consider 
key loan terms before receiving the loan proceeds.
    HOEPA also restricts certain loan terms based on evidence that they 
had been associated with abusive lending practices. These terms include 
short-

[[Page 81439]]

term balloon notes, prepayment penalties, non-amortizing payment 
schedules, and higher interest rates upon default. Creditors are 
prohibited from engaging in a pattern or practice of making HOEPA loans 
without regard to the borrower's ability to repay the loan. HOEPA 
imposes a strict liability rule that holds purchasers and assignees, as 
well as creditors, liable for any violations of law. In addition, HOEPA 
authorizes the Board, under defined criteria, to prohibit specific acts 
or practices.

Continued Concerns About Predatory Lending Practices

    Concerns about predatory lending practices persist, but information 
about predatory lending is essentially anecdotal. There are no precise 
data and no ready means for measuring its prevalence. Yet there have 
been sufficient reports of actual cases to indicate that a problem 
exists.
    Since the enactment of HOEPA in 1994, the volume of home-equity 
lending has increased significantly in the subprime mortgage market. 
Based on data reported under the Home Mortgage Disclosure Act, 12 
U.S.C. 2801 et seq., the number of subprime loans made by lenders that 
identify themselves primarily as subprime lenders increased about six 
times--from 138,000 in 1994 to roughly 856,000 in 1999. This growth in 
subprime lending has expanded the availability of home-secured credit 
for consumers having less-than-perfect credit histories and other 
consumers who do not meet the underwriting standards of prime lenders. 
On the other hand, because consumers who obtain subprime mortgage loans 
have, or may perceive they have, fewer credit options than other 
borrowers, they may be more vulnerable to unscrupulous lenders or 
brokers. There is concern that with the increase in the number of 
subprime loans, there has been a corresponding increase in the number 
of predatory loans.
    In June 1997 the Board held hearings in Los Angeles, Atlanta, and 
Washington, DC, pursuant to HOEPA's mandate that the Board periodically 
hold public hearings on home-equity lending and HOEPA. Participants 
were asked to address several topics, including the effect of HOEPA on 
homeowners seeking home-equity credit and on credit opportunities in 
the communities that had been targeted by unscrupulous lenders prior to 
HOEPA's enactment (for example, whether there had been changes to the 
volume or cost of home-equity installment loans); the effectiveness of 
the disclosures and suggestions for improvements; and whether any 
exemptions or prohibitions would be appropriate for the Board to 
consider under its HOEPA rulemaking authority. 62 FR 23189, April 29, 
1997. Those testifying at the hearings were in general agreement that 
it was too soon after HOEPA's enactment to determine the effectiveness 
of the new law; however, consumer representatives reported continuing 
abusive practices by home-equity lenders against consumers of all 
degrees of sophistication.
    The hearings formed the basis for a detailed analysis of the 
problem of abusive lending practices in mortgage lending contained in a 
July 1998 report to the Congress by the Board and the Department of 
Housing and Urban Development (HUD) on possible reforms to TILA and the 
Real Estate Settlement Procedures Act regarding mortgage-related 
disclosures. The 1998 report is posted at the Board's website: 
www.federalreserve.gov/boarddocs/press/general/1998. Chapter 6 of the 
report suggested a multifaceted approach to curbing predatory lending 
practices, including some legislative action, stronger enforcement of 
current laws, and nonregulatory strategies such as community outreach 
efforts and consumer education and counseling. See also Chapter 2 at 
page 17, Chapter 7 at page 76, and Appendix D.
    Many initiatives to address predatory lending have been undertaken. 
Several bills have been introduced in the Congress, and several states 
have enacted or are considering legislation or regulations. The Board 
convened a federal task force of ten agencies and offices (the five 
agencies supervising depository institutions, the Federal Housing 
Finance Board, the Office of Federal Housing Enterprises Oversight, the 
Federal Trade Commission, the Department of Justice, and HUD) to 
attempt to establish a coordinated approach to deterring abusive and 
predatory practices and to enforcing existing laws that address them. 
HUD and the Department of Treasury (``Treasury'') held five public 
forums on predatory lending this spring and issued a report in June 
2000. The report contained legislative recommendations to the Congress 
and recommendations to the Board regarding the use of its regulatory 
authority to address predatory lending.
    The Board held hearings last summer in Charlotte, Boston, Chicago, 
and San Francisco to consider approaches it might take in exercising 
regulatory authority under HOEPA. The hearings focused on expanding the 
scope of mortgage loans covered by HOEPA, prohibiting specific acts or 
practices, improving consumer disclosures, and educating consumers. In 
the notice announcing the hearings, the Board also solicited written 
comment on possible revisions to Regulation Z's HOEPA rules. 65 FR 
45547, July 24, 2000 (hereinafter referred to as the July notice). The 
Board received approximately 450 comment letters. About two-thirds of 
the letters were general letters from consumers encouraging Board 
action to curb predatory lending. Of the letters that specifically 
addressed possible revisions under HOEPA, views representing the 
mortgage lending industry and consumer and community development 
interests were roughly even in numbers.
    During the hearings and in the comment letters, most creditors and 
others involved in the mortgage lending industry opposed expanding the 
scope of mortgage loans covered by HOEPA. If the scope were to be 
broadened, however, many of these commenters preferred that the APR 
trigger be lowered but that the points and fees trigger remain 
unchanged. Creditors also urged the Board to act cautiously in crafting 
any new rules and stated that existing laws should be more vigorously 
enforced before additional regulation is considered. They expressed 
concern about the potential for reducing the availability of credit in 
the subprime market if more loans become subject to HOEPA and to 
additional restrictions.
    Consumer representatives and community development organizations 
support revisions that would broaden HOEPA's scope. (Some believe that 
predatory lending is responsible for a substantial increase in 
foreclosures in certain communities.) They asked the Board to lower the 
APR trigger to the maximum extent possible, and to add a variety of 
costs to the points and fees tests, including lump-sum premiums for 
credit insurance and similar products, prepayment penalties, and 
lender-paid broker compensaion (yield spread premiums). They recommend 
that the Board ban certain acts or practices associated with predatory 
loans. They were particularly concerned about certain loan terms such 
as prepayment penalties and balloon payments, single-premium credit 
insurance, and ``loan flipping.'' To address concerns about creditors 
that extend credit based on homeowner's equity without regard to 
repayment ability, consumer representatives and others asked the Board 
to require that consumers' income be verified. Additionally, some 
commenters suggested imposing a maximum debt-to-income ratio for 
determining whether creditors appropriately considered a consumer's

[[Page 81440]]

repayment ability. Transcripts of the hearings can be accessed at 
http://www.federalreserve.gov/community.htm.
    Although not specifically addressed in the Board's notice 
announcing the hearings on home-equity lending and possible revisions 
under HOEPA, commenters also recommended the following actions, among 
others: (1) Under the Board's Regulation C (Home Mortgage Disclosure, 
12 CFR Part 203), require additional information for certain home loans 
to be collected; (2) under interagency rules implementing the Community 
Reinvestment Act, 12 U.S.C. 2901 et seq., ensure that ``predatory 
loans'' by a financial institution or its affiliates cannot be used to 
demonstrate that the financial institution is meeting the credit needs 
of the community; and (3) under the Board's authority to monitor the 
activities of bank holding companies, examine nonbank subsidiaries that 
engage in subprime lending for compliance with consumer financial 
services and fair lending laws.

II. Summary of Proposal

    The Board is proposing amendments to Regulation Z to address 
predatory lending and unfair practices in the home-equity market. 
Proposed revisions are issued pursuant to the Board's authority to 
adjust the APR trigger and add additional charges to the points and 
fees test. See 15 U.S.C. 1602(aa). Proposed revisions are also issued 
pursuant to the Board's authority under HOEPA to prohibit certain acts 
or practices affecting (1) mortgage loans if the Board finds the act or 
practice to be unfair, deceptive or designed to evade HOEPA, or (2) 
refinancings if the Board finds the act or practice to be associated 
with abusive lending or otherwise not in the interest of the borrower. 
15 U.S.C. 1639(l)(2). Revisions are also proposed pursuant to section 
105(a) of TILA to effectuate the purposes of TILA, to prevent 
circumvention or evasion, or to facilitate compliance. 15 U.S.C. 
1604(a).
    The proposed amendments would (1) extend the scope of mortgage 
loans subject to HOEPA's protections, (2) prohibit certain acts or 
practices, (3) strengthen HOEPA's prohibition on loans based on 
homeowners' equity without regard to repayment ability, and (4) enhance 
HOEPA disclosures received by consumers before closing, as follows.
    Under the proposal, the APR trigger would be adjusted from 10 
percentage points to 8 percentage points above the rate for Treasury 
securities having a comparable maturity, the maximum amount that the 
trigger may be lowered by the Board. The fee-based trigger would be 
adjusted to include premiums paid at closing for optional credit life 
and disability insurance and other credit protection products.
    The proposed amendments also address some ``loan flipping'' within 
the first twelve months of a HOEPA loan by prohibiting the creditor or 
assignee (or an affiliate) that is holding the loan from refinancing it 
unless the refinancing is in the borrower's interest. The proposal 
would also prohibit creditors in the first five years of a zero 
interest rate or other low-cost loan from replacing that loan with a 
higher-rate loan, unless the refinancing is in the interest of the 
borrower. The proposed rule would define ``low-cost'' loans differently 
for fixed-rate and variable-rate transactions. For fixed-rate 
transactions, a low-cost loan is one that carries a rate that is two 
percentage points or more below the yield on Treasury securities with a 
comparable maturity. For variable-rate transactions, a low-cost loan is 
one where the current rate is at least two percentage points below the 
index or formula used by the creditor for making rate adjustments. This 
rule is designed primarily to protect low-cost home loans offered 
through mortgage assistance programs that give low- and moderate-income 
borrowers the opportunity for homeownership.
    Creditors would also be prohibited from including ``payable on 
demand'' or ``call provisions'' in HOEPA loans. The proposal seeks to 
prevent evasion of HOEPA by prohibiting creditors from representing 
that a mortgage loan is an open-end credit line if it does not meet 
Regulation Z's definition for open-end credit. (HOEPA covers only 
closed-end credit transactions.) For example, a high-cost mortgage 
could not be structured as a home-secured line of credit to evade HOEPA 
if there is no reasonable expectation that repeat transactions will 
occur under a reusable line of credit.
    The proposal would seek to strengthen HOEPA's prohibition on loans 
based on homeowners' equity without regard to repayment ability. A 
rebuttable presumption would be created that the creditor has engaged 
in a pattern or practice of making HOEPA loans based on homeowners' 
equity without regard to repayment ability, if a creditor does not 
document and verify consumers' repayment ability. Regarding 
disclosures, the proposal would revise the HOEPA disclosures to alert 
consumers in advance of loan closing that the total amount borrowed may 
be substantially higher than the amount requested due to the financing 
of insurance, points, and fees.

