[Federal Register Volume 73, Number 147 (Wednesday, July 30, 2008)]
[Rules and Regulations]
[Pages 44522-44614]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-16500]



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Part III





Federal Reserve System





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12 CFR Part 226



Truth in Lending; Final Rule

  Federal Register / Vol. 73, No. 147 / Wednesday, July 30, 2008 / 
Rules and Regulations  

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FEDERAL RESERVE SYSTEM

12 CFR Part 226

[Regulation Z; Docket No. R-1305]


Truth in Lending

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule; official staff commentary.

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SUMMARY: The Board is publishing final rules amending Regulation Z, 
which implements the Truth in Lending Act and Home Ownership and Equity 
Protection Act. The goals of the amendments are to protect consumers in 
the mortgage market from unfair, abusive, or deceptive lending and 
servicing practices while preserving responsible lending and 
sustainable homeownership; ensure that advertisements for mortgage 
loans provide accurate and balanced information and do not contain 
misleading or deceptive representations; and provide consumers 
transaction-specific disclosures early enough to use while shopping for 
a mortgage. The final rule applies four protections to a newly-defined 
category of higher-priced mortgage loans secured by a consumer's 
principal dwelling, including a prohibition on lending based on the 
collateral without regard to consumers' ability to repay their 
obligations from income, or from other sources besides the collateral. 
The revisions apply two new protections to mortgage loans secured by a 
consumer's principal dwelling regardless of loan price, including a 
prohibition on abusive servicing practices. The Board is also 
finalizing rules requiring that advertisements provide accurate and 
balanced information, in a clear and conspicuous manner, about rates, 
monthly payments, and other loan features. The advertising rules ban 
several deceptive or misleading advertising practices, including 
representations that a rate or payment is ``fixed'' when it can change. 
Finally, the revisions require creditors to provide consumers with 
transaction-specific mortgage loan disclosures within three business 
days after application and before they pay any fee except a reasonable 
fee for reviewing credit history.

DATES: This final rule is effective on October 1, 2009, except for 
Sec.  226.35(b)(3)) which is effective on April 1, 2010. See part XIII, 
below, regarding mandatory compliance with Sec.  226.35(b)(3) on 
mortgages secured by manufactured housing.

FOR FURTHER INFORMATION CONTACT: Kathleen C. Ryan or Dan S. Sokolov, 
Counsels; Paul Mondor, Senior Attorney; Jamie Z. Goodson, Brent Lattin, 
Jelena McWilliams, Dana E. Miller, or Nikita M. Pastor, Attorneys; 
Division of Consumer and Community Affairs, Board of Governors of the 
Federal Reserve System, Washington, DC 20551, at (202) 452-2412 or 
(202) 452-3667. For users of Telecommunications Device for the Deaf 
(TDD) only, contact (202) 263-4869.

SUPPLEMENTARY INFORMATION:
I. Summary of Final Rules
    A. Rules To Prevent Unfairness, Deception, and Abuse
    B. Revisions To Improve Mortgage Advertising
    C. Requirement To Give Consumers Disclosures Early
II. Consumer Protection Concerns in the Subprime Market
    A. Recent Problems in the Mortgage Market
    B. Market Imperfections That Can Facilitate Abusive and 
Unaffordable Loans
III. The Board's HOEPA Hearings
    A. Home Ownership and Equity Protection Act (HOEPA)
    B. Summary of 2006 Hearings
    C. Summary of June 2007 Hearing
    D. Congressional Hearings
IV. Interagency Supervisory Guidance
V. Legal Authority
    A. The Board's Authority Under TILA Section 129(l)(2)
    B. The Board's Authority Under TILA Section 105(a)
VI. The Board's Proposal
    A. Proposals To Prevent Unfairness, Deception, and Abuse
    B. Proposals To Improve Mortgage Advertising
    C. Proposal To Give Consumers Disclosures Early
VII. Overview of Comments Received
VIII. Definition of ``Higher-Priced Mortgage Loan''--Sec.  226.35(a)
    A. Overview
    B. Public Comment on the Proposal
    C. General Approach
    D. Index for Higher-Priced Mortgage Loans
    E. Threshold for Higher-Priced Mortgage Loans
    F. The Timing of Setting the Threshold
    G. Proposal To Conform Regulation C (HMDA)
    H. Types of Loans Covered Under Sec.  226.35
IX. Final Rules for Higher-Priced Mortgage Loans and HOEPA Loans
    A. Overview
    B. Disregard of Consumer's Ability To Repay--Sec. Sec.  
226.34(a)(4) and 226.35(b)(1)
    C. Prepayment Penalties--Sec.  226.32(d)(6) and (7); Sec.  
226.35(b)(2)
    D. Escrows for Taxes and Insurance--Sec.  226.35(b)(3)
    E. Evasion Through Spurious Open-End Credit--Sec.  226.35(b)(4)
X. Final Rules for Mortgage Loans--Sec.  226.36
    A. Creditor Payments to Mortgage Brokers--Sec.  226.36(a)
    B. Coercion of Appraisers--Sec.  226.36(b)
    C. Servicing Abuses--Sec.  226.36(c)
    D. Coverage--Sec.  226.36(d)
XI. Advertising
    A. Advertising Rules for Open-End Home-Equity Plans--Sec.  
226.16
    B. Advertising Rules for Closed-End Credit)--Sec.  226.24
XII. Mortgage Loan Disclosures
    A. Early Mortgage Loan Disclosures--Sec.  226.19
    B. Plans To Improve Disclosure
XIII. Mandatory Compliance Dates
XIV. Paperwork Reduction Act
XV. Regulatory Flexibility Analysis

I. Summary of Final Rules

    On January 9, 2008, the Board published proposed rules that would 
amend Regulation Z, which implements the Truth in Lending Act (TILA) 
and the Home Ownership and Equity Protection Act (HOEPA). 73 FR 1672. 
The Board is publishing final amendments to Regulation Z to establish 
new regulatory protections for consumers in the residential mortgage 
market. The goals of the amendments are to protect consumers in the 
mortgage market from unfair, abusive, or deceptive lending and 
servicing practices while preserving responsible lending and 
sustainable homeownership; ensure that advertisements for mortgage 
loans provide accurate and balanced information and do not contain 
misleading or deceptive representations; and provide consumers 
transaction-specific disclosures early enough to use while shopping for 
mortgage loans.

A. Rules To Prevent Unfairness, Deception, and Abuse

    The Board is publishing seven new restrictions or requirements for 
mortgage lending and servicing intended to protect consumers against 
unfairness, deception, and abuse while preserving responsible lending 
and sustainable homeownership. The restrictions are adopted under TILA 
Section 129(l)(2), which authorizes the Board to prohibit unfair or 
deceptive practices in connection with mortgage loans, as well as to 
prohibit abusive practices or practices not in the interest of the 
borrower in connection with refinancings. 15 U.S.C. 1639(l)(2). Some of 
the restrictions apply only to higher-priced mortgage loans, while 
others apply to all mortgage loans secured by a consumer's principal 
dwelling.
Protections Covering Higher-Priced Mortgage Loans
    The Board is finalizing four protections for consumers receiving 
higher-priced mortgage loans. These loans are defined as consumer-
purpose, closed-end loans secured by a consumer's principal dwelling 
and

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having an annual percentage rate (APR) that exceeds the average prime 
offer rates for a comparable transaction published by the Board by at 
least 1.5 percentage points for first-lien loans, or 3.5 percentage 
points for subordinate-lien loans. For higher-priced mortgage loans, 
the final rules:
    [cir] Prohibit creditors from extending credit without regard to a 
consumer's ability to repay from sources other than the collateral 
itself;
    [cir] Require creditors to verify income and assets they rely upon 
to determine repayment ability;
    [cir] Prohibit prepayment penalties except under certain 
conditions; and
    [cir] Require creditors to establish escrow accounts for taxes and 
insurance, but permit creditors to allow borrowers to cancel escrows 12 
months after loan consummation.
    In addition, the final rules prohibit creditors from structuring 
closed-end mortgage loans as open-end lines of credit for the purpose 
of evading these rules, which do not apply to open-end lines of credit.
Protections Covering Closed-End Loans Secured by Consumer's Principal 
Dwelling
    In addition, in connection with all consumer-purpose, closed-end 
loans secured by a consumer's principal dwelling, the Board's rules:
    [cir] Prohibit any creditor or mortgage broker from coercing, 
influencing, or otherwise encouraging an appraiser to provide a 
misstated appraisal in connection with a mortgage loan; and
    [cir] Prohibit mortgage servicers from ``pyramiding'' late fees, 
failing to credit payments as of the date of receipt, or failing to 
provide loan payoff statements upon request within a reasonable time.

The Board is withdrawing its proposal to require servicers to deliver a 
fee schedule to consumers upon request; and its proposal to prohibit 
creditors from paying a mortgage broker more than the consumer had 
agreed in advance that the broker would receive. The reasons for the 
withdrawal of these two proposals are discussed in parts X.A and X.C 
below.

Prospective Application of Final Rule

    The final rule is effective on October 1, 2009, or later for the 
requirement to establish an escrow account for taxes and insurance for 
higher-priced mortgage loans. Compliance with the rules is not required 
before the effective dates. Accordingly, nothing in this rule should be 
construed or interpreted to be a determination that acts or practices 
restricted or prohibited under this rule are, or are not, unfair or 
deceptive before the effective date of this rule.
    Unfair acts or practices can be addressed through case-by-case 
enforcement actions against specific institutions, through regulations 
applying to all institutions, or both. A regulation is prospective and 
applies to the market as a whole, drawing bright lines that distinguish 
broad categories of conduct. By contrast, an enforcement action 
concerns a specific institution's conduct and is based on all of the 
facts and circumstances surrounding that conduct.\1\
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    \1\ See Board and FDIC, CA 04-2, Unfair Acts or Practices by 
State-Chartered Banks (March 11, 2004), available at http://www.federalreserve.gov/boarddocs/press/bcreg/2004/20040311/attachment.pdf.
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    Because broad regulations, such as the rules adopted here, can 
require large numbers of institutions to make major adjustments to 
their practices, there could be more harm to consumers than benefit if 
the rules were effective immediately. If institutions were not provided 
a reasonable time to make changes to their operations and systems to 
comply with this rule, they would either incur excessively large 
expenses, which would be passed on to consumers, or cease engaging in 
the regulated activity altogether, to the detriment of consumers. And 
because the Board finds an act or practice unfair only when the harm 
outweighs the benefits to consumers or to competition, the 
implementation period preceding the effective date set forth in the 
final rule is integral to the Board's decision to restrict or prohibit 
certain acts or practices.
    For these reasons, acts or practices occurring before the effective 
dates of these rules will be judged on the totality of the 
circumstances under other applicable laws or regulations. Similarly, 
acts or practices occurring after the rule's effective dates that are 
not governed by these rules will continue to be judged on the totality 
of the circumstances under other applicable laws or regulations.

B. Revisions To Improve Mortgage Advertising

    Another goal of the final rules is to ensure that mortgage loan 
advertisements provide accurate and balanced information and do not 
contain misleading or deceptive representations. Thus the Board's rules 
require that advertisements for both open-end and closed-end mortgage 
loans provide accurate and balanced information, in a clear and 
conspicuous manner, about rates, monthly payments, and other loan 
features. These rules are adopted under the Board's authorities to: 
adopt regulations to ensure consumers are informed about and can shop 
for credit; require that information, including the information 
required for advertisements for closed-end credit, be disclosed in a 
clear and conspicuous manner; and regulate advertisements of open-end 
home-equity plans secured by the consumer's principal dwelling. See 
TILA Section 105(a), 15 U.S.C. 1604(a); TILA Section 122, 15 U.S.C. 
1632; TILA Section 144, 15 U.S.C. 1664; TILA Section 147, 15 U.S.C. 
1665b.
    The Board is also adopting, under TILA Section 129(l)(2), 15 U.S.C. 
1639(l)(2), rules to prohibit the following seven deceptive or 
misleading practices in advertisements for closed-end mortgage loans:
    [cir] Advertisements that state ``fixed'' rates or payments for 
loans whose rates or payments can vary without adequately disclosing 
that the interest rate or payment amounts are ``fixed'' only for a 
limited period of time, rather than for the full term of the loan;
    [cir] Advertisements that compare an actual or hypothetical rate or 
payment obligation to the rates or payments that would apply if the 
consumer obtains the advertised product unless the advertisement states 
the rates or payments that will apply over the full term of the loan;
    [cir] Advertisements that characterize the products offered as 
``government loan programs,'' ``government-supported loans,'' or 
otherwise endorsed or sponsored by a federal or state government entity 
even though the advertised products are not government-supported or -
sponsored loans;
    [cir] Advertisements, such as solicitation letters, that display 
the name of the consumer's current mortgage lender, unless the 
advertisement also prominently discloses that the advertisement is from 
a mortgage lender not affiliated with the consumer's current lender;
    [cir] Advertisements that make claims of debt elimination if the 
product advertised would merely replace one debt obligation with 
another;
    [cir] Advertisements that create a false impression that the 
mortgage broker or lender is a ``counselor'' for the consumer; and
    [cir] Foreign-language advertisements in which certain information, 
such as a low introductory ``teaser'' rate, is provided in a foreign 
language, while required disclosures are provided only in English.

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C. Requirement To Give Consumers Disclosures Early

    A third goal of these rules is to provide consumers transaction-
specific disclosures early enough to use while shopping for a mortgage 
loan. The final rule requires creditors to provide transaction-specific 
mortgage loan disclosures such as the APR and payment schedule for all 
home-secured, closed-end loans no later than three business days after 
application, and before the consumer pays any fee except a reasonable 
fee for the review of the consumer's credit history.
    The Board recognizes that these disclosures need to be updated to 
reflect the increased complexity of mortgage products. In early 2008, 
the Board began testing current TILA mortgage disclosures and potential 
revisions to these disclosures through one-on-one interviews with 
consumers. The Board expects that this testing will identify potential 
improvements for the Board to propose for public comment in a separate 
rulemaking.

II. Consumer Protection Concerns in the Subprime Market

A. Recent Problems in the Mortgage Market

    Subprime mortgage loans are made to borrowers who are perceived to 
have high credit risk. These loans' share of total consumer 
originations, according to one estimate, reached about nine percent in 
2001 and doubled to 20 percent by 2005, where it stayed in 2006.\2\ The 
resulting increase in the supply of mortgage credit likely contributed 
to the rise in the homeownership rate from 64 percent in 1994 to a high 
of 69 percent in 2005--though about 68 percent now--and expanded 
consumers' access to the equity in their homes.
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    \2\ Inside Mortgage Finance Publications, Inc., The 2007 
Mortgage Market Statistical Annual vol. I (IMF 2007 Mortgage 
Market), at 4.
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    Recently, however, some of these benefits have eroded. In the last 
two years, delinquencies and foreclosure starts among subprime 
mortgages have increased dramatically and reached exceptionally high 
levels as house price growth has slowed or prices have declined in some 
areas. The proportion of all subprime mortgages past-due ninety days or 
more (``serious delinquency'') was about 18 percent in May 2008, more 
than triple the mid-2005 level.\3\ Adjustable-rate subprime mortgages 
have performed the worst, reaching a serious delinquency rate of 27 
percent in May 2008, five times the mid-2005 level. These mortgages 
have seen unusually high levels of early payment default, or default 
after only one or two payments or even no payment at all.
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    \3\ Delinquency rates calculated from data from First American 
LoanPerformance.
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    The serious delinquency rate has also risen for loans in alt-A 
(near prime) securitized pools. According to one source, originations 
of these loans were 13 percent of consumer mortgage originations in 
2006.\4\ Alt-A loans are made to borrowers who typically have higher 
credit scores than subprime borrowers, but the loans pose more risk 
than prime loans because they involve small down payments or reduced 
income documentation, or the terms of the loan are nontraditional and 
may increase risk. The rate of serious delinquency for these loans has 
risen to over 8 percent (as of April 2008) from less than 2 percent 
only a year earlier. In contrast, 1.5 percent of loans in the prime-
mortgage sector were seriously delinquent as of April 2008.
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    \4\ IMF 2007 Mortgage Market at 4.
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    The consequences of default are severe for homeowners, who face the 
possibility of foreclosure, the loss of accumulated home equity, higher 
rates for other credit transactions, and reduced access to credit. When 
foreclosures are clustered, they can injure entire communities by 
reducing property values in surrounding areas. Higher delinquencies are 
in fact showing through to foreclosures. Lenders initiated over 550,000 
foreclosures in the first quarter of 2008, about half of them on 
subprime mortgages. This was significantly higher than the quarterly 
average of 325,000 in the first half of the year, and nearly twice the 
quarterly average of 225,000 for the past six years.\5\
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    \5\ Estimates are based on data from Mortgage Bankers' 
Association's National Delinquency Survey (2007) (MBA Nat'l 
Delinquency Survey).
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    Rising delinquencies have been caused largely by a combination of a 
decline in house price appreciation--and in some areas slower economic 
growth--and a loosening of underwriting standards, particularly in the 
subprime sector. The loosening of underwriting standards is discussed 
in more detail in part II.B. The next section discusses underlying 
market imperfections that facilitated this loosening and made it 
difficult for consumers to avoid injury.

B. Market Imperfections That Can Facilitate Abusive and Unaffordable 
Loans

    The recent sharp increase in serious delinquencies has highlighted 
the roles that structural elements of the subprime mortgage market may 
play in increasing the likelihood of injury to consumers who find 
themselves in that market. Limitations on price and product 
transparency in the subprime market--often compounded by misleading or 
inaccurate advertising--may make it harder for consumers to protect 
themselves from abusive or unaffordable loans, even with the best 
disclosures. The injuries consumers in the subprime market may suffer 
as a result are magnified when originators' incentives to carefully 
assess consumers' repayment ability grow weaker, as can happen when 
originators sell their loans to be securitized.\6\ The fragmentation of 
the originator market can further exacerbate the problem by making it 
more difficult for investors to monitor originators and for regulators 
to protect consumers.
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    \6\ Benjamin J. Keys, Tanmoy K. Mukherjee, Amit Seru and Vikram 
Vig, Did Securitization Lead to Lax Screening? Evidence from Suprime 
Loans at 22, available at: http://ssrn.com/abstract=1093137.
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Limited Transparency and Limits of Disclosure
    Limited transparency in the subprime market increases the risk that 
borrowers in that market will receive unaffordable or abusive loans. 
The transparency of the subprime market to consumers is limited in 
several respects. First, price information for the subprime market is 
not widely and readily available to consumers. A consumer reading a 
newspaper, telephoning brokers or lenders, or searching the Internet 
can easily obtain current prime interest rate quotes for free. In 
contrast, subprime rates, which can vary significantly based on the 
individual borrower's risk profile, are not broadly advertised and are 
usually obtainable only after application and paying a fee. Subprime 
rate quotes may not even be reliable if the originator engages in a 
``bait and switch'' strategy. Price opacity is exacerbated because the 
subprime consumer often does not know her own credit score. Even if she 
knows her score, the prevailing interest rate for someone with that 
score and other credit risk characteristics is not generally publicly 
available.
    Second, products in the subprime market tend to be complex, both 
relative to the prime market and in absolute terms, as well as less 
standardized than in the prime market.\7\ As discussed

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earlier, subprime originations have much more often been ARMs than 
fixed rate mortgages. ARMs require consumers to make judgments about 
the future direction of interest rates and translate expected rate 
changes into changes in their payment amounts. Subprime loans are also 
far more likely to have prepayment penalties. Because the annual 
percentage rate (APR) does not reflect the price of the penalty, the 
consumer must both calculate the size of the penalty from a formula and 
assess the likelihood of moving or refinancing during the penalty 
period. In these and other ways, subprime products tend to be complex 
for consumers.
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    \7\ U.S. Dep't of Housing & Urban Development and U.S. Dep't of 
Treasury, Recommendations to Curb Predatory Home Mortgage Lending 17 
(2000) (``While predatory lending can occur in the prime market, 
such practices are for the most part effectively deterred by 
competition among lenders, greater homogeneity in loan terms and the 
prime borrowers' greater familiarity with complex financial 
transactions.''); Howard Lax, Michael Manti, Paul Raca and Peter 
Zorn, Subprime Lending: An Investigation of Economic Efficiency, 15 
Housing Policy Debate 533, 570 (2004) (Subprime Lending 
Investigation) (stating that the subprime market lacks the ``overall 
standardization of products, underwriting, and delivery systems'' 
that is found in the prime market).
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    Third, the roles and incentives of originators are not transparent. 
One source estimates that 60 percent or more of mortgages originated in 
the last several years were originated through a mortgage broker, often 
an independent entity, who takes loan applications from consumers and 
shops them to depository institutions or other lenders.\8\ Anecdotal 
evidence indicates that consumers in both the prime and subprime 
markets often believe, in error, that a mortgage broker is obligated to 
find the consumer the best and most suitable loan terms available. 
Consumers who rely on brokers often are unaware, however, that a 
broker's interests may diverge from, and conflict with, their own 
interests. In particular, consumers are often unaware that a creditor 
pays a broker more to originate a loan with a rate higher than the rate 
the consumer qualifies for based on the creditor's underwriting 
criteria.
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    \8\ Data reported by Wholesale Access Mortgage Research and 
Consulting, Inc., available at http://www.wholesaleaccess.com/.
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    Limited shopping. In this environment of limited transparency, 
consumers--particularly those in the subprime market--may reasonably 
decide not to shop further among originators or among loan options once 
an originator has told them they will receive a loan, because further 
shopping can be very costly. Shopping may require additional 
applications and application fees, and may delay the consumer's receipt 
of funds. This delay creates a potentially significant cost for the 
many subprime borrowers seeking to refinance their obligations to lower 
their debt payments at least temporarily, to extract equity in the form 
of cash, or both.\9\ In recent years, nearly 90 percent of subprime 
ARMs used for refinancings were ``cash out.'' \10\
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    \9\ See Anthony Pennington-Cross & Souphala Chomsisengphet, 
Subprime Refinancing: Equity Extraction and Mortgage Termination, 35 
Real Estate Economics 2, 233 (2007) (reporting that 49% of subprime 
refinance loans involve equity extraction, compared with 26% of 
prime refinance loans); Marsha J. Courchane, Brian J. Surette, and 
Peter M. Zorn, Subprime Borrowers: Mortgage Transitions and Outcomes 
(Subprime Outcomes), 29 J. of Real Estate Economics 4, 368-371 
(2004) (discussing survey evidence that borrowers with subprime 
loans are more likely to have experienced major adverse life events 
(marital disruption; major medical problem; major spell of 
unemployment; major decrease of income) and often use refinancing 
for debt consolidation or home equity extraction); Subprime Lending 
Investigation, at 551-552 (citing survey evidence that borrowers 
with subprime loans have increased incidence of major medical 
expenses, major unemployment spells, and major drops in income).
    \10\ A ``cash out'' transaction is one in which the borrower 
refinances an existing mortgage, and the new mortgage amount is 
greater than the existing mortgage amount, to allow the borrower to 
extract from the home. Figure calculated from First American 
LoanPerformance data.
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    While shopping costs are likely clear, the benefits may not be 
obvious or may appear minimal. Without easy access to subprime product 
prices, a consumer may have only a limited idea after working with one 
originator whether further shopping is likely to produce a better deal. 
Moreover, consumers in the subprime market have reported in studies 
that they were turned down by several lenders before being 
approved.\11\ Once approved, these consumers may see little advantage 
to continuing to shop for better terms if they expect to be turned down 
by other originators. Further, if a consumer uses a broker believing 
that the broker is shopping for the consumer for the best deal, the 
consumer may believe a better deal is not obtainable. An unscrupulous 
originator may also seek to discourage a consumer from shopping by 
intentionally understating the cost of an offered loan. For all of 
these reasons, borrowers in the subprime market may not shop beyond the 
first approval and may be willing to accept unfavorable terms.\12\
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    \11\ James M. Lacko and Janis K. Pappalardo, Federal Trade 
Commission, Improving Consumer Mortgage Disclosures: An Empirical 
Assessment of Current and Prototype Disclosure Forms at 24-26 
(2007), available at: http://www.ftc.gov/os/2007/06/P025505MortgageDisclosureReport.pdf (Improving Mortgage Disclosures) 
(reporting evidence based on qualitative consumer interviews); 
Subprime Lending Investigation at 550 (finding based on survey data 
that ``[p]robably the most significant hurdle overcome by subprime 
borrowers * * * is just getting approved for a loan for the first 
time. This impact might well make subprime borrowers more willing to 
accept less favorable terms as they become uncertain about the 
possibility of qualifying for a loan at all.'').
    \12\ Subprime Outcomes at 371-372 (reporting survey evidence 
that relative to prime borrowers, subprime borrowers are less 
knowledgeable about the mortgage process, search less for the best 
rates, and feel they have less choice about mortgage terms and 
conditions); Subprime Mortgage Investigation at 554 (``Our focus 
groups suggested that prime and subprime borrowers use quite 
different search criteria in looking for a loan. Subprime borrowers 
search primarily for loan approval and low monthly payments, while 
prime borrowers focus on getting the lowest available interest rate. 
These distinctions are quantitatively confirmed by our survey.'').
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    Limited focus. Consumers considering obtaining a typically complex 
subprime mortgage loan may simplify their decision by focusing on a few 
attributes of the product or service that seem most important.\13\ A 
consumer may focus on loan attributes that have the most obvious and 
immediate consequence such as loan amount, down payment, initial 
monthly payment, initial interest rate, and up-front fees (though up-
front fees may be more obscure when added to the loan amount, and 
``discount points'' in particular may be difficult for consumers to 
understand). These consumers, therefore, may not focus on terms that 
may seem less immediately important to them such as future increases in 
payment amounts or interest rates, prepayment penalties, and negative 
amortization. They are also not likely to focus on underwriting 
practices such as income verification, and on features such as escrows 
for future tax and insurance obligations.\14\ Consumers who do not 
fully understand such terms and features, however, are less able to 
appreciate their risks, which can be significant. For example, the 
payment may increase sharply and a prepayment penalty may hinder the 
consumer from