III. Section-by-Section Analysis of Proposed Rule

Subpart A--General

Section 226.1--Authority, Purpose, Coverage, Organization, Enforcement, 
and Liability

    Section 226.1(b) on the purpose of the regulation would be revised 
to reflect the addition of prohibited acts and practices in connection 
with credit secured by a consumer's dwelling. Section 226.1(d) on the 
organization of the regulation would be revised to reflect the 
restructuring of Subpart E (rules for certain home mortgage 
transactions).

Subpart C--Closed-end Credit

Section 226.23--Right of Rescission

23(a) Consumer's Right To Rescind
    Under section 125 of TILA, consumers have the right to rescind 
certain home-secured loans for three business days after becoming 
obligated on the debt. The right of rescission was created to allow 
consumers time to reexamine their credit contracts and cost disclosures 
and to reconsider whether they want to place their home at risk by 
offering it as security for credit.
    If the required rescission notice or the ``material disclosures'' 
required by TILA are not delivered or are inaccurate, a consumer's 
right to rescind may extend beyond the three business days, for up to 
three years. For HOEPA-covered loans, the term ``material disclosures'' 
includes disclosures required to be given three days before 
consummation. Section 129(j) of TILA also provides that any mortgage 
that contains a provision prohibited by HOEPA is also deemed to be a 
failure to deliver material disclosures. The loan provisions prohibited 
by HOEPA are currently listed in Sec. 226.32(d) of the regulation, and 
a reference to those provisions is included in footnote 48 to 
Sec. 226.23(a)(3).
    As discussed below, the Board is proposing to use its authority 
under HOEPA to prohibit certain acts or practices. The new prohibitions 
would affect the ability of creditors to include certain provisions in 
loans covered by HOEPA. These provisions would be contained in proposed 
Sec. 226.34. Accordingly, the proposed rule would also amend footnote 
48 to Sec. 226.23(a)(3) to include a reference to Sec. 226.34.

[[Page 81441]]

Subpart E--Special Rules for Certain Home Mortgage Transactions

Section 226.31--General Rules

31(c) Timing of Disclosures
31(c)(1)(i) Change in Terms
    Section 226.31(c)(1) requires a three-day ``cooling off'' period 
between the time consumers are furnished with disclosures required 
under Sec. 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 and another three-day cooling off period 
must be given.
    Based on hearing testimony, it appears that some creditors offer 
credit insurance and other optional products at loan closing. If the 
consumer finances the purchase of such products and as a result the 
monthly payment differs from what was previously disclosed under 
Sec. 226.32, the terms of the extension of credit have changed; 
redisclosure is required and a new three-day waiting period applies. 
Comment Sec. 226.31(c)(1)(i)-2 would be added to clarify this 
redisclosure requirement. See discussion below concerning 
Sec. 226.32(c)(3) on when optional items may be included in the regular 
payment disclosure.

Section 226.32--Requirements for Certain Closed-End Home Mortgages

32(a) Coverage
    HOEPA covers mortgage loans that meet one of the act's two ``high-
cost'' triggers--a rate trigger and a points and fees trigger. Under 
the proposed rule, both triggers would be extended to cover more loans.
    APR Trigger--Currently, a loan is covered by HOEPA if the APR 
exceeds by more than 10 percentage points the rate for Treasury 
securities with a comparable maturity. Section 103(aa) of TILA 
authorizes the Board to adjust the APR trigger by 2 percentage points 
from the current standard of 10 percentage points above Treasury 
securities with comparable maturities, upon a determination that the 
adjustment is consistent with the consumer protections against abusive 
lending contained in HOEPA and is warranted by the need for credit.
    In the July notice, the Board invited comment on whether lowering 
the APR trigger to 8 percentage points would be effective in furthering 
the purposes of HOEPA. Comment was also solicited on whether such 
action would have any significant impact on the availability or cost of 
subprime mortgage loans.
    Consumer representatives and community development organizations 
recommended lowering the APR trigger to 8 percent to extend HOEPA's 
protections to a broader class of transactions. Many stated that under 
the current 10 percent test, few subprime loans are covered by HOEPA. 
They believed that lowering the APR trigger by 2 percentage points 
would not affect credit availability. A number of these commenters 
suggested even further adjustments by the Congress.
    Creditors that make subprime loans were generally opposed to 
broadening HOEPA's scope. Some believed that lowering the APR trigger 
will not curb the actions of unscrupulous lenders. Some stated that if 
the Board were to broaden the category of loans subject to HOEPA, 
lowering the APR trigger would be more consistent with the purpose of 
HOEPA than including additional costs in the points and fees test.
    Based on an analysis of hearing testimony, written comments 
received, and other information, and pursuant to its authority under 
section 103(aa) of TILA, the Board is proposing to revise 
Sec. 226.32(a)(1)(i) to lower the APR trigger to 8 percentage points. 
With this change, based on current rates for Treasury securities, loans 
with an APR of approximately 14 percent or higher would be subject to 
HOEPA.
    Data are not available on the number of home-equity loans currently 
subject to HOEPA, or the number of loans that would be covered if the 
APR trigger were lowered. Data compiled by the Office of Thrift 
Supervision reflects that based on interest rate alone, if the HOEPA 
rate trigger were lowered by 2 percentage points, HOEPA's coverage 
would expand from approximately 1 percent to 5 percent of subprime 
mortgage loans. These numbers omit the other costs included in the APR 
trigger, such as points and brokers fees; if those costs were included 
the number of HOEPA-covered loans would be larger.
    If HOEPA's rate trigger were lowered, more consumers with high-cost 
loans would receive HOEPA disclosures and would be covered by HOEPA's 
prohibitions against loan terms such as non-amortizing payment 
schedules, balloon payments on short-term loans, or interest rates that 
increase upon default. More loans would be subject to the rule against 
unaffordable lending. A creditor's ability to impose prepayment 
penalties would also be restricted in most cases. In addition, more 
high-cost loans would be subject to HOEPA's strict liability rule that 
holds purchasers and assignees, as well as creditors, liable for any 
violations of law.
    Some subprime lenders do not make HOEPA loans due to their concerns 
about compliance burdens, potential liability, and reputational risks. 
They believe that expanding HOEPA's coverage will reduce credit 
availability. The extent to which lowering the HOEPA APR trigger may 
affect the availability of credit is difficult to ascertain. Some 
creditors who do not make HOEPA loans may withdraw from making loans in 
the range of rates that would be covered by the expanded triggers. 
Other creditors may fill any void left by creditors that choose not to 
make HOEPA loans. And others may have the flexibility to lower rates or 
fees for some loans to avoid HOEPA's coverage.
    The subprime lending market has grown substantially and has 
increased the availability of credit to borrowers having less-than-
perfect credit histories and other consumers who are underserved by 
prime lenders. A borrower does not benefit from this expanded access to 
credit if the credit is offered on unfair terms or involves predatory 
practices. Because consumers who obtain subprime mortgage loans have 
fewer credit options than other borrowers, or because they perceive 
that they have fewer options, they may be more vulnerable to 
unscrupulous lenders or brokers. The proposed revisions are intended to 
ensure that the need for credit by subprime borrowers will be fulfilled 
more often by loans that are subject to HOEPA's protections against 
predatory practices. To avoid coverage by the HOEPA rules, some 
creditors may choose not to make loans covered by the revised rate 
triggers but there is no evidence to date that the impact on credit 
availability would be significant.
    APR trigger based on lien status--When a consumer seeks a loan to 
consolidate debts or finance home repairs, some creditors may require 
consumers to borrow additional funds to pay off the existing first 
mortgage as a condition of providing the loan. This ensures that the 
creditor will be the senior lien-holder, but also will increase, 
perhaps significantly, the points and fees paid for the new loan. In 
addition, the existing first mortgage may have been at a lower rate. 
Some commenters, including creditors and consumer groups, suggested a 
two-tiered APR trigger, to encourage creditors to offer subordinate-
lien mortgages rather than to refinance existing mortgages to obtain a 
first-lien position. To illustrate, the APR trigger for first-lien 
mortgages could be lowered to 8 percentage points above Treasury 
securities with comparable maturities, and the APR trigger for 
subordinate-lien mortgages could remain unchanged at 10 percentage 
points. The Board requests