[[Page 44526]]

refinancing to avoid the payment increase. Thus, consumers may 
unwittingly accept loans that they will have difficulty repaying.
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    \13\ Jinkook Lee and Jeanne M. Hogarth, Consumer Information 
Search for Home Mortgages: Who, What, How Much, and What Else?, 
Financial Services Review 291 (2000) (Consumer Information Search) 
(``In all, there are dozens of features and costs disclosed per 
loan, far in excess of the combination of terms, lenders, and 
information sources consumers report using when shopping.'').
    \14\ Consumer Information Search at 285 (reporting survey 
evidence that most consumers compared interest rate or APR, loan 
type (fixed-rate or ARM), and mandatory up-front fees, but only a 
quarter considered the costs of optional products such as credit 
insurance and back-end costs such as late fees). There is evidence 
that borrowers are not aware of, or do not understand, terms of this 
nature even after they have obtained a loan. See Improving Mortgage 
Disclosures at 27-30 (discussing anecdotal evidence based on 
consumer interviews that borrowers were not aware of, did not 
understand, or misunderstood an important cost or feature of their 
loans that had substantial impact on the overall cost, the future 
payments, or the ability to refinance with other lenders); Brian 
Bucks and Karen Pence, Do Homeowners Know Their House Values and 
Mortgage Terms? 18-22 (Board Fin. and Econ. Discussion Series 
Working Paper No. 2006-3, 2006) (discussing statistical evidence 
that borrowers with ARMs underestimate annual as well as life-time 
caps on the interest rate; the rate of underestimation increases for 
lower-income and less-educated borrowers), available at http://www.federalreserve.gov/pubs/feds/2006/200603/200603pap.pdf.
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    Limits of disclosure. Disclosures describing the multiplicity of 
features of a complex loan could help some consumers in the subprime 
market, but may not be sufficient to protect them against unfair loan 
terms or lending practices. Obtaining widespread consumer understanding 
of the many potentially significant features of a typical subprime 
product is a major challenge.\15\ If consumers do not have a certain 
minimum level understanding of the market and products, disclosures for 
complex and infrequent transactions may not effectively provide that 
minimum understanding. Moreover, even if all of a loan's features are 
disclosed clearly to consumers, they may continue to focus on a few 
features that appear most significant. Alternatively, disclosing all 
features may ``overload'' consumers and make it more difficult for them 
to discern which features are most important.
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    \15\ Improving Mortgage Disclosures at 74-76 (finding that 
borrowers in the subprime market may have more difficulty 
understanding their loan terms because their loans are more complex 
than loans in the prime market).
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    Moreover, consumers may rely more on their originators to explain 
the disclosures when the transaction is complex; some originators may 
have incentives to misrepresent the disclosures so as to obscure the 
transaction's risks to the consumer; and such misrepresentations may be 
particularly effective if the originator is face-to-face with the 
consumer.\16\ Therefore, while the Board anticipates proposing changes 
to Regulation Z to improve mortgage loan disclosures, it is unlikely 
that better disclosures, alone, will address adequately the risk of 
abusive or unaffordable loans in the subprime market.
---------------------------------------------------------------------------

    \16\ U.S. Gen. Accounting Office, GAO 04-280, Consumer 
Protection: Federal and State Agencies Face Challenges in Combating 
Predatory Lending 97-98 (2004) (stating that the inherent complexity 
of mortgage loans, some borrowers' lack of financial sophistication, 
education, or infirmities, and misleading statements and actions by 
lenders and brokers limit the effectiveness of even clear and 
transparent disclosures).
---------------------------------------------------------------------------

Misaligned Incentives and Obstacles to Monitoring
    Not only are consumers in the subprime market often unable to 
protect themselves from abusive or unaffordable loans, originators may 
at certain times be more likely to extend unaffordable loans. The 
recent sharp rise in serious delinquencies on subprime mortgages has 
made clear that originators were not adequately assessing repayment 
ability, particularly where mortgages were sold to the secondary market 
and the originator retained little of the risk. The growth of the 
secondary market gave lenders--and, thus, mortgage borrowers--greater 
access to capital markets, lowered transaction costs, and allowed risk 
to be shared more widely. This ``originate-to-distribute'' model, 
however, has also contributed to the loosening of underwriting 
standards, particularly during periods of rapid house price 
appreciation, which may mask problems by keeping default and 
delinquency rates low until price appreciation slows or reverses.\17\
---------------------------------------------------------------------------

    \17\ Atif Mian and Amir Sufi, The Consequences of Mortgage 
Credit Expansion: Evidence from the 2007 Mortgage Default Crisis 
(May 2008), available at: http://ssrn.com/abstract=1072304.
---------------------------------------------------------------------------

    This potential tendency has several related causes. First, when an 
originator sells a mortgage and its servicing rights, depending on the 
terms of the sale, most or all of the risks typically are passed on to 
the loan purchaser. Thus, originators that sell loans may have less of 
an incentive to undertake careful underwriting than if they kept the 
loans. Second, warranties by sellers to purchasers and other 
``repurchase'' contractual provisions have little meaningful benefit if 
originators have limited assets. Third, fees for some loan originators 
have been tied to loan volume, making loan sales--sometimes 
accomplished through aggressive ``push marketing''--a higher priority 
than loan quality for some originators. Fourth, investors may not 
exercise adequate due diligence on mortgages in the pools in which they 
are invested, and may instead rely heavily on credit-ratings firms to 
determine the quality of the investment.\18\
---------------------------------------------------------------------------

    \18\ Benjamin J. Keys, Tanmoy K. Mukherjee, Amit Seru and Vikram 
Vig, Did Securitization Lead to Lax Screening? Evidence from Suprime 
Loans at 22, available at: http://ssrn.com/abstract=1093137.
---------------------------------------------------------------------------

    Fragmentation in the originator market can further exacerbate the 
problem. Data reported under the Home Mortgage Disclosure Act (HMDA) 
show that independent mortgage companies--those not related to 
depository institutions or their subsidiaries or affiliates--in 2005 
and 2006 made nearly one-half of first-lien mortgage loans reportable 
as being higher-priced but only one-fourth of loans that were not 
reportable as higher-priced. Nor was lending by independent mortgage 
companies particularly concentrated: In each of 2005 and 2006 around 
150 independent mortgage companies made 500 or more first-lien mortgage 
loans on owner-occupied dwellings that were reportable as higher-
priced. In addition, as noted earlier, one source suggests that 60 
percent or more of mortgages originated in the last several years were 
originated through mortgage brokers.\19\ This same source estimates the 
number of brokerage companies at over 50,000 in recent years.
---------------------------------------------------------------------------

    \19\ Data reported by Wholesale Access Mortgage Research and 
Consulting, Inc., available at http://www.wholesaleaccess.com.
---------------------------------------------------------------------------

    Thus, a securitized pool of mortgages may have been sourced by tens 
of lenders and thousands of brokers. Investors have limited ability to 
directly monitor these originators' activities. Further, government 
oversight of such a fragmented market faces significant challenges 
because originators operate in different states and under different 
regulatory and supervisory regimes and different practices in sharing 
information among regulators. These circumstances may inhibit the 
ability of regulators to protect consumers from abusive and 
unaffordable loans.
A Role for New HOEPA Rules
    As explained above, consumers in the subprime market face serious 
constraints on their ability to protect themselves from abusive or 
unaffordable loans, even with the best disclosures; originators 
themselves may at times lack sufficient market incentives to ensure 
loans they originate are affordable; and regulators face limits on 
their ability to oversee a fragmented subprime origination market. 
These circumstances warrant imposing a new national legal standard on 
subprime lenders to help ensure that consumers receive mortgage loans 
they can afford to repay, and help prevent the equity-stripping abuses 
that unaffordable loans facilitate. Adopting this standard under 
authority of HOEPA ensures that it is applied uniformly to all 
originators and provides consumers an opportunity to redress wrongs 
through civil actions to the extent authorized by TILA. As explained in 
the next part, substantial information supplied to the Board through 
several public hearings confirms the need for new HOEPA rules.

III. The Board's HOEPA Hearings

A. Home Ownership and Equity Protection Act (HOEPA)

    The Board has recently held extensive public hearings on consumer 
protection issues in the mortgage market, including the subprime 
sector. These hearings were held pursuant to the Home Ownership and 
Equity Protection Act (HOEPA), which directs the Board to hold public 
hearings periodically on the home equity lending market and the 
adequacy of existing law for protecting

[[Page 44527]]

the interests of consumers, particularly low income consumers. HOEPA 
imposes substantive restrictions, and special pre-closing disclosures, 
on particularly high-cost refinancings and home equity loans (``HOEPA 
loans'').\20\ These restrictions include limitations on prepayment 
penalties and ``balloon payment'' loans, and prohibitions of negative 
amortization and of engaging in a pattern or practice of lending based 
on the collateral without regard to repayment ability.
---------------------------------------------------------------------------

    \20\ HOEPA loans are closed-end, non-purchase money mortgages 
secured by a consumer's principal dwelling (other than a reverse 
mortgage) where either: (a) The APR at consummation will exceed the 
yield on Treasury securities of comparable maturity by more than 8 
percentage points for first-lien loans, or 10 percentage points for 
subordinate-lien loans; or (b) the total points and fees payable by 
the consumer at or before closing exceed the greater of 8 percent of 
the total loan amount, or $547 for 2007 (adjusted annually).
---------------------------------------------------------------------------

    When it enacted HOEPA, Congress granted the Board authority, 
codified in TILA Section 129(l), to create exemptions to HOEPA's 
restrictions and to expand its protections. 15 U.S.C. 1639(l). Under 
TILA Section 129(l)(1), the Board may create exemptions to HOEPA's 
restrictions as needed to keep responsible credit available; and under 
TILA Section 129(l)(2), the Board may adopt new or expanded 
restrictions as needed to protect consumers from unfairness, deception, 
or evasion of HOEPA. In HOEPA Section 158, Congress directed the Board 
to monitor changes in the home equity market through regular public 
hearings.
    Hearings the Board held in 2000 led the Board to expand HOEPA's 
protections in December 2001.\21\ Those rules, which took effect in 
2002, lowered HOEPA's rate trigger, expanded its fee trigger to include 
single-premium credit insurance, added an anti-``flipping'' 
restriction, and improved the special pre-closing disclosure.
---------------------------------------------------------------------------

    \21\ Truth in Lending, 66 FR 65604, 65608, Dec. 20, 2001.
---------------------------------------------------------------------------

B. Summary of 2006 Hearings

    In the summer of 2006, the Board held four hearings in four cities 
on three broad topics: (1) The impact of the 2002 HOEPA rule changes on 
predatory lending practices, as well as the effects on consumers of 
state and local predatory lending laws; (2) nontraditional mortgage 
products and reverse mortgages; and (3) informed consumer choice in the 
subprime market. Hearing panelists included mortgage lenders and 
brokers, credit ratings agencies, real estate agents, consumer 
advocates, community development groups, housing counselors, 
academicians, researchers, and state and federal government officials. 
In addition, consumers, housing counselors, brokers, and other 
individuals made brief statements at the hearings during an ``open 
mike'' period. In all, 67 individuals testified on panels and 54 
comment letters were submitted to the Board.
    Consumer advocates and some state officials stated that HOEPA is 
generally effective in preventing abusive terms in loans subject to the 
HOEPA price triggers. They noted, however, that very few loans are made 
with rates or fees at or above the HOEPA triggers, and some advocated 
that Congress lower them. Consumer advocates and state officials also 
urged regulators and Congress to curb abusive practices in the 
origination of loans that do not meet HOEPA's price triggers.
    Consumer advocates identified several particular areas of concern. 
They urged the Board to prohibit or restrict certain loan features or 
terms, such as prepayment penalties, and underwriting practices such as 
``stated income'' or ``low documentation'' (``low doc'') loans for 
which the borrower's income is not documented or verified. They also 
expressed concern about aggressive marketing practices such as steering 
borrowers to higher-cost loans by emphasizing initial low monthly 
payments based on an introductory rate without adequately explaining 
that the consumer will owe considerably higher monthly payments after 
the introductory rate expires.
    Some consumer advocates stated that brokers and lenders should be 
held to a duty of care such as a duty of good faith and fair dealing or 
a duty to make only loans suitable for the borrower. These advocates 
also urged the Board to ban ``yield spread premiums,'' payments that 
brokers receive from the lender at closing for delivering a loan with 
an interest rate that is higher than the lender's ``buy rate,'' because 
they provide brokers an incentive to increase consumers' interest 
rates. They argued that such steps would align reality with consumers' 
perceptions that brokers serve their best interests. Consumer advocates 
also expressed concerns that brokers, lenders, and others may coerce 
appraisers to misrepresent the value of a dwelling; and that servicers 
may charge consumers unwarranted fees and in some cases make it 
difficult for consumers who are in default to avoid foreclosure.
    Industry panelists and commenters, on the other hand, expressed 
concern that state predatory lending laws may reduce the availability 
of credit for some subprime borrowers. Most industry commenters opposed 
prohibiting stated income loans, prepayment penalties, or other loan 
terms, asserting that this approach would harm borrowers more than help 
them. They urged the Board and other regulators to focus instead on 
enforcing existing laws to remove ``bad actors'' from the market. Some 
lenders indicated, however, that restrictions on certain features or 
practices might be appropriate if the restrictions were clear and 
narrow. Industry commenters also stated that subjective suitability 
standards would create uncertainties for brokers and lenders and 
subject them to excessive litigation risk.

C. Summary of June 2007 Hearing

    In light of the information received at the 2006 hearings and the 
rise in defaults that began soon after, the Board held an additional 
hearing in June 2007 to explore how it could use its authority under 
HOEPA to prevent abusive lending practices in the subprime market while 
still preserving responsible subprime lending. The Board focused the 
hearing on four specific areas: Lenders' determination of borrowers' 
repayment ability; ``stated income'' and ``low doc'' lending; the lack 
of escrows in the subprime market relative to the prime market; and the 
high frequency of prepayment penalties in the subprime market.
    At the hearing, the Board heard from 16 panelists representing 
consumers, mortgage lenders, mortgage brokers, and state government 
officials, as well as from academicians. The Board also received almost 
100 written comments after the hearing from an equally diverse group.
    Industry representatives acknowledged concerns with recent lending 
practices but urged the Board to address most of these concerns through 
supervisory guidance rather than regulations under HOEPA. They 
maintained that supervisory guidance, unlike regulation, is flexible 
enough to preserve access to responsible credit. They also suggested 
that supervisory guidance issued recently regarding nontraditional 
mortgages and subprime lending, as well as market self-correction, have 
reduced the need for new regulations. Industry representatives support 
improving mortgage disclosures to help consumers avoid abusive loans. 
They urged that any substantive rules adopted by the Board be clearly 
drawn to limit uncertainty and narrowly drawn to avoid unduly 
restricting credit.
    In contrast, consumer advocates, state and local officials, and 
Members of Congress urged the Board to adopt regulations under HOEPA. 
They acknowledged a proper place for

[[Page 44528]]

guidance but contended that recent problems indicate the need for 
requirements enforceable by borrowers through civil actions, which 
HOEPA enables and guidance does not. They also expressed concern that 
less responsible, less closely supervised lenders are not subject to 
the guidance and that there is limited enforcement of existing laws for 
these entities. Consumer advocates and others welcomed improved 
disclosures but insisted they would not prevent abusive lending. More 
detailed accounts of the testimony and letters are provided below in 
the context of specific issues the Board is addressing in these final 
rules.

D. Congressional Hearings

    Congress has also held a number of hearings in the past year about 
consumer protection concerns in the mortgage market.\22\ In these 
hearings, Congress has heard testimony from individual consumers, 
representatives of consumer and community groups, representatives of 
financial and mortgage industry groups and federal and state officials. 
These hearings have focused on rising subprime foreclosure rates and 
the extent to which lending practices have contributed to them.
---------------------------------------------------------------------------

    \22\ E.g., Foreclosure Problems and Solutions: Federal, State, 
and Local Efforts to Address the Foreclosure Crisis in Ohio: Hearing 
before the Subcomm. on Housing and Comm. Oppty. of the H. Comm. on 
Fin. Servs., 110th Cong. (2008); Targeting Federal Aid to 
Neighborhoods Distressed by the Subprime Mortgage Crisis: Hearing 
before the Subcomm. on Housing and Comm. Oppty. of the H. Comm. on 
Fin. Servs., 110th Cong. (2008); Improving Consumer Protections in 
Subprime Lending: Hearing before the Subcomm. on Int. Comm., Trade, 
and Tourism of the S. Comm. on Comm., Sci., and Trans., 110th Cong. 
(2008); H.R. 5679, The Foreclosure Prevention and Sound Mortgage 
Servicing Act of 2008: Hearing before the Subcomm. on Housing and 
Comm. Oppty. of the H. Comm. on Fin. Servs., 110th Cong. (2008); 
Restoring the American Dream: Solutions to Predatory Lending and the 
Foreclosure Crisis: S. Comm. on Banking, Hsg., and Urban Affairs, 
110th Cong. (2008); Consumer Protection in Financial Services: 
Subprime Lending and Other Financial Activities: Hearing before the 
Subcomm. on Fin. Svcs. and Gen. Gov't of the H. Approp. Comm., 110th 
Cong. (2008); Progress in Administration and Other Efforts to 
Coordinate and Enhance Mortgage Foreclosure Prevention: Hearing 
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Legislative 
Proposals on Reforming Mortgage Practices: Hearing before the H. 
Comm. on Fin. Servs., 110th Cong. (2007); Legislative and Regulatory 
Options for Minimizing and Mitigating Mortgage Foreclosures: Hearing 
before the H. Comm. on Fin. Servs., 110th Cong. (2007); Ending 
Mortgage Abuse: Safeguarding Homebuyers: Hearing before the S. 
Subcomm. on Hous., Transp., and Cmty. Dev. of the S. Comm. on 
Banking, Hous., and Urban Affairs, 110th Cong. (2007); Improving 
Federal Consumer Protection in Financial Services: Hearing before 
the H. Comm. on Fin. Servs., 110th Cong. (2007).
---------------------------------------------------------------------------

    Consumer and community group representatives testified that certain 
lending terms or practices, such as hybrid adjustable-rate mortgages, 
prepayment penalties, low or no documentation loans, lack of escrows 
for taxes and insurance, and failure to consider the consumer's ability 
to repay have contributed to foreclosures. In addition, these witnesses 
testified that consumers often believe that mortgage brokers represent 
their interests and shop on their behalf for the best loan terms. As a 
result, they argue that consumers do not shop independently to ensure 
that they are getting the best terms for which they qualify. They also 
testified that, because originators sell most loans into the secondary 
market and do not share the risk of default, brokers and lenders have 
less incentive to ensure consumers can afford their loans.
    Financial services and mortgage industry representatives testified 
that consumers need better disclosures of their loan terms, but that 
substantive restrictions on subprime loan terms would risk reducing 
access to credit for some borrowers. In addition, these witnesses 
testified that applying a fiduciary duty to the subprime market, such 
as requiring that a loan be in the borrower's best interest, would 
introduce subjective standards that would significantly increase 
compliance and litigation risk. According to these witnesses, some 
lenders would be less willing to offer loans in the subprime market, 
making it harder for some consumers to get loans.

IV. Interagency Supervisory Guidance

    In December 2005, the Board and the other federal banking agencies 
responded to concerns about the rapid growth of nontraditional 
mortgages in the previous two years by proposing supervisory guidance. 
Nontraditional mortgages are mortgages that allow the borrower to defer 
repayment of principal and sometimes interest. The guidance advised 
institutions of the need to reduce ``risk layering'' practices with 
respect to these products, such as failing to document income or 
lending nearly the full appraised value of the home. The proposal, and 
the final guidance issued in September 2006, specifically advised 
lenders that layering risks in nontraditional mortgage loans to 
subprime borrowers may significantly increase risks to borrowers as 
well as institutions.\23\
---------------------------------------------------------------------------

    \23\ Interagency Guidance on Nontraditional Mortgage Product 
Risks, 71 FR 58609, Oct. 4, 2006 (Nontraditional Mortgage Guidance).
---------------------------------------------------------------------------

    The Board and the other federal banking agencies addressed concerns 
about the subprime market more broadly in March 2007 with a proposal 
addressing the heightened risks to consumers and institutions of ARMs 
with two or three-year ``teaser'' rates followed by substantial 
increases in the rate and payment. The guidance, finalized in June 
2007, sets out the standards institutions should follow to ensure 
borrowers in the subprime market obtain loans they can afford to 
repay.\24\ Among other steps, the guidance advises lenders to (1) use 
the fully-indexed rate and fully-amortizing payment when qualifying 
borrowers for loans with adjustable rates and potentially non-
amortizing payments; (2) limit stated income and reduced documentation 
loans to cases where mitigating factors clearly minimize the need for 
full documentation of income; (3) provide that prepayment penalty 
clauses expire a reasonable period before reset, typically at least 60 
days.
---------------------------------------------------------------------------

    \24\ Statement on Subprime Mortgage Lending, 72 FR 37569, Jul. 
10, 2007 (Subprime Statement).
---------------------------------------------------------------------------

    The Conference of State Bank Supervisors (CSBS) and American 
Association of Residential Mortgage Regulators (AARMR) issued parallel 
statements for state supervisors to use with state-supervised entities, 
and many states have adopted the statements.
    The guidance issued by the federal banking agencies has helped to 
promote safety and soundness and protect consumers in the subprime 
market. Guidance, however, is not necessarily implemented uniformly by 
all originators. Originators who are not subject to routine examination 
and supervision may not adhere to guidance as closely as originators 
who are. Guidance also does not provide individual consumers who have 
suffered harm because of abusive lending practices an opportunity for 
redress. The new and expanded consumer protections that the Board is 
adopting apply uniformly to all creditors and are enforceable by 
federal and state supervisory and enforcement agencies and in many 
cases by borrowers.

V. Legal Authority

A. The Board's Authority Under TILA Section 129(l)(2)

    The substantive limitations in new Sec. Sec.  226.35 and 226.36 and 
corresponding revisions to Sec. Sec.  226.32 and 226.34, as well as 
restrictions on misleading and deceptive advertisements, are based on 
the Board's authority under TILA Section 129(l)(2), 15 U.S.C. 
1639(l)(2). That provision gives the Board authority to prohibit acts 
or practices in connection with:

[[Page 44529]]

     Mortgage loans that the Board finds to be unfair, 
deceptive, or designed to evade the provisions of HOEPA; and
     Refinancing of mortgage loans that the Board finds to be 
associated with abusive lending practices or that are otherwise not in 
the interest of the borrower.
    The authority granted to the Board under TILA Section 129(l)(2), 15 
U.S.C. 1639(l)(2), is broad. It reaches mortgage loans with rates and 
fees that do not meet HOEPA's rate or fee trigger in TILA Section 
103(aa), 15 U.S.C. 1602(aa), as well as types of mortgage loans not 
covered under that section, such as home purchase loans. Section 
129(l)(2) also authorizes the Board to strengthen the protections in 
Section 129 (c)-(i) for the loans to which Section 103(aa) applies 
these protections (HOEPA loans). In TILA Section 129 (c)-(i), Congress 
set minimum standards for HOEPA loans. The Board is authorized to 
strengthen those standards for HOEPA loans when the Board finds 
practices unfair, deceptive, or abusive. The Board is also authorized 
by Section 129(l)(2) to apply those strengthened standards to loans 
that are not HOEPA loans. Moreover, while HOEPA's statutory 
restrictions apply only to creditors and only to loan terms or lending 
practices, Section 129(l)(2) is not limited to acts or practices by 
creditors, nor is it limited to loan terms or lending practices. See 15 
U.S.C. 1639(l)(2). It authorizes protections against unfair or 
deceptive practices when such practices are ``in connection with 
mortgage loans,'' and it authorizes protections against abusive 
practices ``in connection with refinancing of mortgage loans.'' Thus, 
the Board's authority is not limited to regulating specific contractual 
terms of mortgage loan agreements; it extends to regulating loan-
related practices generally, within the standards set forth in the 
statute.
    HOEPA does not set forth a standard for what is unfair or 
deceptive, but the Conference Report for HOEPA indicates that, in 
determining whether a practice in connection with mortgage loans is 
unfair or deceptive, the Board should look to the standards employed 
for interpreting state unfair and deceptive trade practices statutes 
and the Federal Trade Commission Act (FTC Act), Section 5(a), 15 U.S.C. 
45(a).\25\
---------------------------------------------------------------------------

    \25\ H.R. Rep. 103-652, at 162 (1994) (Conf. Rep.).
---------------------------------------------------------------------------

    Congress has codified standards developed by the Federal Trade 
Commission (FTC) for determining whether acts or practices are unfair 
under Section 5(a), 15 U.S.C. 45(a).\26\ Under the FTC Act, an act or 
practice is unfair when it causes or is likely to cause substantial 
injury to consumers which is not reasonably avoidable by consumers 
themselves and not outweighed by countervailing benefits to consumers 
or to competition. In addition, in determining whether an act or 
practice is unfair, the FTC is permitted to consider established public 
policies, but public policy considerations may not serve as the primary 
basis for an unfairness determination.\27\
---------------------------------------------------------------------------

    \26\ See 15 U.S.C. 45(n); Letter from FTC to the Hon. Wendell H. 
Ford and the Hon. John C. Danforth (Dec. 17, 1980).
    \27\ 15 U.S.C. 45(n).
---------------------------------------------------------------------------

    The FTC has interpreted these standards to mean that consumer 
injury is the central focus of any inquiry regarding unfairness.\28\ 
Consumer injury may be substantial if it imposes a small harm on a 
large number of consumers, or if it raises a significant risk of 
concrete harm.\29\ The FTC looks to whether an act or practice is 
injurious in its net effects.\30\ The agency has also observed that an 
unfair act or practice will almost always reflect a market failure or 
market imperfection that prevents the forces of supply and demand from 
maximizing benefits and minimizing costs.\31\ In evaluating unfairness, 
the FTC looks to whether consumers' free market decisions are 
unjustifiably hindered.\32\
---------------------------------------------------------------------------

    \28\ Statement of Basis and Purpose and Regulatory Analysis, 
Credit Practices Rule, 42 FR 7740, 7743, March 1, 1984 (Credit 
Practices Rule).
    \29\ Letter from Commissioners of the FTC to the Hon. Wendell H. 
Ford, Chairman, and the Hon. John C. Danforth, Ranking Minority 
Member, Consumer Subcomm. of the H. Comm. on Commerce, Science, and 
Transp., n.12 (Dec. 17, 1980).
    \30\ Credit Practices Rule, 42 FR at 7744.
    \31\ Id.
    \32\ Id.
---------------------------------------------------------------------------

    The FTC has also adopted standards for determining whether an act 
or practice is deceptive (though these standards, unlike unfairness 
standards, have not been incorporated into the FTC Act).\33\ First, 
there must be a representation, omission or practice that is likely to 
mislead the consumer. Second, the act or practice is examined from the 
perspective of a consumer acting reasonably in the circumstances. 
Third, the representation, omission, or practice must be material. That 
is, it must be likely to affect the consumer's conduct or decision with 
regard to a product or service.\34\
---------------------------------------------------------------------------

    \33\ Letter from James C. Miller III, Chairman, FTC to the Hon. 
John D. Dingell, Chairman, H. Comm. on Energy and Commerce (Oct. 14, 
1983) (Dingell Letter).
    \34\ Dingell Letter at 1-2.
---------------------------------------------------------------------------

    Many states also have adopted statutes prohibiting unfair or 
deceptive acts or practices, and these statutes employ a variety of 
standards, many of them different from the standards currently applied 
to the FTC Act. A number of states follow an unfairness standard 
formerly used by the FTC. Under this standard, an act or practice is 
unfair where it offends public policy; or is immoral, unethical, 
oppressive, or unscrupulous; and causes substantial injury to 
consumers.\35\
---------------------------------------------------------------------------

    \35\ See, e.g., Kenai Chrysler Ctr., Inc. v. Denison, 167 P.3d 
1240, 1255 (Alaska 2007) (quoting FTC v. Sperry & Hutchinson Co., 
405 U.S. 233, 244-45 n.5 (1972)); State v. Moran, 151 N.H. 450, 452, 
861 A.2d 763, 755-56 (N.H. 2004) (concurrently applying the FTC's 
former test and a test under which an act or practice is unfair or 
deceptive if ``the objectionable conduct * * * attain[s] a level of 
rascality that would raise an eyebrow of someone inured to the rough 
and tumble of the world of commerce.'') (citation omitted); Robinson 
v. Toyota Motor Credit Corp., 201 Ill. 2d 403, 417-418, 775 N.E.2d 
951, 961-62 (2002) (quoting 405 U.S. at 244-45 n.5).
---------------------------------------------------------------------------

    In adopting final rules under TILA Section 129(l)(2)(A), 15 U.S.C. 
1639(l)(2)(A), the Board has considered the standards currently applied 
to the FTC Act's prohibition against unfair or deceptive acts or 
practices, as well as the standards applied to similar state statutes.