[[Page 81442]]

comments on this approach, including the benefits and compliance 
burdens associated with this approach to adjusting the APR trigger.
32(b) Definition
    Points and fees test--The fee-based trigger is met if the points 
and fees payable by the consumer at or before loan closing exceed the 
greater of 8 percent of the total loan amount or $451 ($465 for 2001). 
Except for interest, ``points and fees'' cover all finance charges 
(including brokers' fees). The act specifically excludes reasonable 
closing costs that are paid to unaffiliated third parties. HOEPA also 
authorizes the Board to add ``such other charges'' to the points and 
fees test as the Board deems appropriate. The proposed rule would 
expand the points and fees test to include amounts paid at or before 
closing for optional credit life, accident, health, or loss-of-income 
insurance and other credit-protection products such as debt-
cancellation coverage.
    The Board requested comment on the merits of including the 
following fees in the points and fees test: (1) Lump-sum premiums for 
optional credit life insurance or similar products collected at 
closing; (2) prepayment penalties (assessed on the original loan) when 
the loan is refinanced with the same creditor or an affiliate; and (3) 
points paid by the consumer for the existing loan when the same 
creditor (or an affiliate) refinances the loan within a specified time 
period. The Board also solicited comment on whether a better approach 
would be to recommend a statutory amendment that would include all 
closing costs in the points and fees test.
    Premiums for credit insurance, disability insurance, and similar 
products--Concerns have been raised about high-pressure sales tactics 
associated with single-premium credit life insurance and ``insurance 
packing,'' where creditors automatically include the insurance in the 
loan amount without the consumer's request. As a result, consumers may 
perceive that the insurance is a required part of the loan. Consumer 
advocates assert that because these premiums are excluded from the 
finance charge (and thus excluded from HOEPA's triggers), predatory 
lenders may avoid HOEPA coverage by ``packing'' loans with high-priced 
credit insurance that represents a significant source of fee income, in 
lieu of charging fees that would be included under the current HOEPA 
trigger.
    On the other hand, industry commenters have argued that optional 
credit insurance should not be considered a cost of the loan, and 
therefore should not be included in the HOEPA fee trigger. Because the 
cost of credit insurance is significant, some of these commenters 
assert that many mortgage loans with single-premium credit insurance 
could become HOEPA loans, regardless of the interest rate or points 
charged on the loan. They noted that creditors might cease offering 
single-premium credit insurance to avoid HOEPA's coverage.
    To the extent that some creditors choose not to offer single-
premium policies, consumer advocates note that credit insurance could 
be made available through other vehicles--for example, policies that 
collect premiums monthly based on the outstanding loan balance. 
Industry commenters responded that some borrowers find it more 
affordable to finance a single-premium policy over the full loan term 
rather than paying premiums monthly during the shorter term of the 
insurance policy, which is typically 60 months or less.
    Section 103(aa) of TILA defines ``points and fees'' for purposes of 
HOEPA to include all items included in the finance charge except 
interest or the time-price differential. Under section 106 of TILA 
premiums for optional credit insurance are treated as finance charges, 
unless certain disclosures are provided to consumers. The Board may 
also include charges other than finance charges in HOEPA's fee-based 
trigger, if it determines that their inclusion would be appropriate. 
The legislative history of HOEPA specifically suggests that the Board 
might consider including the cost of credit insurance premiums in the 
HOEPA calculation.
    The Board believes that including optional single-premium insurance 
and other credit protection products in the HOEPA points and fees 
trigger is appropriate when the amounts are paid by the consumer at or 
before closing. The creditor or the credit account is the beneficiary 
and the cost of the insurance may represent a significant cost of the 
credit transaction. In addition, creditors receive significant 
commissions for selling credit insurance. Moreover, including optional 
credit insurance and similar products in the points and fees test would 
prevent a creditor from evading HOEPA by packing a loan with such 
products in lieu of charging fees that would be included under the 
current HOEPA trigger.
    Section 226.32(b)(1) would be revised to include in the points and 
fees test, the cost of premiums or other charges for credit life, 
accident, health, or loss-of-income insurance, debt-cancellation 
coverage (whether or not the debt-cancellation coverage is insurance 
under applicable law), or similar products paid by a borrower at or 
before closing. (Premiums paid for required credit insurance policies 
are considered finance charges and are already included in the points 
and fees trigger.) Under the proposal, premiums paid at or before 
closing for credit insurance are included whether they are paid in cash 
or financed, and whether the amount represents the entire premium for 
the coverage or an initial payment. Proposed comment 32(b)(1)(iv)-1 
contains this guidance.
    A mortgage loan is covered by HOEPA if the ``points and fees'' 
exceed 8 percent of the ``total loan amount.'' The total loan amount is 
based on the ``amount financed'' as provided in 226.18(b). Comment 
32(a)(1)(ii)-1 discusses the calculation of the total loan amount. The 
comment would be revised to illustrate that premiums for credit life, 
accident, health, loss-of-income, debt cancellation coverage, or 
similar products that are financed by the creditor must be deducted 
from the amount financed in calculating the total loan amount.
    Conditional inclusion of insurance and other credit protection 
products--Comment is solicited on whether exclusion of the optional 
premiums from the points and fees test would be warranted under some 
circumstances. Charges for optional insurance and similar products are 
finance charges under the TILA unless certain disclosures are provided 
to consumers. Would a similar approach be appropriate in connection 
with the points and fees trigger under HOEPA? For example, credit 
insurance or debt protection coverage might be excluded from the points 
and fees test based on the consumer's ability to cancel the coverage 
and obtain a full refund, where the consumer is also provided with 
adequate information about their rights after the loan closing.
    Additional data--The Board seeks information about any further 
studies or data pertaining to subprime lending or HOEPA loans that 
would be useful in determining the effect of the proposal adjusting the 
HOEPA rate and fee triggers. Other data or studies relevant to the 
proposal, about subprime lending generally, and HOEPA loans in 
particular, are also requested.
    Other fees--The Board is not proposing to include any other charges 
in the points and fees test at this time. Some commenters supported the 
inclusion of lender paid broker compensation (yield spread premiums) 
which are paid indirectly by the borrower in the form of a higher 
interest rate. It is not clear that an amount paid

[[Page 81443]]

over the life of the loan and included in HOEPA's APR trigger should 
also be included in the points and fees trigger as an amount paid at or 
before closing. Consumer representatives and others believed that 
prepayment penalties and points paid on an existing loan should be 
included in the points and fees test when the loan is refinanced by the 
same creditor or an affiliate, to expand HOEPA to more transactions. 
Many industry representatives opposed this approach. It is not clear 
that it is appropriate to include as part of a new loan, for purposes 
of the HOEPA fee trigger, fees paid in connection with an earlier 
transaction.
    Views were mixed on whether the Board should recommend a statutory 
amendment to TILA that would include all closing costs in the points 
and fees test. Some commenters generally supported including closing 
costs typically charged by third parties; others believed that 
creditors may not be aware of costs charged to consumers by third 
parties and therefore should not be held accountable for including such 
costs in the points and fees calculation. One trade association 
representing creditors supported the recommendation as a part of any 
legislative reformation of existing consumer protection laws affecting 
mortgage lending.
32(c) Disclosures
    Section 129(a) of TILA requires creditors offering HOEPA loans to 
provide abbreviated disclosures to consumers at least three days before 
the loan is closed, in addition to the disclosures generally required 
by TILA at or before closing. The HOEPA disclosures inform consumers 
that they are not obligated to complete the transaction and could lose 
their home if they obtain the loan and fail to make payments. The HOEPA 
disclosures also include a few key cost disclosures, such as the APR 
and the monthly payment (including the maximum payment for variable-
rate loans and any balloon payment).
    In the July notice, the Board requested comment on whether these 
disclosures could be improved. The Board referred to the Board and 
HUD's 1998 report to the Congress, where the agencies recommended 
adding references to the availability of credit counseling and 
requiring the consumer's monthly income to be stated in close proximity 
to the consumer's monthly payment. The Board asked specifically about 
the effect of adding to the HOEPA disclosures the total amount 
borrowed, to alert consumers to the fact that additional costs may have 
been included in the loan amount.
    Creditors and consumer representatives question the benefit of 
requiring additional HOEPA disclosures to combat predatory lending. In 
addition, consumer representatives stated their preference for the 
Board to use its rulewriting authority to prohibit specific acts 
associated with predatory lending rather than to require additional 
disclosures. Industry commenters expressed concern about additional 
disclosures that might increase compliance costs without a commensurate 
benefit to consumers.
    The Board believes, however, that an additional disclosure might be 
in the interest of borrowers. Pursuant to its authority under section 
129(l)(2)(B) of TILA, the Board is proposing to add a disclosure for 
refinancings subject to HOEPA in Sec. 226.32(c)(5).
32(c)(3) Regular Payment
    Comment 32(c)(3)-1 would be revised for clarity. The rule allows 
creditors to include voluntary items in the regular payment disclosed 
under Sec. 226.32 only if the consumer has previously agreed to such 
items. Comment is solicited on whether consumers should be required to 
request or affirmatively agree to purchase voluntary items in writing, 
to aid in enforcing the rule. Testimony and comments suggest that some 
consumers do not agree to the insurance in advance of closing although 
the HOEPA disclosures provided in advance of closing may already 
include insurance premiums in the monthly payment.
    Section 226.32(c)(3) requires creditors to disclose to consumers 
the amount of the regular monthly (or other periodic) payment. Comment 
32(c)(3)-2 requires creditors to disclose any balloon payment along 
with the regular periodic payment. Under the proposal, the disclosure 
requirement for the amount of the balloon payment would be moved from 
the commentary to the regulation, to aid in compliance. Also, Model 
Sample H-16, which illustrates the disclosures required under 
Sec. 226.32(c), would be revised to include a model clause on balloon 
payments.
32(c)(5) Amount Borrowed
    Under the proposal, Sec. 226.32(c)(5) would be added to require 
disclosure of the total amount the consumer will borrow, as reflected 
by the face amount of the note. Adding the total amount borrowed is 
intended to alert consumers in advance of the loan closing that the 
amount of the loan may be substantially higher than requested due to 
the financing of points, fees, and insurance. Consumers and consumer 
representatives note that consumers often seek a modest loan amount for 
medical or home improvement costs, only to discover at closing (or 
thereafter) that the note amount is substantially higher, due to fees 
and insurance premiums that are financed along with the requested loan 
amount. This disclosure may help some consumers avoid entering into 
unaffordable loans.
    Creditors must provide the disclosures required by Sec. 226.32(c) 
if, after giving the disclosures to the consumer and before 
consummation, the creditor changes any terms that make the disclosure 
inaccurate. Sec. 226.31(c)(1). The Board requests comment on whether it 
would be appropriate to provide for a tolerance for insignificant 
changes to the amount borrowed, and if so, what is a suitable margin.
    Counseling. Both consumer and creditor commenters acknowledged the 
benefits of pre-loan counseling as a means to counteract predatory 
lending. There was uniform concern, however, about requiring a referral 
to counseling for HOEPA loans because the actual availability of local 
counselors may be uncertain. The Board requests comment on whether a 
generic disclosure advising consumers to seek independent advice might 
encourage borrowers to seek credit counseling.
32(d) Limitations
32(d)(1) Balloon Payment
    Section 129(e) of TILA prohibits balloon payments for loans covered 
by Sec. 226.32 that have terms of less than five years. In the July 
notice, the Board noted that lenders that price their loans just below 
HOEPA's triggers might include balloon payments that force consumers to 
refinance the loan and pay additional points and fees. The Board 
requested comment on any restrictions or additional disclosures that 
might be appropriate in connection with balloon payments in order to 
prevent abusive practices.
    Consumer representatives and others asked the Board to ban balloon 
payments for all HOEPA loans. They contend that consumers are just as 
unlikely to repay or refinance the loan on more affordable terms after 
five years than they are after two or three years. Creditors were 
generally opposed to adding restrictions for balloon payments beyond 
those currently in HOEPA. They believe that balloon notes can be as 
beneficial to consumers obtaining HOEPA loans, as they may be for other 
borrowers. Because HOEPA limits the prohibition on balloon payments to 
loans shorter than five years, the Board does not believe it is 
appropriate to impose restrictions on longer term loans