B. The Board's Authority Under TILA Section 105(a)

    Other aspects of these rules are based on the Board's general 
authority under TILA Section 105(a) to prescribe regulations necessary 
or proper to carry out TILA's purposes 15 U.S.C. 1604(a). This section 
is the basis for the requirement to provide early disclosures for 
residential mortgage transactions as well as many of the revisions to 
improve advertising disclosures. These rules are intended to carry out 
TILA's purposes of informing consumers about their credit terms and 
helping them shop for credit. See TILA Section 102, 15 U.S.C. 1603.

VI. The Board's Proposal

    On January 9, 2008, the Board published a notice of proposed 
rulemaking in the Federal Register (73 FR 1672) proposing to amend 
Regulation Z.

A. Proposals To Prevent Unfairness, Deception, and Abuse

    The Board proposed new restrictions and requirements for mortgage 
lending and servicing intended to protect consumers against unfairness, 
deception, and abuse while preserving responsible lending and 
sustainable homeownership. Some of the proposed restrictions would 
apply only to higher-priced mortgage loans, while others

[[Page 44530]]

would apply to all mortgage loans secured by a consumer's principal 
dwelling.
Protections Covering Higher-Priced Mortgage Loans
    The Board proposed certain protections for consumers receiving 
higher-priced mortgage loans. Higher-priced mortgage loans would have 
been loans with an annual percentage rate (APR) that exceeds the 
comparable Treasury security by three or more percentage points for 
first-lien loans, or five or more percentage points for subordinate-
lien loans. For such loans, the Board proposed to:
    [cir] Prohibit creditors from engaging in a pattern or practice of 
extending credit without regard to borrowers' ability to repay from 
sources other than the collateral itself;
    [cir] Require creditors to verify income and assets they rely upon 
in making loans;
    [cir] Prohibit prepayment penalties unless certain conditions are 
met; and
    [cir] Require creditors to establish escrow accounts for taxes and 
insurance, but permit creditors to allow borrowers to opt out of 
escrows 12 months after loan consummation.
    In addition, the proposal would have prohibited creditors from 
structuring closed-end mortgage loans as open-end lines of credit for 
the purpose of evading these rules, which do not apply to lines of 
credit.
Proposed Protections Covering Closed-End Loans Secured by Consumer's 
Principal Dwelling
    In addition, in connection with all consumer-purpose, closed-end 
loans secured by a consumer's principal dwelling, the Board proposed 
to:
    [cir] Prohibit creditors from paying a mortgage broker more than 
the consumer had agreed in advance that the broker would receive;
    [cir] Prohibit any creditor or mortgage broker from coercing, 
influencing, or otherwise encouraging an appraiser to provide a 
misstated appraisal in connection with a mortgage loan; and
    [cir] Prohibit mortgage servicers from ``pyramiding'' late fees, 
failing to credit payments as of the date of receipt, failing to 
provide loan payoff statements upon request within a reasonable time, 
or failing to deliver a fee schedule to a consumer upon request.

B. Proposals To Improve Mortgage Advertising

    Another goal of the Board's proposal was to ensure that mortgage 
loan advertisements provide accurate and balanced information and do 
not contain misleading or deceptive representations. The Board proposed 
to require that advertisements for both open-end and closed-end 
mortgage loans provide accurate and balanced information, in a clear 
and conspicuous manner, about rates, monthly payments, and other loan 
features. The proposal was issued under the Board's authorities to: 
Adopt regulations to ensure consumers are informed about and can shop 
for credit; require that information, including the information 
required for advertisements for closed-end credit, be disclosed in a 
clear and conspicuous manner; and regulate advertisements of open-end 
home-equity plans secured by the consumer's principal dwelling. See 
TILA Section 105(a), 15 U.S.C. 1604(a); Section 122, 15 U.S.C. 1632; 
Section 144, 15 U.S.C. 1664; Section 147, 15 U.S.C. 1665b.
    The Board also proposed, under TILA Section 129(l)(2), 15 U.S.C. 
1639(l)(2), to prohibit the following seven deceptive or misleading 
practices in advertisements for closed-end mortgage loans:
    [cir] Advertising ``fixed'' rates or payments for loans whose rates 
or payments can vary without adequately disclosing that the interest 
rate or payment amounts are ``fixed'' only for a limited period of 
time, rather than for the full term of the loan;
    [cir] Comparing an actual or hypothetical consumer's rate or 
payment obligations and the rates or payments that would apply if the 
consumer obtains the advertised product unless the advertisement states 
the rates or payments that will apply over the full term of the loan;
    [cir] Advertisements that characterize the products offered as 
``government loan programs,'' ``government-supported loans,'' or 
otherwise endorsed or sponsored by a federal or state government entity 
even though the advertised products are not government-supported or -
sponsored loans;
    [cir] Advertisements, such as solicitation letters, that display 
the name of the consumer's current mortgage lender, unless the 
advertisement also prominently discloses that the advertisement is from 
a mortgage lender not affiliated with the consumer's current lender;
    [cir] Advertising claims of debt elimination if the product 
advertised would merely replace one debt obligation with another;
    [cir] Advertisements that create a false impression that the 
mortgage broker or lender has a fiduciary relationship with the 
consumer; and
    [cir] Foreign-language advertisements in which certain information, 
such as a low introductory ``teaser'' rate, is provided in a foreign 
language, while required disclosures are provided only in English.

C. Proposal To Give Consumers Disclosures Early

    A third goal of the proposal was to provide consumers transaction-
specific disclosures early enough to use while shopping for a mortgage 
loan. The Board proposed to require creditors to provide transaction-
specific mortgage loan disclosures such as the APR and payment schedule 
for all home-secured, closed-end loans no later than three business 
days after application, and before the consumer pays any fee except a 
reasonable fee for the originator's review of the consumer's credit 
history.

VII. Overview of Comments Received

    The Board received approximately 4700 comments on the proposal. The 
comments came from community banks, independent mortgage companies, 
large bank holding companies, secondary market participants, credit 
unions, state and national trade associations for financial 
institutions in the mortgage business, mortgage brokers and mortgage 
broker trade associations, realtors and realtor trade associations, 
individual consumers, local and national community groups, federal and 
state regulators and elected officials, appraisers, academics, and 
other interested parties.
    Commenters generally supported the Board's effort to protect 
consumers from unfair practices, particularly in the subprime market, 
while preserving responsible lending and sustainable homeownership. 
However, industry commenters generally opposed the breadth of the 
proposal; favoring narrower and more flexible rules. They also 
expressed concerns about the costs of certain proposals, such as the 
requirement to establish escrows for all first-lien higher-priced 
mortgage loans. Consumer advocates, federal and state regulators 
(including the Federal Deposit Insurance Corporation (FDIC)), and 
elected officials (including members of Congress and some state 
attorneys general) supported the proposal as addressing some of the 
abuses in the subprime market, but argued that additional consumer 
protections are needed.
    Many commenters supported the approach of using loan price to 
identify ``higher-priced'' loans. Financial institution commenters and 
their trade associations were concerned, however, that the proposed 
price thresholds were too low, and could capture many prime loans. They 
contended that broad

[[Page 44531]]

coverage would reduce credit availability because creditors would 
refrain from making covered loans or would pass on compliance costs. 
Many industry commenters urged the Board to use a different index to 
define higher-priced mortgage loans than the proposed index of Treasury 
security yields, because the spread between Treasury yields and 
mortgage rates can change. Consumer advocate commenters generally, but 
not uniformly, favored applying the Board's proposed protections to all 
loans secured by a principal dwelling regardless of loan price. In the 
alternative, they favored the proposed price thresholds but urged the 
Board also to apply the protections to nontraditional mortgage loans.
    Industry commenters generally, but not uniformly, supported or did 
not oppose a rule prohibiting lenders from engaging in a pattern or 
practice of unaffordable lending. They urged the Board, however, to 
provide a clear and specific ``safe harbor'' and remove the 
presumptions of violations in order to avoid unduly constraining 
credit. In contrast, consumer advocate commenters and others urged the 
Board to revise the ability to repay rule so that it applies on a loan-
by-loan basis and not only to a pattern or practice of disregarding 
borrowers' ability to repay. These commenters argued that a requirement 
to prove a ``pattern or practice'' would prevent consumers from 
bringing claims and would weaken the rule's power to deter abuse.
    Consumer advocate commenters and some federal and state regulators 
and elected officials also maintained that a complete ban on prepayment 
penalties is necessary to protect consumers. In particular, many of 
these commenters argued that prepayment penalties' harms to subprime 
consumers outweigh the benefits of any reductions in interest rate 
consumers receive, and that the Board's proposed restrictions on 
prepayment penalties would not adequately address the harms. However, 
most banks and their trade associations stated that the interest rate 
benefit afforded to consumers with loans having prepayment penalty 
provisions lowers credit costs and increases credit availability.
    Many community banks and mortgage brokers as well as several 
industry trade associations opposed the proposed escrow requirement, 
contending that escrow infrastructures would be costly and that 
creditors would either refrain from making higher-priced loans or would 
pass costs on to consumers. Consumers also expressed concern that they 
would lose interest on their escrowed funds and that servicers would 
fail to properly pay tax and insurance obligations. Several industry 
trade associations, several large creditors and some mortgage brokers, 
consumer and community development groups, and state and federal 
officials, however, supported the proposed escrow requirement as 
protecting consumers from expensive force-placed insurance or default, 
and possibly foreclosure.
    For their part, mortgage brokers and their trade associations 
principally addressed the yield spread premium proposal, which they 
strongly opposed. They, as well as FTC staff, argued that prohibiting 
creditors from paying brokers more than the consumer agreed to in 
writing would put brokers at a competitive disadvantage relative to 
retail lenders. They also argued that consumers would be confused and 
misled by a broker compensation disclosure. Consumer advocates, several 
members of Congress, several state attorneys general, and the FDIC 
contended that the proposal would do little to protect consumers and 
urged the Board to ban yield spread premiums outright.
    Most commenters generally supported the Board's proposed 
advertising rules, although some commenters requested clarifications 
and modifications. Commenters were divided about the proposal to 
require early mortgage loan disclosures. Many creditors and their trade 
associations opposed the proposal because of perceived operational cost 
and compliance difficulties, and concerns about the scope of the fee 
restriction and its application to third party originators. Consumer 
groups, state regulators and enforcement generally supported the 
proposed rule, however, because it would make more information 
available to consumers when they are shopping for loans. Some of the 
commenters requested that the Board require lenders to redisclose 
before loan consummation to enhance the accuracy of information.
    Industry commenters urged the Board to adopt all of the proposed 
restrictions in Sec. Sec.  226.35 and 226.36 under its TILA Section 
105(a) authority rather than its Section 129(l)(2) authority. They 
argued that using Section 129(l)(2) authority would impose 
disproportionately heavy penalties on lenders for violations and 
unnecessary costs on consumers. Consumer advocates, on the other hand, 
supported using Section 129(l)(2) authority and urged the Board use it 
more broadly to adopt the other proposed rules concerning early 
disclosures and advertising.
    Public comments with respect to these and other provisions of the 
rule are described and discussed in more detail below.