[[Page 81444]]

without evidence of a particular problem related to longer term balloon 
notes. The Board proposes to provide additional guidance on disclosing 
balloon payments where they are permitted under HOEPA. See 
Sec. 226.32(c)(3) and Model Sample H-16.
32(d)(8) Due-On-Demand Clause
    Balloon notes in loans shorter than five years are prohibited by 
HOEPA to prevent a creditor from forcing a consumer to refinance a loan 
and pay additional points and fees. The same concerns would be raised 
if a creditor could force the consumer to refinance by reserving the 
right to call the loan at any time and then demanding payment of the 
entire outstanding balance. Pursuant to the Board's authority under 
section 129(l)(2)(A), ``payable on demand'' or ``call'' provisions for 
HOEPA loans would be prohibited under Sec. 226.32(d)(8), unless the 
clause is exercised in connection with a consumer's default. Although 
these terms currently do not appear to be widely used in HOEPA loans, 
demand clauses raise the same concerns as balloon notes. Moreover, TILA 
has a similar prohibition for home-secured lines of credit. Proposed 
commentary to Sec. 226.32(d)(8) would provide guidance similar to the 
guidance to creditors offering home-equity lines of credit.
    The Board requested comment in the July notice on the merits of 
prohibiting ``due on demand'' clauses for loans covered by Sec. 226.32 
unless such a clause is exercised in connection with a consumer's 
default. Creditors and consumer representatives that commented 
generally supported such a prohibition, although some creditors 
suggested that, similar to balloon notes, the prohibition be limited to 
loans with terms of less than five years.

Section 226.34--Prohibited Acts or Practices in Connection With Credit 
Secured by a Consumer's Dwelling

    Section 129(l) of TILA authorizes the Board to prohibit specific 
acts or practices to curb abusive lending practices. The act provides 
that the Board shall prohibit practices: (1) In connection with all 
mortgage loans, if the Board finds the practice to be unfair, 
deceptive, or designed to evade HOEPA; and (2) in connection with 
refinancings of mortgage loans, if the Board finds that the practice is 
associated with abusive lending practices or otherwise not in the 
interest of the borrower. The Board has not previously exercised this 
authority.
    The July notice requested comment on specific approaches to deal 
with predatory lending practices, both regulatory and legislative, and 
whether any new requirements or prohibitions should apply to all 
mortgage transactions, only to refinancings, or only to HOEPA-covered 
refinancings. Specific questions were posed about credit insurance, 
unaffordable lending, balloon payments, consolidation loans, prepayment 
penalties, foreclosure notices, misrepresentation about a borrower's 
qualifications, reporting borrowers' payment history, credit 
counseling, and disclosures. Consumer representatives, community 
organizations, and others offered numerous recommendations. Industry 
commenters generally opposed any new rules based on the view that 
better enforcement of existing law would be sufficient to address 
concerns about predatory lending.
    HUD and Treasury held five public forums on predatory lending this 
spring and issued a report in June 2000. The report contained 
legislative recommendations to the Congress and recommendations to the 
Board regarding the use of its regulatory authority to address 
predatory lending. HUD and Treasury recommended rules to address ``loan 
flipping'' and fraudulent acts or practices, unaffordable lending, and 
the sale of single-premium credit insurance products.
    Based on the written comments received, testimony provided at Board 
hearings on home-equity lending, and other information, the Board 
proposes to prohibit certain acts or practices that are deemed to be 
unfair, deceptive, designed to evade the provisions of section 129 of 
the TILA, associated with abusive lending practices, or otherwise not 
in the interest of the borrower in connection with mortgage loans, as 
described below. The rules are intended to target unfair or abusive 
lending practices without unduly interfering with the flow of credit, 
creating unnecessary credit burden, or narrowing consumers' options in 
legitimate transactions.
    Organization of Sec. 226.34. The proposed rule creates a new 
Sec. 226.34 which contains prohibitions against certain acts or 
practices in connection with credit secured by a consumer's dwelling. 
This section would include the rules currently contained in 
Sec. 226.32(e).
34(a) Prohibited Acts or Practices for Loans Subject to Sec. 226.32
34(a)(1) Home Improvement Contracts
    Section 226.32(e)(2) regarding home-improvement contracts would be 
renumbered as Sec. 226.34(a)(1) without substantive change.
34(a)(2) Notice to Assignee
    Section 226.32 (e)(3) regarding assignee liability for claims and 
defenses consumers may have in connection with HOEPA loans would be 
renumbered as Sec. 226.34(a)(2).
    Proposed comment 34(a)(2)-3 would be added to clarify the statutory 
provision on the liability of purchasers or other assignees of HOEPA 
loans. Section 131 of TILA provides that, with limited exceptions, 
purchasers or other assignees of HOEPA loans are subject to all claims 
and defenses with respect to a mortgage that the consumer could assert 
against the creditor. The comment would clarify that the phrase ``all 
claims and defenses'' is not limited to violations of TILA or HOEPA. 
This interpretation is based on the legislative history. See Conference 
Report, Joint Statement of Conference Committee, H. Rep. No. 103-652, 
at 22 (Aug. 2, 1994).
34(a)(3) Refinancings Within Twelve-Month Period
    ``Loan flipping'' refers to the practice by brokers and creditors 
of frequently refinancing home-secured loans to generate additional fee 
income even though the refinancing is not in the borrower's interest. 
Loan flipping is among the most flagrant of lending abuses. Victims 
tend to be borrowers who are having difficulty repaying a high-cost 
loan. The creditor holding the loan promises to refinance the loan on 
more affordable loan terms. The creditor relies on the consumer's 
remaining home equity to support the new, larger loan and to finance 
additional fees, sometimes without regard to the consumer's ability to 
make the new scheduled payments. These loans typically provide little 
benefit to the borrower because the loan amount increases mostly to 
cover fees and there may be no significant reduction in the interest 
rate. As a result, the monthly payment may increase, making the loan 
even more unaffordable.
    In assessing possible approaches to address loan flipping, the 
Board has considered rules that would (1) be effective in curbing 
detrimental refinancings without limiting consumer choice in legitimate 
credit transactions, and (2) provide clear guidance to creditors on 
what acts or practices are prohibited.
    The Board has received many suggestions on how it might address 
loan flipping. Those suggestions generally fall into two categories: 
(1) Limiting fees to a specified percentage of the total loan amount, 
requiring that

[[Page 81445]]

fees be charged solely on any additional funds being borrowed, or 
generally restricting fees on refinancings; and (2) prohibiting 
refinancings that do not provide a ``tangible benefit'' to borrowers. 
While loan flipping occurs in both HOEPA and non-HOEPA loans, the Board 
believes that any rule restricting refinancings to address loan 
flipping could be overly broad if it is not limited to HOEPA loans.
    Limiting the amount of fees charged on a refinancing would reduce 
the economic incentive for creditors to flip loans, and thus would be 
the most direct way to curb loan flipping. While the Board has broad 
authority under HOEPA to prohibit specific acts and practices for all 
mortgage loans, it is questionable whether this authority includes 
restricting loan fees by capping them. Moreover, there are no clear 
standards for determining an appropriate level of fees. A rule 
permitting creditors to charge fees only on additional funds being 
borrowed could be effective only if the amount of fees is also capped, 
because creditors could impose fees that are excessive in relation to 
the new amount borrowed.
    A rule prohibiting outright the imposition of upfront fees on a 
refinancing would remove the economic incentive for loan flipping (as 
the loan costs would be built into the interest rate and there would be 
no immediate benefit to the broker or creditor). But such a rule could 
unduly limit consumer choice in legitimate transactions. Some consumers 
may prefer to pay points to buy down the rate. Others may not qualify 
for monthly payments at a higher interest rate. Moreover, a ban on all 
up front fees, in conjunction with the current HOEPA restriction on 
prepayment penalties could prevent creditors from recovering their 
origination costs if the loan is paid off early; creditors would have 
to charge interest rates that are adequate to cover potential losses 
due to prepayments.
    Under the second approach, setting a ``tangible benefit'' test, 
loan flipping would be addressed by prohibiting refinancings of HOEPA 
loans that do not provide benefit to the borrower or are not in the 
borrower's interest. This approach seeks to ensure that the borrower 
obtains benefits from the refinancing that would justify the additional 
costs. Because the rule is subjective, however, it does not provide 
creditors with clear guidance on what transactions are permitted. 
Without adequate guidance, it would be up to the courts to construe 
what constitutes a sufficient benefit on a case-by-case basis. This 
could affect the willingness of some creditors to refinance HOEPA 
loans.
    Pursuant to its authority under Sec. 129(l)(2)(B), the Board is 
proposing a rule based on a narrower benefits test that would only 
apply for a twelve month period. A creditor or assignee (or an 
affiliate) holding a HOEPA loan would be prohibited from refinancing it 
within the first twelve months unless the refinancing is in the 
borrower's interest. Anecdotal evidence suggests that creditors 
frequently flip loans by pressuring their existing customers who may be 
having difficulty making payments on their current mortgage. This more 
narrowly tailored rule should prevent abuses in the most egregious 
cases, where creditors or brokers flip loans shortly after loan 
consummation. Even under this approach, there is some uncertainty about 
what constitutes a benefit; however, the advantage of the rule in 
preventing loan flipping in the clearest cases of abuse seems to 
outweigh the effect of creating some uncertainty in marginal cases. The 
determination of whether or not a benefit exists would be based on the 
totality of the circumstances. For example, consideration should be 
given to the amount of any new funds advanced in comparison to the 
total loan charges on the refinancing (which may be based predominately 
on the pre-existing loan balance). Proposed comment 34(a)(3)-1 would 
provide guidance on this standard.
    The proposed rule in Sec. 226.34(a)(3) would not prevent a consumer 
from seeking a refinancing from another lender. Creditors would also be 
prohibited from engaging in acts or practices designed to evade the 
rule. For example, a creditor that arranged refinancings of its own 
loans with an unaffiliated creditor would be deemed to be seeking to 
evade the rule. Similarly, a creditor would be deemed to be seeking to 
evade the rule if the creditor modified the existing loan agreement 
(but did not replace the existing loan with the new loan) and charged a 
fee.
34(a)(4) Repayment Ability
34(a)(4)(i)
    Under section 129(h) of TILA, 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 consumer's repayment ability, 
including the consumer's current and expected income, current 
obligations, and employment status. The rule currently in 
Sec. 226.32(e)(1) would be moved to 226.34(a)(4)(i) and revised to 
parallel the statutory language.
    Comment 32(e)(1)-1 on determining repayment ability would be 
renumbered as comment 34(a)(4)(i)-1, and modified to address proposed 
documentation and verification requirements below.
    Pattern or Practice--Section 129(h) of TILA does not define 
``pattern or practice,'' nor does the legislative history provide any 
guidance as to how the phrase should be applied. In the July notice, 
the Board solicited comment on whether additional interpretive guidance 
on the ``pattern or practice'' requirement would be useful, or whether 
case-by-case determinations are more appropriate. Comment was also 
solicited on whether, if additional guidance would be useful, what 
elements of the requirement should the guidance address.
    Some commenters believe guidance is not needed and a case-by-case 
approach is sufficient. Industry commenters requested that the pattern 
and practice standard be quantified. Consumer representatives suggested 
that the Board adopt the standard applied in cases under civil rights 
and fair lending laws.
    Proposed comment 34(a)(4)(i)-2 provides that determining whether a 
pattern or practice exists depends on the totality of the circumstances 
and cites various statutes that may be helpful in analyzing factors 
that are relevant to a pattern or practice determination. The proposed 
comment does not identify individual factors raised in the case law, 
given the fact-specific nature of a pattern or practice determination.
    Discounted Introductory Rates--Concern has been raised about 
creditors determining a consumer's repayment ability based on low 
introductory rates offered under some variable-rate programs. Comment 
34(a)(4)(i)-3 would be added to provide that in transactions where the 
creditor sets the initial interest rate and the rate is later adjusted 
(whether fixed or later determined by an index or formula), in 
considering consumers' repayment ability, the creditor must consider 
increases to the consumer's payments assuming the maximum possible 
increases in rates in the shortest possible time frame.
34(a)(4)(ii)
    Currently compliance with the prohibition against unaffordable 
lending is difficult to enforce because creditors may not be able to 
show how they considered the consumer's ability to repay. In addition, 
there have been reports of creditors relying on inaccurate information 
provided by unscrupulous loan brokers.

[[Page 81446]]

    In the July notice, the Board invited comment on what standards the 
Board might adopt for determining whether a creditor has considered the 
consumer's ability to repay. Some commenters suggested that creditors 
be required to document and verify the basis for the creditor's 
consideration of the consumers' repayment ability. Many creditors 
stated that they routinely document and verify financial information. 
Commenters also suggested that creditors be prohibited from extending 
credit where the borrower's monthly debt-to-income ratio exceeds 50 
percent, except perhaps in the case of high-income borrowers. However, 
there is no clear standard for an appropriate debt-to-income ratio, 
which may vary depending on a particular borrower's circumstance.
    Proposed Sec. 226.34(a)(4)(ii) would be added to require that 
creditors generally document and verify consumers' current or expected 
income, current obligations, and employment to the extent applicable. 
If a creditor engages in a pattern or practice of making loans without 
documenting and verifying consumers' repayment ability, there would be 
a presumption that the creditor has violated the rule. For borrowers 
who are self-employed, the verification rules would be more flexible. A 
creditor may rely on tax returns or any other source that provides the 
creditor with a reasonable basis for believing that the income exists 
and will support the loan. Proposed comment 34(a)(4)(ii)-1 contains 
this guidance.
34(b) Prohibited Acts or Practices for Dwelling-Secured Loans
34(b)(1) Limitations on Refinancing Certain Low-Rate Loans
    When a consumer seeks a second mortgage to consolidate debts or to 
finance home improvements, some creditors also require the existing 
first mortgage to be paid off as a condition of providing the new 
funds. This ensures that the creditor will be the senior lien-holder, 
but may increase significantly the points and fees paid for the new 
loan. In the July notice of the hearings, the Board solicited comment 
on whether regulatory action is appropriate to protect consumers from 
abuses and, if so, what type of action could be taken without 
restricting credit in legitimate transactions?
    Industry commenters stated that there is nothing inherently abusive 
about refinancing an existing first-lien mortgage loan when the 
creditor provides new funds, for example, to consolidate debt. To 
address any concerns, one trade association suggested requiring a 
disclosure reminding borrowers that funds are being borrowed to pay off 
the prior loan and that points and fees are charged on the total amount 
of the new financing. In response to creditors who will only make loans 
if they have first-lien priority, they noted that the mortgagee will 
often allow subordination of their security interest to lenders when 
the borrower seeks a second loan.
    Hearing testimony reflects abuses in connection with the 
refinancing of loans that were made through mortgage assistance 
programs designed to give low- or moderate-income borrowers the 
opportunity for homeownership. Some of these homeowners who have 
unsecured debts have been targeted by unscrupulous lenders who 
consolidate the debts and replace the low-cost first-lien mortgage with 
a substantially higher cost loan. The replacement loans are often 
unaffordable, may involve ``loan flipping'' and, as a result, 
homeowners have lost their homes. In some cases, the low-cost loan is 
replaced even though the first-lien holder may be willing to 
subordinate its security interest. Where subordination does not occur, 
it might be more beneficial for the borrower to keep the original low-
rate mortgage loan and obtain a second mortgage, if that option is 
available.
    Pursuant to the Board's authority under section 129(l)(2)(B), to 
protect against abusive refinancings, the Board is proposing a rule 
that would prohibit creditors in the first five years of a zero 
interest rate or other low-cost loan from replacing that loan with a 
higher-rate loan, unless the refinancing is in the interest of the 
borrower. The proposed rule would define ``low-cost'' loans differently 
for fixed-rate and variable-rate transactions. For fixed-rate 
transactions, a low cost loan is one that carries an interest rate that 
is two percentage points or more below the yield on Treasury securities 
with a comparable maturity. For variable-rate transactions, a low-cost 
loan is one where the current interest rate is at least two percentage 
points below the index or formula used by the creditor for making rate 
adjustments. This rule, contained in Sec. 226.34(b)(1), is designed 
primarily to protect low-cost, home loans offered through mortgage 
assistance programs that give low- and moderate-income borrowers the 
opportunity for homeownership. Proposed comment 34(b)(1)-1 would be 
added to provide that creditors may rely on a statement by the borrower 
regarding the current rate of interest on their existing loan.
34(b)(2) Open-end Credit
    HOEPA covers only closed-end loans. If a consumer obtains a home-
secured line of credit (``open-end'') with an APR or points and fees 
above HOEPA's rate and fee triggers, the loan is not subject to HOEPA's 
disclosure requirements or limitations. In the July notice, the Board 
solicited comment on the extent to which creditors may be using open-
end credit lines to evade HOEPA. The FTC has brought two enforcement 
actions to prevent creditors from evading HOEPA in this manner. See FTC 
v. CLS Fin. Services, Inc., No. C99-1215Z (W.D. Wash. July 30, 1999); 
FTC v. Wasatch Credit Corp., No. 2-99CV579G (D. Utah Aug. 3, 1999).
    Consumer representatives and others generally believe that HOEPA 
should cover home-secured lines of credit (``open-end credit''). If 
open-end credit is not covered under HOEPA, they support explicit rules 
to ban the use of open-end credit to evade HOEPA. Some consumer 
representatives at the Board's hearings reported cases where consumers 
applied for a closed-end home-secured loan but learned for the first 
time at closing that the loan documents were structured as open-end 
credit, with credit limits far in excess of the amount requested. Some 
consumer advocates have reported cases where creditors have documented 
loans as open-end ``revolving'' credit, even if there was no 
expectation of repeat transactions under a reusable line of credit. 
Some of the cases reported by consumer advocates involved loans with 
high rates and fees that exceeded HOEPA's price triggers for closed-end 
loans.
    Industry commenters opposed any rules for open-end credit. They 
believe there is insufficient evidence that creditors are using open-
end credit to evade HOEPA. Some commenters stated that additional rules 
are unnecessary because it is currently a violation of TILA to provide 
disclosures for an open-end credit plan if the legal obligation does 
not meet the criteria for open-end credit.
    Where a loan is documented as open-end credit but the features and 
terms demonstrate that it does not meet the definition of open-end 
credit, the loan is subject to the rules for closed-end credit, 
including HOEPA if the rate or fee trigger is met. Pursuant to its 
authority under section 129(2)(A), under Sec. 226.34(b)(2), the Board 
is proposing a rule to clarify this point and apply HOEPA's remedies to 
such cases.
    The Board is also soliciting comment on the need and feasibility of 
rules to prevent evasions of HOEPA in other

[[Page 81447]]

circumstances. For example, should there be a rebuttable presumption 
that a creditor intended to evade HOEPA, in violation of the law, if a 
consumer applies for a closed-end home-secured loan but receives an 
open-end line of credit that is priced above HOEPA's triggers.

Appendix H to Part 226--Closed-end Model Forms and Clauses

    Model Form H-16--Mortgage Sample illustrates the disclosures 
required by 226.32(c), which must be provided to consumers at least 
three days before becoming obligated on a mortgage transaction subject 
to Sec. 226.32. Under the proposal, Model Form H-16 would be amended to 
illustrate the additional disclosures required for refinancings 
proposed at Sec. 226.32(c)(5). The Sample also includes an illustration 
for loans with balloon payments. A new comment app. H-20 would clarify 
that although the additional proposed disclosure is required for 
refinancings that are subject to `` 226.32, creditors may, at their 
option, include this disclosure for any loan subject to that section.