VIII. Definition of ``Higher-Priced Mortgage Loan''--Sec.  226.35(a)

A. Overview

    The Board proposed to extend certain consumer protections to a 
subset of consumer residential mortgage loans referred to as ``higher-
priced mortgage loans.'' This part VIII discusses the definition of 
``higher-priced mortgage loan'' the Board is adopting. A discussion of 
the specific protections that apply to these loans follows in part IX. 
The Board is also finalizing the proposal to apply certain other 
restrictions to closed-end consumer mortgage loans secured by the 
consumer's principal dwelling without regard to loan price. These 
restrictions are discussed separately in part X.
    Under the proposal, higher-priced mortgage loans would be defined 
as consumer credit transactions secured by the consumer's principal 
dwelling for which the APR on the loan exceeds the yield on comparable 
Treasury securities by at least three percentage points for first-lien 
loans, or five percentage points for subordinate-lien loans. The 
proposed definition would include home purchase loans, refinancings, 
and home equity loans. The definition would exclude home equity lines 
of credit (``HELOCs''). There would also be exclusions for reverse 
mortgages, construction-only loans, and bridge loans.
    The Board is adopting a definition of ``higher-priced mortgage 
loan'' that is substantially similar to that proposed but different in 
the particulars. The changes to the final rule are being made in 
response to commenters' concerns. The final definition, like the 
proposed definition, sets a threshold above a measure of market rates 
to distinguish higher-priced mortgage loans from the rest of the 
mortgage market. But the measure the Board is adopting is different, 
and therefore so is the threshold. Instead of yields on Treasury 
securities, the definition uses average offer rates for the lowest-risk 
prime mortgages, termed ``average prime offer rates.'' For the 
foreseeable future, the Board will obtain or, as applicable, derive 
average prime offer rates from the Freddie Mac Primary Mortgage Market 
Survey[reg]. The threshold is set at 1.5 percentage points above the 
average prime offer rate on a comparable transaction for first-lien 
loans, and 3.5 percentage points for subordinate-lien loans. The 
exclusions from ``higher-priced mortgage loans'' for HELOCs and

[[Page 44532]]

certain other types of transactions are adopted as proposed.
    The definition of ``higher-priced mortgage loans'' appears in Sec.  
226.35(a). Such loans are subject to the restrictions and requirements 
in Sec.  226.35(b) concerning repayment ability, income verification, 
prepayment penalties, escrows, and evasion, except that only first-lien 
higher-priced mortgage loans are subject to the escrow requirement.

B. Public Comment on the Proposal

    Most industry commenters, a national consumer advocacy and research 
organization, and others supported the approach of using loan price to 
identify loans subject to stricter regulations. A large number and wide 
variety of these commenters, however, urged the Board to use a prime 
mortgage market rate instead of, or in addition to, Treasury yields to 
avoid arbitrary changes in coverage due to changes in the premium for 
mortgages over Treasuries or in the relationship between short-term and 
long-term Treasury yields. The precise recommendations are discussed in 
more detail in subpart D below. Industry commenters were particularly 
concerned that the threshold over the chosen index be set high enough 
to exclude the prime market. They maintained that the proposed 
thresholds of 300 and 500 basis points over Treasury yields would cover 
a significant part of the prime market and reduce credit availability.
    Consumer and civil rights group commenters generally, but not 
uniformly, opposed limiting protections to higher-priced mortgage loans 
and recommended applying these protections to all loans secured by a 
principal dwelling. They recommended in the alternative that the 
thresholds be adopted at the levels proposed, or even lower, and that 
nontraditional mortgage loans, which permit non-amortizing payments or 
negatively amortizing payments, be covered regardless of loan price. 
They believe the Nontraditional Mortgage Guidance is not adequate to 
protect consumers.
    The proposed exclusion of HELOCs drew criticism from several 
consumer and civil rights groups but strong support from industry 
commenters. The other proposed exclusions drew limited comment. Some 
industry commenters proposed additional exclusions for loans with 
federal guaranties such as FHA, VA, and Rural Housing Service. A few 
commenters also proposed excluding ``jumbo'' loans, that is, loans in 
an amount that exceeds the threshold of eligibility for purchase by 
Fannie Mae or Freddie Mac. Other proposed exclusions are discussed 
below.

C. General Approach

Cover Subprime, Exclude Prime
    The Board stated in connection with the proposal a general 
principle that new regulations should be applied as broadly as needed 
to protect consumers from actual or potential injury, but not so 
broadly that the costs, including the always-present risk of unintended 
consequences, would clearly outweigh the benefits. Consistent with this 
principle, the Board believes, as it stated in connection with the 
proposal, that the stricter regulations of Sec.  226.35 should cover 
the subprime market and generally exclude the prime market.
    The Board believes that the practices that Sec.  226.35 would 
prohibit--lending without regard to ability to pay from verified income 
and non-collateral assets, failure to establish an escrow for taxes and 
insurance, and prepayment penalties outside of prescribed limits--are 
so clearly injurious on balance to consumers within the subprime market 
that they should be categorically barred in that market. The reasons 
for this conclusion are detailed below in part IX with respect to each 
practice. Moreover, the Board has concluded that, to be effective, 
these prohibitions must cover the entire subprime market and not just 
subprime products with particular terms or features. Market 
imperfections discussed in part II--the subprime market's lack of 
transparency and potentially inadequate incentives for creditors to 
make only loans that consumers can repay--affect consumers throughout 
the subprime market. To be sure, risk within the subprime market has 
varied by loan type. For example, delinquencies on fixed-rate subprime 
mortgages have been lower in recent years than on adjustable-rate 
subprime mortgages. It is not likely to be practical or effective, 
however, to target certain types of loans in the subprime market for 
coverage while excluding others. Such a rule would be unduly complex, 
likely fail to adapt quickly enough to ever-changing products, and 
encourage creditors to steer borrowers to uncovered products.
    In the prime market, however, the Board believes that a case-by-
case approach to determining whether the Sec.  226.35 practices are 
unfair or deceptive is more appropriate. By nature, loans in the prime 
market have a lower credit risk. Moreover, the prime market is more 
transparent and competitive, characteristics that make it less likely a 
creditor can sustain an unfair, abusive, or deceptive practice. In 
addition, borrowers in the prime market are less likely to be under the 
degree of financial stress that tends to weaken the ability of many 
borrowers in the subprime market to protect themselves against unfair, 
abusive, or deceptive practices. The final rule applies protections 
against coercion of appraisers and unfair servicing practices to the 
prime market because, with respect to these particular practices, the 
prime market, too, suffers a lack of transparency and these practices 
do not appear to be limited to the subprime market.
    With these limited exceptions, at present the Board believes that 
any undue risks to consumers in the prime market from particular loan 
terms or lending practices are better addressed through means other 
than new regulations under HOEPA. Supervisory guidance from the federal 
agencies influences a large majority of the prime market which, unlike 
the subprime market, has been dominated by federally supervised 
institutions.\36\ Such guidance affords regulators and institutions 
alike more flexibility than a regulation, with potentially fewer 
unintended consequences. In addition, the standards the Government 
Sponsored Enterprises set for the loans they will purchase continue to 
have significant influence within the prime market, and these entities 
are accountable for those standards to regulators and Congress.\37\
---------------------------------------------------------------------------

    \36\ According to HMDA data from 2005 and 2006, more than three-
quarters of prime, conventional first-lien mortgage loans on owner-
occupied properties were made by depository institutions or their 
affiliates. For this purpose, a loan for which price information was 
not reported is treated as a prime loan.
    \37\ According to HMDA data from 2005 and 2006, nearly 30 
percent of prime, conventional first-lien mortgage loans on owner-
occupied properties were purchased by Fannie Mae or Freddie Mac. 
This figure understates the GSEs' influence on the prime market 
because it excludes the many loans that were underwritten using the 
GSEs' standards but were not sold to the GSEs.
---------------------------------------------------------------------------

Use the APR
    The Board also continues to believe--and few, if any, commenters 
disagreed--that the best way to identify the subprime market is by loan 
price rather than by borrower characteristics. Identifying a class of 
protected borrowers would present operational difficulties and other 
problems. For example, it is common to distinguish borrowers by credit 
score, with lower-scoring borrowers generally considered to be at 
higher risk of injury in the mortgage market. Defining the protected 
field as lower-scoring consumers would fail to protect higher-scoring 
consumers ``steered'' to loans meant for lower-scoring consumers. 
Moreover, the market uses different commercial scores, and choosing a 
particular score

[[Page 44533]]

as the benchmark for a regulation could give unfair advantage to the 
company that provides that score.
    The most appropriate measure of loan price for this regulation is 
the APR; few, if any, commenters disagreed with this point either. The 
APR corresponds closely to credit risk, that is, the risk of default as 
well as the closely related risks of serious delinquency and 
foreclosure. Loans with higher APRs generally have higher credit risks, 
whatever the source of the risk might be--weaker borrower credit 
histories, higher borrower debt-to-income ratios, higher loan-to-value 
ratios, less complete income or asset documentation, less traditional 
loan terms or payment schedules, or combinations of these or other risk 
factors. Because disclosing an APR has long been required by TILA, the 
figure is also very familiar and readily available to creditors and 
consumers. Therefore, the Board believes it appropriate to use a loan's 
APR to identify loans having a high enough credit risk to warrant the 
protections of Sec.  226.35.
    Two loans with identical risk characteristics will likely have 
different APRs if they were originated when market rates were 
different. It is important to normalize the APR by an index that moves 
with mortgage market rates so that loans with the same risk 
characteristics will be treated the same regardless of when the loans 
were originated. The Board proposed to use as this index the yields on 
comparable Treasury securities, which HOEPA uses currently to identify 
HOEPA-covered loans, see TILA Section 103(aa), 15 U.S.C. 1602(aa), and 
Sec.  226.32(a), and Regulation C uses to identify mortgage loans 
reportable under HMDA as being higher-priced, see 12 CFR 203.4(a)(12). 
For reasons discussed in more detail below, the final rule uses instead 
an index that more closely tracks movements in mortgage rates than do 
Treasury yields.
Uncertainty
    As the Board stated in connection with the proposal, there are 
three major reasons why it is inherently uncertain which APR threshold 
would achieve the twin objectives of covering the subprime market and 
generally excluding the prime market. First, there is not a uniform 
definition of the prime or subprime market, or of a prime or subprime 
loan. Moreover, the markets are separated by a somewhat loosely defined 
segment known as the alt-A market, the precise boundaries of which are 
not clear.
    Second, available data sets provide only a rough measure of the 
empirical relationship between APR and credit risk. A proprietary 
dataset such as the loan-level data on subprime securitized mortgages 
published by First American LoanPerformance may contain detailed 
information on loan characteristics, including the contract rate, but 
lack the APR or sufficient data to derive the APR. Other data must be 
consulted to estimate APRs based on contract rates. HMDA data contain 
the APR for mortgage loans reportable as being higher-priced (as 
adjusted by comparable Treasury securities), but they have little 
information about credit risk.
    Third, data sets can of course show only the existing or past 
distribution of loans across market segments, which may change in ways 
that are difficult to predict. In particular, the distribution could 
change in response to the Board's imposition of the restrictions in 
Sec.  226.35, but the likely direction of the change is not clear. 
``Over compliance'' could effectively lower the threshold. While a 
loan's APR can be estimated early in the application process, it is 
typically not known to a certainty until after the underwriting has 
been completed and the interest rate has been locked. Creditors might 
build in a ``cushion'' against this uncertainty by voluntarily setting 
their internal thresholds lower than the threshold in the regulation.
    Creditors would have a competing incentive to avoid the 
restrictions, however, by restructuring the prices of potential loans 
that would have APRs just above the threshold to cause the loans' APRs 
to come under the threshold. Different combinations of contract rates 
and points that are economically identical for an originator produce 
different APRs. With the adoption of Sec.  226.35, an originator may 
have an incentive to achieve a rate-point combination that would bring 
a loan's APR below the threshold (if the borrower had the resources or 
equity to pay the points). Moreover, some fees, such as late fees and 
prepayment penalties, are not included in the APR. Creditors could 
increase the number or amounts of such fees to maintain a loan's 
effective price while lowering its APR below the threshold. It is not 
clear whether the net effect of these competing forces of over-
compliance and circumvention would be to capture more, or fewer, loans.
    For all of the above reasons, there is inherent uncertainty as to 
what APR threshold would perfectly achieve the objectives of covering 
the subprime market and generally excluding the prime market. In the 
face of this uncertainty, deciding on an APR threshold calls for 
judgment. As the Board stated with the proposal, the Board believes it 
is appropriate to err on the side of covering somewhat more than the 
subprime market.
The Alt-A Market
    If the selected thresholds cover more than the subprime market, 
then they likely extend into what has been known as the alt-A market. 
The alt-A market is generally understood to be for borrowers who 
typically have higher credit scores than subprime borrowers but still 
pose more risk than prime borrowers because they make small down 
payments or do not document their incomes, or for other reasons. The 
definition of this market is not precise, however.
    The Board judges that the benefits of extending Sec.  226.35's 
restrictions into some part of the alt-A market to ensure coverage of 
the entire subprime market outweigh the costs. This market segment also 
saw undue relaxation of underwriting standards, one reason that its 
share of residential mortgage originations grew sixfold from 2003 to 
2006 (from two percent of originations to 13 percent). \38\ See part 
VIII.C for further discussion of the relaxation of underwriting 
standards in the alt-A market.
---------------------------------------------------------------------------

    \38\ IMF 2007 Mortgage Market at 4.
---------------------------------------------------------------------------

    To the extent Sec.  226.35 covers the higher-priced end of the alt-
A market, where risks in that segment are highest, the regulation will 
likely benefit consumers more than it would cost them. Prohibiting 
lending without regard to repayment ability in this market slice would 
likely reduce the risk to consumers from ``payment shock'' on 
nontraditional loans. Applying the income verification requirement of 
Sec. Sec.  226.32(a)(4)(ii) and 226.35(b)(1) to the riskier part of the 
alt-A market could ameliorate injuries to consumers from lending based 
on inflated incomes without necessarily depriving consumers of access 
to credit.