Other Matters

    Credit Insurance--Some commenters urged the Board to (1) prohibit 
the financing of single premium credit insurance, or (2) delay the sale 
of credit insurance until after the loan is closed. The regulation of 
insurance has historically been a matter of state law. Under the 
McCarran-Ferguson Act, 15 U.S.C. 1012, unless a federal statute 
specifically relates to the business of insurance, it may not be 
construed to invalidate, impair, or supercede any state law enacted for 
the purpose of regulating the business of insurance. It is not clear 
the extent to which rules issued by the Board under HOEPA that seek to 
prohibit or regulate the sale of single premium credit insurance would 
be consistent with that standard.
    In its July 1998 report to Congress on mortgage disclosure reform, 
the Board and HUD suggested that Congress consider whether adequate 
consumer protections currently exist. The report discussed possible 
approaches to regulating the sales of credit insurance in connection 
with mortgage loans to prevent abusive practices. The Congress might 
consider regulating the use of single-premium credit insurance policies 
in connection with HOEPA loans or other transactions.
    Foreclosure Notice--State law and local practice generally govern 
the procedures followed for foreclosures. Most states require direct 
notice to the consumer but, in a few states, notice by publication is 
legally sufficient. Even when consumers do receive direct notice, they 
may not be aware of their legal options.
    In the July notice, the Board solicited comment on whether it 
should set minimum federal standards for foreclosure involving a 
consumer's primary dwelling. Some commenters supported minimum 
foreclosure standards, citing statistics showing an increase in 
foreclosures of subprime loans. Some consumer representatives believe 
that consumers should be provided with a substantive right to cure the 
foreclosure. Industry commenters believed federal standards are 
unnecessary. Other commenters stated that state law generally governs 
property and foreclosure law, and that the Congress is the better forum 
to establish a federal minimum standard for notices.
    The Board is not proposing rules governing foreclosure notices at 
this time. The process of determining ownership rights in real property 
is historically left to the states. It is unclear whether HOEPA was 
intended to effect a change in the relationship between state and 
federal law. HOEPA's legislative history does not directly address the 
issue of foreclosure.
    In a 1998 joint report to Congress on mortgage disclosure reform, 
the Board and HUD recommended that Congress consider the adoption of 
certain minimum standards for the notice creditors must provide 
consumers prior to a home foreclosure. The goal would be to establish 
procedures that avoid unwarranted foreclosures by maximizing consumers' 
opportunities to cure a delinquency or arrange other financing. These 
procedures are especially important where a consumer who is 
overburdened by an abusive loan can qualify for financing on less 
onerous terms. See 1998 Joint Report, Chapter 6, at page 68.
    Disclosures about Payment History--The July notice solicited 
comment on whether creditors that choose not to report borrowers' 
positive payment history should be required to disclose that fact. 
Consumer representatives that commented on the issue suggested that the 
Board should require lenders to report a borrower's payment history to 
a nationally recognized credit bureau, or, at a minimum, require 
lenders to disclose whether they do or do not report borrowers' payment 
histories to credit bureaus. Industry representatives commenting on the 
issue noted that they currently report payment histories; these 
commenters generally supported a rule requiring reports of positive 
payment histories, although some noted that legislative action is 
necessary to effect such a requirement.
    The Fair Credit Reporting Act (FCRA) sets standards for the 
collection, communication and use of information bearing on, among 
other things, consumers' creditworthiness, credit standing, and credit 
capacity. 15 U.S.C. 1681 et seq. The Act does not, however, require 
creditors to report any information. The FCRA also contains detailed 
requirements for the information that consumers are entitled to receive 
regarding creditors use of consumer reports. Because the Congress has 
regulated this area in detailed fashion under the FCRA, the Board 
believes that adding any rules governing the reporting of credit 
information is a policy matter better left to the Congress.
    Prepayment Penalties--For HOEPA loans, creditors' use of prepayment 
penalties is restricted during the first five years of a loan, and is 
prohibited after that. The July notice solicited comment on creditors' 
use of prepayment penalties, and whether it would be feasible to limit 
the use of prepayment penalties to transactions where consumers 
receive, in return, a benefit in the form of lower up-front costs or 
lower interest rates. In some cases, creditors impose prepayment 
penalties to ensure a minimum return on the transaction if loans are 
prepaid earlier than expected. In other cases, however, the penalty 
might be used only to deter the customer from refinancing the loan on 
more favorable terms. Because of the inherent difficulty in 
establishing a rule that addresses abusive practices without limiting 
consumer options in legitimate transactions, the Board is not proposing 
additional rules on prepayment penalties at this time.
    Mandatory Arbitration--Consumer representatives asked the Board to 
prohibit mandatory arbitration clauses for all HOEPA loans. These 
commenters maintain that mandatory arbitration clauses often contain 
provisions that limit the consumer's remedies, particularly with 
respect to punitive damages and class actions, or that require the 
consumer to bear the filing fees and other costs of arbitration. In 
light of the Federal Arbitration Act (FAA), there is a substantial 
federal question raised by these recommendations. In a recent decision, 
the Supreme Court reaffirmed that under the FAA, federal statutory 
claims may be appropriately resolved through arbitration. See Green 
Tree Financial Corp. v. Randolph, No. 99-1235, 2000 U.S. LEXIS 8279 
(Dec. 11, 2000).

[[Page 81448]]

IV. Form of Comment Letters

    Comment letters should refer to Docket No. R-1090, and, when 
possible, should use a standard typeface with a font size of 10 or 12. 
This will enable the Board to convert the text to machine-readable form 
through electronic scanning, and will facilitate automated retrieval of 
comments for review. Also, if accompanied by an original document in 
paper form, comments may be submitted on 3\1/2\ inch computer diskettes 
in any IBM-compatible DOS- or Windows-based format.

V. Initial Regulatory Flexibility Analysis

    In accordance with section 3(a) of the Regulatory Flexibility Act, 
the Board has reviewed the proposed amendments to Regulation Z. The 
proposed amendments would: (1) Extend the protections of HOEPA to more 
loans; (2) prohibit certain acts or practices, to address some ``loan 
flipping'' within the first twelve months of a HOEPA loan, prohibiting 
the creditor or assignee that is holding the loan (or their affiliates) 
from refinancing it unless the holder demonstrates that it is in the 
borrower's interest; (3) strengthen HOEPA's prohibition on loans based 
on homeowners' equity without regard to repayment ability; and (4) 
improve disclosures received by consumers before closing. A regulatory 
flexibility analysis has been prepared by the Division of Research and 
Statistics. A final analysis will be conducted after consideration of 
comments received during the public comment period.

VI. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3506; 5 CFR part 1320 Appendix A.1), the Board reviewed the rule under 
the authority delegated to the Board by the Office of Management and 
Budget. The Federal Reserve may not conduct or sponsor, and an 
organization is not required to respond to, this information collection 
unless it displays a currently valid OMB control number. The OMB 
control number is 7100-0199.
    The collection of information that is revised by this rulemaking is 
found in 12 CFR part 226 and in Appendices F, G, H, J, K, and L. This 
information is mandatory (15 U.S.C. 1601 et seq.) to evidence 
compliance with the requirements of Regulation Z and the Truth in 
Lending Act (TILA). The respondents/recordkeepers are for-profit 
financial institutions, including small businesses. Institutions are 
required to retain records for twenty-four months. This regulation 
applies to all types of creditors, not just state member banks. 
However, under Paperwork Reduction Act regulations, the Federal Reserve 
accounts for the burden of the paperwork associated with the regulation 
only for state member banks, their subsidiaries, and subsidiaries of 
bank holding companies (not otherwise regulated). Other agencies 
account for the paperwork burden on their respective constituencies 
under this regulation. The proposed rule would broaden the scope of two 
``high-cost'' triggers (the APR trigger and the fee-based trigger) for 
mortgage loans; and would require creditors to revise a disclosure 
currently implemented in Sec. 226.32 of Regulation Z. There should be a 
minimal burden increase associated with this revision due to the fact 
that most institutions use an automated version of the model forms 
provided in Appendix H and the calculation revisions need only be 
incorporated into an automated system one time. The disclosure revision 
would cover refinancings subject to HOEPA and would state the total 
loan amount of the borrower's obligation (Sec. 226.32(c)(5)). Model 
clauses will be provided for this new disclosure to help minimize 
burden on the creditors.
    With respect to state member banks, it is estimated that there are 
988 respondent/recordkeepers and an average frequency of 136,294 
responses per respondent each year. Therefore, the current amount of 
annual burden is estimated to be 1,863,754 hours. The Federal Reserve 
will estimate the burden hours for: Creating and distributing the three 
proposed disclosure requirements, programming systems with the proposed 
disclosures, revising the current disclosure affected by the APR 
trigger and the fee-based trigger changes, and updating systems with 
the new trigger figures. The staff will also reestimate the burden 
hours for all the current disclosure requirements. The Federal Reserve 
estimates that the annual burden hours imposed on creditors will 
increase by approximately 25 percent. The Federal Reserve believes that 
reverse and high-cost mortgages trigger special disclosures but are not 
typically offered by state member banks; thus the requirements have 
only a negligible effect on the paperwork burden for state member 
banks. The Federal Reserve solicits specific comments on: (1) Whether 
state member banks offer reverse and high-cost mortgages, (2) the 
length of time creditors will devote to these proposed changes, and (3) 
the length of time creditors spend complying with current Regulation Z 
requirements.
    Because the records would be maintained at state member banks and 
the notices are not provided to the Federal Reserve, no issue of 
confidentiality under the Freedom of Information Act arises; however, 
any information obtained by the Federal Reserve may be protected from 
disclosure under exemptions (b)(4), (6), and (8) of the Freedom of 
Information Act (5 U.S.C. 522 (b)(4), (6) and (8)). The disclosures and 
information about error allegations are confidential between creditors 
and the customer.
    The Federal Reserve requests comments from creditors, especially 
state member banks, that will help to estimate the number and burden of 
the various disclosures that would be made in the first year this 
proposed regulation would be effective. Comments are invited on: (a) 
The cost of compliance; (b) ways to enhance the quality, utility, and 
clarity of the information to be disclosed; and (c) ways to minimize 
the burden of disclosure on respondents, including through the use of 
automated disclosure techniques or other forms of information 
technology. Comments on the collection of information should be sent to 
the Office of Management and Budget, Paperwork Reduction Project (7100-
0199), Washington, DC 20503, with copies of such comments sent to Mary 
M. West, Federal Reserve Board Clearance Officer, Division of Research 
and Statistics, Mail Stop 97, Board of Governors of the Federal Reserve 
System, Washington, DC 20551.

List of Subjects in 12 CFR Part 226

    Advertising, Federal Reserve System, Mortgages, Reporting and 
recordkeeping requirements, Truth in lending.

Text of Proposed Revisions

    Certain conventions have been used to highlight the proposed 
revisions to the text of the staff commentary. New language is shown 
inside bold-faced arrows, while language that would be deleted is set 
off with bold-faced brackets. Brackets in proposed Model Form H-16 are 
not bold-faced; brackets are employed in the Board's model clauses and 
samples to illustrate how creditors may adapt the required disclosures 
to the particular transaction.
    For the reasons set forth in the preamble, the Board proposes to 
amend Regulation Z, 12 CFR part 226, as set forth below:

PART 226--TRUTH IN LENDING (REGULATION Z)

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


[[Page 81449]]


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

Subpart A--General

    2. Section 226.1 would be amended by:
    a. Revising paragraph (b); and
    b. Revising paragraph (d)(5).
* * * * *


Sec. 226.1  Authority, purpose, coverage, organization, enforcement and 
liability.

* * * * *
    (b) Purpose. The purpose of this regulation 
is to promote the informed use of consumer credit by requiring 
disclosures about its terms and cost. The regulation gives consumers 
the right to cancel certain credit transactions that involve a lien on 
a consumer's principal dwelling, regulates certain credit card 
practices, and provides a means for fair and timely resolution of 
credit billing disputes. The regulation does not govern charges for 
consumer credit. The regulation requires a maximum interest rate to be 
stated in variable-rate contracts secured by the consumer's dwelling. 
It also imposes limitations on home equity plans that are subject to 
the requirements of Sec. 226.5b and mortgages that are subject to the 
requirements of Sec. 226.32. The regulation prohibits 
certain acts or practices in connection with credit secured by a 
consumer's principal dwelling.
* * * * *
    (d) Organization. * * *
* * * * *
    (5) Subpart E contains special rules for mortgage 
transactions. Section 226.32 requires certain disclosures and provides 
limitations for loans that have rates and fees above a specified 
amount. Section 226.33 requires disclosures, including the total annual 
loan cost rate, for reverse mortgage transactions. Section 226.34 
prohibits specific acts and practices in connection with mortgage 
transactions. [relates to mortgage transactions covered by 
Sec. 226.32 and reverse mortgage transactions. It contains rules on 
disclosures, fees, and total annual loan cost rates.]
* * * * *

Subpart C--Closed-End Credit

    3. Section 226.23 would be amended by revising footnote 48 to read 
as follows:
* * * * *


Sec. 226.23  Right of rescission.

* * * * *
    \48\The term ``material disclosures'' means the required 
disclosures of the annual percentage rate, the finance charge, the 
amount financed, the total of payments, the payment schedule, [and] 
the disclosures and limitations referred to in Sec. 226.32(c) and 
(d), and provisions in a mortgage that are prohibited 
under Sec.  226.34.
* * * * *

Subpart E--Special Rules for Certain Home Mortgage Transactions

    4. Section 226.32 would be amended by:
    a. Republishing paragraph (a)(1) introductory text and revising 
paragraph (a)(1)(i);
    b. Republishing paragraphs (b) introductory text and (b)(1) 
introductory text and adding paragraph (b)(1)(iv);
    c. Republshing paragraph (c) introductory text, revising paragraph 
(c)(3) and adding paragraph (c)(5);
    d. Republishing paragraph (d) introductory text and adding 
paragraph (d)(8); and
    e. Removing paragraph (e).
* * * * *


Sec. 226.32  Requirements for certain closed-end home mortgages.

    (a) Coverage.
    (1) Except as provided in paragraph (a)(2) of this section, the 
requirements of this section apply to a consumer credit transaction 
that is secured by the consumer's principal dwelling, and in which 
either:
    (i) The annual percentage rate at consummation will exceed by more 
than [10] 8 percentage points the yield on 
Treasury securities having comparable periods of maturity to the loan 
maturity as of the fifteenth day of the month immediately preceding the 
month in which the application for the extension of credit is received 
by the creditor; or
* * * * *
    (b) Definitions. For purposes of this subpart, the following 
definitions apply:
    (1) For purposes of paragraph (a)(1)(ii) of this section, points 
and fees mean:
* * * * *
    (iv) premiums or other charges for credit life, 
accident, health, or loss-of-income insurance, debt-cancellation 
coverage (whether or not the debt-cancellation coverage is insurance 
under applicable law), or similar products.
* * * * *
    (c) Disclosures. In addition to other disclosures required by this 
part, in a mortgage subject to this section, the creditor shall 
disclose the following:
* * * * *
    (3) Regular payment balloon payment. The 
amount of the regular monthly (or other periodic) payment  
and the amount of a balloon payment
* * * * *
    (5) Amount borrowed. For a mortgage refinancing, the 
total amount the consumer will borrow, as reflected by the face amount 
of the note.
* * * * *
    (d) Limitations. A mortgage transaction subject to this section may 
not provide for the following terms:
* * * * *
    (8) Due-on-demand clause. A demand feature that permits 
the creditor to terminate the loan in advance of the original maturity 
date and to demand repayment of the entire outstanding balance, except 
in the following circumstances:
    (i) There is fraud or material misrepresentation by the consumer in 
connection with the loan;
    (ii) The consumer fails to meet the repayment terms of the 
agreement for any outstanding balance; or
    (iii) Any action or inaction by the consumer that adversely affects 
the creditor's security for the loan, or any right of the creditor in 
such security.
* * * * *
    5. A new `` 226.34 would be added to read as follows:


Sec. 226.34  Prohibited acts or practices in connection with credit 
secured by a consumer's dwelling.

    (a) Prohibited acts or practices for loans subject to ''226.32. A 
creditor extending mortgage credit subject to Sec. 226.32 may not--
    (1) Home improvement contracts. Pay a contractor under a home 
improvement contract from the proceeds of a mortgage covered by 
Sec. 226.32, other than:
    (i) By an instrument payable to the consumer or jointly to the 
consumer and the contractor; or
    (ii) At the election of the consumer, through a third-party escrow 
agent in accordance with terms established in a written agreement 
signed by the consumer, the creditor, and the contractor prior to the 
disbursement.
    (2) Notice to assignee. Sell or otherwise assign a mortgage subject 
to Sec. 226.32 without furnishing the following statement to the 
purchaser or assignee: ``Notice: This is a mortgage subject to special 
rules under the federal Truth in Lending Act. Purchasers or assignees 
of this mortgage could be liable for all claims and defenses with 
respect to the mortgage that the borrower could assert against the 
creditor.''
    (3) Refinancings within twelve-month period. Refinance a loan 
subject to Sec. 226.32 within the first twelve months

[[Page 81450]]

unless the refinancing is in the borrower's interest, if the creditor 
(or its affiliate) holds the existing loan. Creditors are prohibited 
from engaging in acts or practices to evade this provision, including 
arranging for the refinancing of its own loans with unaffiliated 
creditors, or modifying a loan agreement (whether or not the existing 
loan is satisfied and replaced by the new loan) and charging a fee.
    (4) Repayment ability. (i) Engage in a pattern or practice of 
extending credit subject to Sec. 226.32 to a consumer based on the 
consumer's collateral without regard to the consumer's repayment 
ability, including the consumer's current and expected income, current 
obligations, and employment.
    (ii) If a creditor engages in a pattern or practice of making loans 
subject to Sec. 226.32 without documenting and verifying consumers'' 
repayment ability, such as the consumer's current or expected income, 
current obligations, and employment status, there is a presumption that 
the creditor has violated paragraph (a)(4)(i) of this section.
    (b) Prohibited acts or practices for dwelling-secured loans. A 
creditor may not engage in the following acts or practices in 
connection with credit secured by the consumer's dwelling:
    (1) Limitations on refinancing certain low-rate loans. Replacing or 
consolidating a zero interest rate or other low-cost loan with a 
higher-rate loan within the first five years, unless the refinancing is 
in the borrower's interest. For purposes of this paragraph, a ``low-
cost'' loan is:
    (i) A fixed-rate loan that carries an interest rate two percentage 
points or more below the yield on Treasury securities with a comparable 
maturity; or
    (ii) A variable-rate loan where the current interest rate is at 
least two percentage points below the index or formula used to make 
rate adjustments.
    (2) Open-end credit. Structuring a home-secured loan as an open-end 
plan to evade the requirements of Sec. 226.32, if the credit does not 
meet the definition in Sec. 226.2(a)(20).
    6. Appendix H to Part Sec. 226 would be amended by revising Model 
Form H-16.

Appendix H to Part 226--Closed-End Model Forms and Clauses

* * * * *

    H-16--Mortgage Sample
    You are not required to complete this agreement merely because 
you have received these disclosures or have signed a loan 
application.
    If you obtain this loan, the lender will have a mortgage on your 
home.
    You could lose your home, and any money you have put into it, If 
you do not meet your obligations under the loan.
    [You are borrowing $________].
    The annual percentage rate on your loan will be: ____%.
    Your regular frequency] payment will be: $____.
    [At the end of your loan, you will still owe us: $ 
[balloon amount].
    [Your interest rate may increase. Increases in the interest rate 
could increase your payment. The highest amount your payment could 
increase is to $____.]
* * * * *
    7. In Supplement I to Part 226, the following amendments would 
be made:
    a. Under Section 226.31--General Rules, under Paragraph 
31(c)(1)(i), paragraph 2. would be added;
    b. Under Section 226.32--Requirements for Certain Closed-End 
Home Mortgages, under Paragraph 32(a)(1)(ii), paragraph 1. 
introductory text would be revised and paragraph 1. iv. would be 
added;
    c. Under Section 226.32--Requirements for Certain Closed-End 
Home Mortgages, a new heading Paragraph 32(b)(1)(iv) would be added 
and a new paragraph 1. would be added;
    d. Under Section 226.32--Requirements for Certain Closed-End 
Home Mortgages, under Paragraph (32)(c)(3), paragraph 1. 
introductory text would be revised and paragraph 2. would be 
removed;
    e. Under Section 226.32--Requirements for Certain Closed-End 
Home Mortgages, a new heading Paragraph 32(d)(8) would be added; a 
new heading Paragraph 32(d)(8)(ii) would be added and a new 
paragraph 1. would be added; and a new heading Paragraph 32(d)
(8)(iii) would be added and new paragraphs 1. and 2. would be added.
    f. Under Section 226.32--Requirements for Certain Closed-End 
Home Mortgages, 32(e) Prohibited Acts and Practices would be 
removed;
    g. A new Section 226.34--Prohibited Acts or Practices in 
Connection with Credit Secured by a Consumer's Dwelling would be 
added; and
    h. Under Appendix H--Closed-End Model Forms and Clauses, 
paragraphs 20. through 23. would be redesignated as paragraphs 21. 
through 24., and new paragraph 20. would be added.