D. Index for Higher-Priced Mortgage Loans

    Under the proposal, higher-priced mortgage loans would be defined 
as consumer credit transactions secured by the consumer's principal 
dwelling for which the APR on the loan exceeds the yield on comparable 
Treasury securities by at least three percentage points for first-lien 
loans, or five percentage points for subordinate-lien loans. The 
proposed definition would include home purchase loans, refinancings of 
home purchase loans, and home equity

[[Page 44534]]

loans. The definition would exclude home equity lines of credit 
(``HELOCs''), reverse mortgages, construction-only loans, and bridge 
loans.
    The Board is adopting a definition of ``higher-priced mortgage 
loan'' that is substantially similar to that proposed but different in 
the particulars. The final definition, like the proposed definition, 
sets a threshold above a measure of market rates to distinguish higher-
priced mortgage loans from the rest of the mortgage market. But the 
measure the Board is adopting is different, and therefore so is the 
threshold. Instead of yields on Treasury securities, the final 
definition uses average offer rates for the lowest-risk prime 
mortgages, termed ``average prime offer rates.'' For the foreseeable 
future, the Board will obtain or, as applicable, derive average prime 
offer rates for a wide variety of types of transactions from the 
Primary Mortgage Market Survey[reg] (PMMS) conducted by Freddie Mac, 
and publish these rates on at least a weekly basis. The Board will 
conduct its own survey if it becomes appropriate or necessary to do so. 
The threshold is set at 1.5 percentage points above the average prime 
offer rate on a comparable transaction for first-lien loans, and 3.5 
percentage points for subordinate-lien loans. The exclusions from 
``higher-priced mortgage loans'' for HELOCs and certain other types of 
transactions are adopted as proposed.
Public Comment
    A large number and wide variety of industry commenters, as well as 
a consumer research and advocacy group, urged the Board to use a prime 
mortgage market rate instead of, or in addition to, Treasury yields. 
First, they argued the tendency of prime mortgage rates at certain 
times to deviate significantly from Treasury yields--such as during the 
``flight to quality'' seen in recent months--would lead to unwarranted 
coverage of the prime market and arbitrary swings in coverage. Many of 
these commenters also pointed out that changes in the Treasury yield 
curve (the relationship of short-term to long-term Treasury yields) can 
increase or decrease coverage even though neither borrower risk 
profiles nor creditor practices or products have changed. The Board's 
proposal to address this second problem by matching Treasuries to 
mortgages on the basis of the loan's expected life span drew limited, 
but mostly negative, comment. Although one large lender specifically 
agreed with the proposed matching rules, a few others stated the rules 
were too complicated.
    The precise recommendations for a measure of mortgage market rates 
varied. Several commenters specifically recommended using the PMMS. 
They recommended that a threshold be added to the PMMS figure because 
it is, by design, at the low end of the range of rates that can be 
found in the prime market. Recommendations for thresholds for first-
lien loans ranged from 150 to 300 basis points over the PMMS. Some 
commenters recommended approaches that would rely on both Treasuries 
and the PMMS. A few recommended the approach of a recent North Carolina 
law, which covers a first-lien loan only if its APR exceeds two 
thresholds: 300 basis points over the comparable Treasury yield and 175 
basis points over the PMMS rate for the 30-year fixed-rate loan. A few 
recommended a different way to integrate Treasuries and the PMMS. Under 
this approach, the threshold would be set at the comparable Treasury 
yield (determined as proposed) plus 200 basis points (400 for 
subordinate-lien loans), plus the spread between the PMMS 30-year FRM 
rate and the seven-year Treasury.
    Some commenters offered alternatives to the PMMS. A consumer 
research and advocacy group and Freddie Mac suggested that the Board 
could use the higher of the Freddie Mac Required Net Yield (the yield 
Freddie Mac expects from purchasing a conforming mortgage) and the 
equivalent Fannie Mae yield. Fannie Mae offered a similar, but not 
identical, recommendation to use the higher of the current coupon yield 
for Fannie Mae Mortgage Backed Securities and Freddie Mac participation 
certifications (PC). These yields reflect the price at which a 
government-sponsored entity (GSE) security can be sold in the market. 
At least one commenter suggested that the Board could conduct its own 
survey of mortgage market rates.
Discussion
    Based on these comments and the analysis below, the final rule does 
not use Treasury yields as the index for higher-priced mortgage loans. 
Instead, the rule uses average offer rates on the lowest-risk prime 
mortgage loans, termed ``average prime offer rates.'' For the 
foreseeable future, the Board will obtain or, as applicable, derive 
these rates for a wide variety of types of transactions from the PMMS 
and publish them on a weekly basis.
    Drawbacks of using Treasury security yields. There are significant 
advantages to using Treasury yields to set the APR thresholds. 
Treasuries are traded in a highly liquid market; Treasury yield data 
are published for many different maturities and can easily be 
calculated for other maturities; and the integrity of published yields 
is not subject to question. For these reasons, Treasuries are also 
commonly used in federal statutes, such as HOEPA, for benchmarking 
purposes.
    As recent events have highlighted, however, using Treasury yields 
to set the APR threshold in a law regulating mortgage loans has two 
major disadvantages. The most significant disadvantage is that the 
spread between Treasuries and mortgage rates, even prime mortgage 
rates, changes in the short term and in the long term. Moreover, the 
comparable Treasury security for a given mortgage loan is quite 
difficult to determine accurately.
    The Treasury-mortgage spread can change for at least three 
different reasons. First, credit risk may change on mortgages, even for 
the highest-quality borrowers. For example, credit risk increases when 
house prices fall. Second, competition for prime borrowers can 
increase, tightening spreads, or decrease, allowing lenders to charge 
wider spreads. Third, movements in financial markets can affect 
Treasury yields but have no effect on lenders' cost of funds or, 
therefore, on mortgage rates. For example, Treasury yields fall 
disproportionately more than mortgage rates during a ``flight to 
quality.''
    Recent events illustrate how much the Treasury-mortgage spread can 
swing. The spread averaged about 170 basis points in 2007, but 
increased to an average of about 220 basis points in the first half of 
2008. In addition, the spread was highly volatile in this period, 
shifting as much as 25 basis points in a week. The spread may decrease, 
but predictions of long-term spreads are highly uncertain.
    Changes in the Treasury-mortgage spread can undermine key 
objectives of the regulation. These changes mean that loans with 
identical credit risk are covered in some periods but not in others, 
contrary to the objective of consistent and predictable coverage over 
time. Moreover, lenders' uncertainty as to when such changes will occur 
can cause them to set an internal threshold below the regulatory 
threshold. This may reduce credit availability directly (if a lender's 
policy is not to make higher-priced mortgage loans) or indirectly, by 
increasing regulatory burden. The recent volatility might lead lenders 
to set relatively conservative cushions.
    Adverse consequences of volatility in the spread between mortgages 
rates and Treasuries could be reduced simply by setting the regulatory 
threshold at a high enough level to ensure it excludes all

[[Page 44535]]

prime loans. But a threshold high enough to accomplish this objective 
would likely fail to meet another, equally important objective of 
covering essentially all of the subprime market. Instead, the Board is 
adopting a rate that closely follows mortgage market rates, which 
should mute the effects on coverage of changes in the spread between 
mortgage rates and Treasury yields.
    The second major disadvantage of using Treasury yields to set the 
threshold is that the comparable Treasury security for a given mortgage 
loan is quite difficult to determine accurately. Regulation C 
determines the comparable Treasury security on the basis of contractual 
maturity: A loan is matched to a Treasury with the same contract term. 
For example, the regulation matches a 30-year mortgage loan to a 30-
year Treasury security. This method does not, however, account for the 
fact that very few loans reach their full maturity, and it causes 
significant distortions when the yield curve changes shape.\39\ These 
distortions can bias coverage, sometimes in unpredictable ways, and 
consequently might influence the preferences of lenders to offer 
certain loan products in certain environments. For example, a steep 
yield curve will create two regulatory forces pushing the subprime 
market toward ARMs: A lender could avoid coverage on the margins by 
selling ARMs rather than fixed-rate mortgages, and the consumer would 
receive an APR that understates the interest rate risk from an ARM 
relative to that from a fixed-rate mortgage. (Regulation Z requires the 
APR be calculated as if the index does not change; a steep yield curve 
indicates that the index will likely rise.) Artificial regulatory 
incentives to increase ARMs production in the subprime market could 
undermine consumer protection.
---------------------------------------------------------------------------

    \39\ Robert B. Avery, Kenneth P. Brevoort, and Glenn B. Canner, 
Higher-Priced Home Lending and the 2005 HMDA Data, 92 Fed. Res. 
Bulletin A123-66 (Sept. 8, 2006).
---------------------------------------------------------------------------

    The Board proposed to reduce distortions in coverage resulting from 
changes in the yield curve by matching loans to Treasury securities on 
the basis of the loan's expected life span rather than its legal term 
to maturity. For example, the Board proposed to match a 30-year fixed-
rate mortgage loan to a 10-year Treasury security on the supposition 
that the mortgage loan will prepay (or default) in ten years or less. A 
limitation of this approach is that loan life spans change as rates of 
house price appreciation, mortgage rates, and macroeconomic factors 
such as unemployment rates change. Loan life spans also change as 
specific loan features that influence default or prepayment rates 
change, such as prepayment penalties. The challenge of adjusting the 
regulation's matching rules on a timely basis would be substantial, and 
too-frequent adjustments would complicate creditors' compliance. 
Indeed, many commenters judged the proposed matching rules to be too 
complicated. This matching problem can be reduced, if not necessarily 
eliminated, by using mortgage market rates instead of Treasury security 
yields to set the threshold.
    A rate from the prime mortgage market. To address the principal 
drawbacks of Treasury security yields, the Board is adopting a final 
rule that relies instead on a rate that more closely tracks rates in 
the prime mortgage market. Section 226.35(a)(2) defines an ``average 
prime offer rate'' as an annual percentage rate derived from average 
interest rates, points, and other pricing terms offered by a 
representative sample of creditors for mortgage transactions that have 
low-risk pricing characteristics. Comparing a transaction's annual 
percentage rate to this average offered annual percentage rate, rather 
than to an average offered contract interest rate, should make the 
rule's coverage more accurate and consistent. A transaction is a 
higher-priced mortgage loan if its APR exceeds the average prime offer 
rate for a comparable transaction by 1.5 percentage points, or 3.5 
percentage points in the case of a subordinate-lien transaction. (The 
basis for selecting these thresholds is explained further in part 
VIII.E) The creditor uses the most recently available average prime 
offer rate as of the date the creditor sets the transaction's interest 
rate for the final time before consummation.
    To facilitate compliance, the final rule and commentary provide 
that the Board will derive average prime offer rates from survey data 
according to a methodology it will make publicly available, and publish 
these rates in a table on the Internet on at least a weekly basis. This 
table will indicate how to identify a comparable transaction.
    As noted above, the survey the Board intends to use for the 
foreseeable future is the PMMS, which contains weekly average rates and 
points offered by a representative sample of creditors to prime 
borrowers seeking a first-lien, conventional, conforming mortgage and 
who would have at least 20 percent equity. The PMMS contains pricing 
data for four types of transactions: ``1-year ARM,'' ``5/1-year ARM,'' 
``30-year fixed,'' and ``15-year fixed.'' For the two types of ARMs, 
PMMS pricing data are based on ARMs that adjust according to the yield 
on one-year Treasury securities; the pricing data include the margin 
and the initial rate (if it differs from the sum of the index and 
margin). These data are updated every week and are published on Freddie 
Mac's Web site.\40\
---------------------------------------------------------------------------

    \40\ See http://www.freddiemac.com/dlink/html/PMMS/display/PMMSOutputYr.jsp.
---------------------------------------------------------------------------

    The Freddie Mac PMMS is the most viable option for obtaining 
average prime offer rates. This is the only publicly available data 
source that has rates for more than one kind of fixed-rate mortgage 
(the 15-year and the 30-year) and more than one kind of variable-rate 
mortgage (the 1-year ARM and the 5/1 ARM). Having rates on at least two 
fixed-rate products and at least two variable-rate products supplies a 
firmer basis for estimating rates for other fixed-rate and variable-
rate products (such as a 20-year fixed or a 3/1 ARM).
    Other publicly available surveys the Board considered are less 
suitable for the purposes of this rule. Only one ARM rate is collected 
by the Mortgage Bankers Association's Weekly Mortgage Applications 
Survey and the Federal Housing Finance Board's Monthly Survey of 
Interest Rates and Terms on Conventional Single-Family Non-Farm 
Mortgage Loans. Moreover, the FHFB Survey has a substantial lag because 
it is monthly and reports rates on closed loans. The Board also 
evaluated two non-survey options involving Fannie Mae and Freddie Mac. 
One is the Required Net Yield, the prices these institutions will pay 
to purchase loans directly. The other is the yield on mortgage-backed 
securities issued by Fannie Mae and Freddie Mac. With either option, 
data for ARM yields would be difficult to obtain.
    These other data sources, however, provide useful benchmarks to 
evaluate the accuracy of the PMMS. The PMMS has closely tracked these 
other indices, according to a Board staff analysis. The Board will 
continue to use them periodically to help it determine whether the PMMS 
remains an appropriate data source for Regulation Z. If the PMMS ceases 
to be available, or if circumstances arise that render it unsuitable 
for this rule, the Board will consider other alternatives including 
conducting its own survey.
    The Board will use the pricing terms from the PMMS, such as 
interest rate and points, to calculate an annual percentage rate 
(consistent with Regulation Z, Sec.  226.22) for each of the four types 
of transactions that the

[[Page 44536]]

PMMS reports. These annual percentage rates are the average prime offer 
rates for transactions of that type. The Board will derive annual 
percentage rates for other types of transactions from the loan pricing 
terms available in the survey. The method of derivation the Board 
expects to use is being published for comment in connection with the 
simultaneously proposed revisions to Regulation C. When finalized, the 
method will be published on the Internet along with the table of annual 
percentage rates.