Supplement I to Part 226--Official Staff Interpretations

* * * * *

Subpart E--Special Rules for Certain Home Mortgage Transactions

Sec. 226.31--General Rules


31(c)  Timing of disclosure.

* * * * *
    Paragraph 31(c)(1)(i) Change in terms. 
* * * * *
    2. Sale of optional products at consummation. If the 
consumer finances the purchase of optional products such as credit 
insurance and as a result the monthly payment differs from what was 
previously disclosed under Sec. 226.32, redisclosure is required and a 
new three-day waiting period applies. (See comment 32(c)(3)-1 on when 
optional items may be included in the regular payment 
disclosure.)
* * * * *

Sec. 226.32--Requirements for Certain Closed-End Home Mortgages

    32(a) Coverage.
* * * * *
    Paragraph 32(a)(1)(ii).
    1. Total loan amount. For purposes of the ``points and fees'' test, 
the total loan amount is calculated by taking the amount financed, as 
determined according to Sec. 226.18(b), and deducting any cost listed 
in Sec. 226.32(b)(1)(iii)  and Sec. 226.32(b)(1)(iv) 
 that is both             included as points and fees under  
           Sec. 226.32(b)(1) and financed by the credi-             
tor. Some examples follow, each using a             $10,000 amount 
borrowed, a $300             appraisal fee, and $400 in points[:] 
.             A $500 premium for optional credit life         
    insurance is used in one example.
* * * * *
    iv. If the consumer financed a $300 fee for a creditor-
conducted appraisal and a $500 single premium for optional credit life 
insurance, and pays $400 in points at closing, the amount financed 
under Sec. 226.18(b) is $10,400 ($10,000, plus the $300 appraisal fee 
that is paid to and financed by the creditor, plus the $500 insurance 
premium that is financed by the creditor, less $400 in prepaid finance 
charges). The $300 appraisal fee paid to the creditor is added to other 
points and fees under Sec. 226.32(b)(1)(iii), and the $500 insurance 
premium is added under 226.32(b)(1)(iv). The $300 and $500 costs are 
deducted from the amount financed ($10,400) to derive a total loan 
amount of $9,600.
* * * * *
    32(b) Definitions.
* * * * *
    Paragraph 32(b)(1)(iv).
    1. Premium amount. In determining ``points and fees'' for purposes 
of this section, premiums paid at or before closing for credit 
insurance are included whether they are paid in cash or financed, and 
whether the amount represents the entire premium for the coverage or an 
initial payment.
* * * * *
    32(c) Disclosures.
* * * * *
    Paragraph 32(c)(3) Regular payment.
    1. General. The regular payment is the amount due from the borrower 
at regular intervals, such as monthly, bimonthly, quarterly, or 
annually. There must be at least two payments, and the payments must be 
in an amount and at

[[Page 81451]]

such intervals that they fully amortize the amount owed. In disclosing 
the regular payment, creditors may rely on the rules set forth in 
Sec. 226.18(g); however, the amounts for voluntary items , 
such as credit life insurance, may be included in the regular payment 
disclosure only if the consumer has previously agreed to the 
items. [not agreed to by the consumer such as credit life 
insurance may not be included in the regular payment.]
* * * * *
    32(d) Limitations.
* * * * *
    32(d)(8) Due-on-demand clauses. 
    Paragraph 32(d)(8)(ii).
    1. Failure to meet repayment terms. A creditor may terminate a loan 
and accelerate the balance when the consumer fails to meet the 
repayment terms provided for in the agreement. However, a creditor may 
terminate and accelerate under this provision only if the consumer 
actually fails to make payments. For example, a creditor may not 
terminate and accelerate if the consumer, in error, sends a payment to 
the wrong location, such as a branch rather than the main office of the 
creditor. If a consumer files for or is placed in bankruptcy, the 
creditor may terminate and accelerate under this provision if the 
consumer fails to meet the repayment terms of the agreement. This 
section does not override any state or other law that requires a right 
to cure notice, or otherwise places a duty on the creditor before it 
can terminate a loan and accelerate the balance.
    Paragraph 32(d)(8)(iii).
    1. Impairment of security. A creditor may terminate a loan and 
accelerate the balance if the consumer's action or inaction adversely 
affects the creditor's security for the loan, or any right of the 
creditor in that security. Action or inaction by third parties does 
not, in itself, permit the creditor to terminate and accelerate.
    2. Examples. i. A creditor may terminate and accelerate, for 
example, if:
    A. The consumer transfers title to the property or sells the 
property without the permission of the creditor.
    B. The consumer fails to maintain required insurance on the 
dwelling.
    C. The consumer fails to pay taxes on the property.
    D. The consumer permits the filing of a lien senior to that held by 
the creditor.
    E. The sole consumer obligated on the plan dies.
    F. The property is taken through eminent domain.
    G. A prior lienholder forecloses.
    ii. By contrast, the filing of a judgment against the consumer 
would permit termination and acceleration only if the amount of the 
judgment and collateral subject to the judgment is such that the 
creditor's security is adversely affected. If the consumer commits 
waste or otherwise destructively uses or fails to maintain the property 
such that the action adversely affects the security, the loan may be 
terminated and the balance accelerated. Illegal use of the property by 
the consumer would permit termination and acceleration if it subjects 
the property to seizure. If one of two consumers obligated on a loan 
dies, the creditor may terminate the loan and accelerate the balance if 
the security is adversely affected. If the consumer moves out of the 
dwelling that secures the loan and that action adversely affects the 
security, the creditor may terminate a loan and accelerate the 
balance.
* * * * *

Sec. 226.34--Prohibited Acts or Practices in Connection with Credit 
Secured by a Consumer's Dwelling

    34(a) Prohibited Acts or Practices for Loans Subject to 
Sec. 226.32.
    34(a)(1) Home-improvement contracts.
    34(a)(1)(i).
    1. Joint payees. If a creditor pays a contractor with an instrument 
jointly payable to the contractor and the consumer, the instrument must 
name as payee each consumer who is primarily obligated on the note.
    Paragraph 34(a)(2) Notice to assignee.
    1. Subsequent sellers or assignors. Any person, whether or not the 
original creditor, that sells or assigns a mortgage subject to 
Sec. 226.32 must furnish the notice of potential liability to the 
purchaser or assignee.
    2. Format. While the notice of potential liability need not be in 
any particular format, the notice must be prominent. Placing it on the 
face of the note, such as with a stamp, is one means of satisfying the 
prominence requirement.
    3. Assignee liability. Pursuant to section 131(d) of the Act, the 
Act's general holder-in-due course protections do not apply to 
purchasers and assignees of loans covered by Sec. 226.32.
    Paragraph 34(a)(3) Refinancings within twelve-month period.
    1. Benefit to the borrower. The determination of whether or not a 
benefit exists would be based on the totality of the circumstances. For 
example, consideration should be given to the amount of any new funds 
advanced in comparison to the total loan charges on the refinancing 
(which may be based predominately on the pre-existing loan balance).
    Paragraph 34(a)(4) Repayment ability.
    Paragraph 34(a)(4)(i).
    1. Determining repayment ability. The information provided to 
creditors in connection with Sec. 226.32(d)(7) may be used to show that 
creditors considered the consumer's income and obligations before 
extending the credit. Any expected income can be considered by the 
creditor, except equity income that the consumer would obtain through 
the foreclosure of the consumer's principal dwelling. For example, a 
creditor may use information about income other than regular salary or 
wages such as gifts, expected retirement payments, or income from 
housecleaning or childcare.
    2. Pattern or practice of extending credit--repayment ability. 
Whether a creditor has engaged in a pattern or practice of violations 
of this section depends on the totality of the circumstances in each 
particular case. General guidance, however, on pattern or practice for 
purposes of this section can be found in case law interpreting pattern 
or practice provisions in the Truth in Lending Act, the Equal Credit 
Opportunity Act (ECOA), the Fair Housing Act (FHA), and Title VII of 
the Civil Rights Act of 1964 (equal employment opportunity).
    3. Discounted introductory rates. In transactions where the 
creditor sets the initial interest rate and the rate is later adjusted 
(whether fixed or later determined by an index or formula), in 
determining repayment ability the creditor must consider increases to 
the consumer's payments based on the maximum possible increases in 
rates in the shortest possible time frame.
    Paragraph 34(a)(4)(ii).
    1. Documenting and verifying income. Creditors may document and 
verify a consumer's repayment ability in various ways. For example, a 
creditor may document and verify a consumer's income and current 
obligations through a consumer's signed financial statement, a credit 
report, and payment records for employment income. For the self-
employed, in lieu of employment payment records, a creditor may rely on 
tax returns or any other source that provides the creditor with a 
reasonable basis for believing that the income exists and will support 
the loan.
* * * * *
    Paragraph 34(b)(1) Limitation on refinancing certain low-rate 
loans.
    1. Borrower's statement. A creditor may rely on a statement by the 
borrower regarding the current rate of interst on their existing 
loan.
* * * * *

[[Page 81452]]

Appendix H--Closed-End Model Forms and Clauses

* * * * *
    20. Sample H-16. This sample illustrates the 
disclosures required under Sec. 226.32(c). The sample includes 
disclosures required under Sec. 226.32(c)(3) when the legal 
obligation includes a balloon payment. The sample also illustrates 
the disclosures required for refinancings under Sec. 226.32(c)(5) 
and Sec. 226.32(c)(6). Although these disclosures are required for 
refinancings that are subject to Sec. 226.32, creditors may, at 
their option, include these disclosures for all loans subject to 
that section.
* * * * *

    By order of the Board of Governors of the Federal Reserve 
System, December 15, 2000.
Jennifer J. Johnson,
Secretary of the Board.

[FR Doc. 00-32504 Filed 12-22-00; 8:45 am]
BILLING CODE 6210-01-P