E. Threshold for Higher-Priced Mortgage Loans

    The Board proposed a threshold of three percentage points above the 
comparable Treasury security for first-lien loans, or five percentage 
points for subordinate-lien loans. Since the final rule uses a 
different index, it must also use a different threshold. The Board is 
adopting a threshold for first-lien loans of 1.5 percentage points 
above the average prime offer rate for a comparable transaction, and 
3.5 percentage points for second-lien loans.
Public Comment
    Industry commenters consistently contended that, should the Board 
use Treasury yields as proposed, thresholds of 300 and 500 basis points 
would be too low to meet the Board's stated objective of excluding the 
prime market.\41\ These commenters recommended thresholds of 400 basis 
points (600 for subordinate-lien loans) or higher, but a few trade 
associations recommended 500 (700) or 600 (800). These commenters 
contended that covering any part of the prime market would harm 
consumers because the secondary market would not purchase loans with 
rates over the threshold. They also stated that many originators would 
seek to avoid originating such loans because of a stigma these 
commenters expect will attach to such loans, the increased compliance 
cost associated with the proposed regulations, and the substantial 
monetary recovery TILA Section 130 would provide plaintiffs for 
violations of the regulations.
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    \41\ One trade association reported that some of its members 
found the proposal would have covered up to one-third of prime loans 
originated between November 2007 and January 2008. This and other 
commenters said the effect was particularly pronounced with ARMs. 
Several members of this association were reported to have found that 
more than one-half of prime 7/1, 5/1, and 3/1 ARMs originated 
between November 2007 and January 2008 would have been covered. A 
different association of mortgage lenders indicated that some of its 
members had found that almost 20 percent of prime and alt-A loans 
would be covered under the proposal, though the time frame its 
members used was not specified. A major lender reported that the 
proposal would have captured 8-10 percent of its portfolio in 2006 
and 2007, about twice the portion of its portfolio that it was 
required to report as higher-priced under HMDA. The lender 
represents that it did not make subprime loans in this period and 
asserts that its figures are predictive of the impact the proposal 
would have on the prime market overall. Another large lender that 
stated it does not make subprime loans believes that about 10 
percent of its current originations would fall above the proposed 
thresholds. One lender, however, expressed satisfaction with the 
proposed 300 basis points for first-lien loans and said an internal 
analysis of historical data found it would not have captured 
significant numbers of its prime loans. But this lender's analysis 
found that significant numbers of prime subordinate-lien loans would 
have been captured, leading the lender to recommend raising the 
threshold for subordinate-lien loans to 600 basis points.
---------------------------------------------------------------------------

    A trade association for the manufactured housing industry submitted 
that the proposed thresholds would cover a substantial majority of 
personal property loans used to purchase manufactured homes. This 
commenter contended that the reasons these loans are priced higher than 
loans secured by real estate (such as the smaller loan amounts and the 
lack of real property securing the loan) do not support a rule that 
would cover personal property loans disproportionately.
    Consumer and civil rights group commenters generally, but not 
uniformly, opposed limiting protections to higher-rate loans and 
recommended applying these protections to all loans secured by a 
principal dwelling. They recommended in the alternative that the 
thresholds be adopted at the levels proposed or even lower. They argued 
it was critical to cover all of the subprime market and much if not all 
of the alt-A market.
Discussion
    As discussed above, the Board has concluded that the stricter 
regulations of Sec.  226.35 should cover the subprime market and 
generally exclude the prime market; and in the face of uncertainty it 
is appropriate to err on the side of covering somewhat more than the 
subprime market. Based on available data, it appeared that the 
thresholds the Board proposed would capture all of the subprime market 
and a portion of the alt-A market.\42\ Based also on available data, 
the Board believes that the thresholds it is adopting would cover all, 
or virtually all, of the subprime market and a portion of the alt-A 
market. The Board considered loan-level origination data for the period 
2004 to 2007 for subprime and alt-A securitized pools. The proprietary 
source of these data is FirstAmerican Loan Performance.\43\ The Board 
also ascertained from a proprietary database of mostly prime loans 
(McDash Analytics) that coverage of the prime market during the first 
three quarters of 2007 at these thresholds would have been very 
limited. The Board recognizes that the recent mortgage market 
disruption began at the end of this period, but it is the latest period 
for which data were available.
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    \42\ The Board noted in the proposal that the percentage of the 
first-lien mortgage market Regulation C has captured as higher-
priced using a threshold of three percentage points has been greater 
than the percentage of the total market originations that one 
industry source has estimated to be subprime (25 percent vs. 20 
percent in 2005; 28 percent vs. 20 percent in 2006). For industry 
estimates see IMF 2007 Mortgage Market at 4. Regulation C's coverage 
of higher-priced loans is not thought, however, to have reached the 
prime market in those years. Rather, in both 2005 and 2006 it 
reached into the alt-A market, which the same source estimated to be 
12 percent in 2005 and 13 percent in 2006. In 2004, Regulation C 
captured a significantly smaller part of the market than an industry 
estimate of the subprime market (11 percent vs. 19 percent), but 
that year's HMDA data were somewhat anomalous because of a steep 
yield curve.
    \43\ Annual percentage rates were estimated from the contract 
rates in these data using formulas derived from a separate 
proprietary database of subprime loans that collects contract rates, 
points, and annual percentage rates. This separate database, which 
contains data on the loan originations of eight subprime mortgage 
lenders, is maintained by the Financial Services Research Program at 
George Washington University.
---------------------------------------------------------------------------

    The Board is adopting a threshold for subordinate-lien loans of 3.5 
percentage points. This is consistent with the Board's proposal to set 
the threshold over Treasury yields for these loans two percentage 
points above the threshold for first-lien loans. With rare exceptions, 
commenters explicitly endorsed, or at least did not raise any objection 
to, this approach. The Board recognizes that it would be preferable to 
set a threshold for second-lien loans above a measure of market rates 
for second-lien loans, but it does not appear that a suitable measure 
of this kind exists. Although data are very limited, the Board believes 
it is appropriate to apply the same difference of two percentage points 
to the thresholds above average prime offer rates.
    As discussed earlier, the Board recognizes that there are 
limitations to making judgments about the future scope of the rule 
based on past data. For example, when the final rule takes effect, the 
risk premiums for alt-A loans compared to the conforming loans in the 
PMMS may be higher than the risk premiums for the period 2004-2007. In 
that case, coverage of alt-A loans would be higher than an estimate for 
that period would indicate.
    Another important example is prime ``jumbo'' loans, or loans 
extended to borrowers with low-risk mortgage

[[Page 44537]]

pricing characteristics, but in amounts that exceed the threshold for 
loans eligible for purchase by Freddie Mac or Fannie Mae. The PMMS 
collects pricing data only on loans eligible for purchase by one of 
these entities (``conforming loans''). Prime jumbo loans have always 
had somewhat higher rates than prime conforming loans, but the spread 
has widened significantly and become much more volatile since August 
2007. If this spread remains wider and more volatile when the final 
rule takes effect, the rule will cover a significant share of 
transactions that would be prime jumbo loans. While covering prime 
jumbo loans is not the Board's objective, the Board does not believe 
that it should set the threshold at a higher level to avoid what may be 
only temporary coverage of these loans relative to the long time 
horizon for this rule.
    A third example is a request from a trade association for the 
manufactured housing industry, including lenders specializing in this 
industry, that the thresholds be set higher for loans secured by 
dwellings deemed to be personal property. This association pointed to 
the higher risk creditors bear on these loans compared to loans secured 
by real property, which makes their rates systematically higher for 
reasons apart from the risks they pose to consumers. It also maintained 
that such loans have not been associated with the abusive practices of 
the subprime market.\44\
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    \44\ The specific concern of the commenter is with the 
requirement to escrow, not, apparently, with the other requirements 
for higher-priced loans. As discussed in part IX.D, the Board is 
providing creditors two years to comply with the escrow requirement 
for manufactured home loans.
---------------------------------------------------------------------------

    Credit risk and liquidity risk can vary by many factors, including 
geography, property type, and type of loan. This may suggest to some 
that different thresholds should be applied to different classes of 
transactions. This approach would make the regulation inordinately 
complicated and subject it to frequent revision, which would not be in 
the interest of creditors, investors, or consumers. Although the 
simpler approach the Board is adopting--just two thresholds, one for 
first-lien loans and another for subordinate-lien loans--has its 
disadvantages, the Board believes they are outweighed by its benefits 
of simplicity and stability.

F. The Timing of Setting the Threshold

    The Board proposed to set the threshold for a dwelling-secured 
mortgage loan as of the application date. Specifically, a creditor 
would use the Treasury yield as of the 15th of the month preceding the 
month in which the application is received. The Board noted that 
inconsistency with Regulation C, which sets the threshold as of the 
15th of the month before the rate is locked, could increase regulatory 
burden. The Board suggested, however, that setting the threshold as of 
the application date might introduce more certainty, earlier in the 
application process, to the determination as to whether a potential 
transaction would be a higher-priced mortgage loan when consummated.
    Very few commenters addressed the precise issue. A couple of them 
specifically advocated using the rate lock date to select the Treasury 
yield, as in Regulation C, rather than the application date. Subsequent 
outreach by the Board indicated that there are different views as to 
which date to use. Some parties prefer the rate lock date because it is 
more accurate and therefore would minimize coverage of loans that are 
not intended to be covered and maximize coverage of loans that are 
intended to be covered. Other parties prefer the application date 
because they believe it increases the creditor's ability to predict, 
when underwriting the loan, that the loan is, or is not, covered by 
Sec.  226.35.
    As noted above, the final rule requires the creditor to use the 
rate lock date, the date the rate is set for the final time before 
consummation, rather than the application date. Using the application 
date might increase the predictability of coverage at the time of 
underwriting. Using the rate lock date would increase the accuracy of 
coverage at least somewhat. On balance, the Board believes it is more 
important to maximize coverage accuracy.

G. Proposal To Conform Regulation C (HMDA)

    Regulation C, which implements HMDA, requires creditors to report 
price data on higher-priced mortgage loans. A creditor reports the 
difference between a loan's annual percentage rate and the yield on 
Treasury securities having comparable periods of maturity, if that 
difference is at least three percentage points for first-lien loans or 
at least five percentage points for subordinate-lien loans. 12 CFR 
203.4(a)(12). Many commenters suggested that the Board establish a 
uniform definition of ``higher-priced mortgage loan'' for purposes of 
Regulation C and Regulation Z. Having a single definition would reduce 
regulatory burden and make the HMDA data a more useful tool to evaluate 
effects of Regulation Z. Moreover, the Board adopted Regulation C's 
requirement to report certain mortgage loans as being higher-priced 
with an objective of covering the subprime market and exclude the prime 
market, and the definition of ``higher-priced mortgage loan'' adopted 
in this rule better achieves this objective than the definition in 
Regulation C for the reasons discussed in part VIII.D. Accordingly, in 
a separate notice published simultaneously with this final rule the 
Board is proposing to amend Regulation C to apply the same index and 
threshold adopted in Sec.  226.35(a).

H. Types of Loans Covered Under Sec.  226.35

    The Board proposed to apply the protections of Sec.  226.35 to 
first-lien, as well as subordinate-lien, closed-end mortgage loans 
secured by the consumer's principal dwelling. This would include home 
purchase loans, refinancings, and home equity loans. The proposed 
definition would not cover loans that do not have primarily a consumer 
purpose, such as loans for real estate investment. The proposed 
definition also would not cover HELOCs, reverse mortgages, 
construction-only loans, or bridge loans. In these respects, the rule 
is adopted as proposed.
Coverage of Home Purchase Loans, Refinancings, and Home Equity Loans
    The statutory protections for HOEPA loans are generally limited to 
closed-end refinancings and home equity loans. See TILA Section 
103(aa), 15 U.S.C. 1602(aa). The final rule applies the protections of 
Sec.  226.35 to loans of these types, which have historically presented 
the greatest risk to consumers. These loans are often made to consumers 
who have home equity and, therefore, have an existing asset at risk. 
These loans also can be marketed aggressively by originators to 
homeowners who may not benefit from them and who, if responding to the 
marketing and not shopping independently, may have limited information 
about their options.
    The Board proposed to use its authority under TILA Section 
129(l)(2), 15 U.S.C. 1639(l)(2), to apply the protections of Sec.  
226.35 to home purchase loans as well. Commenters did not object, and 
the Board is adopting the proposal. Covering only refinancings of home 
purchase loans would fail to protect consumers adequately. From 2003 
through the first half of 2007, 42 percent of the higher-risk ARMs that 
came to dominate the subprime market in recent years were extended to

[[Page 44538]]

consumers to purchase a home.\45\ Delinquencies on subprime ARMs used 
for home purchase have risen more sharply than they have for 
refinancings. Moreover, comments and testimony at the Board's hearings 
indicate that the problems with abusive lending practices are not 
confined to refinancings and home equity loans.
---------------------------------------------------------------------------

    \45\ Figure calculated from First American LoanPerformance data.
---------------------------------------------------------------------------

    Furthermore, consumers who are seeking home purchase loans can face 
unique constraints on their ability to make decisions. First-time 
homebuyers are likely unfamiliar with the mortgage market. Homebuyers 
generally are primarily focused on acquiring a new home, arranging to 
move into it, and making other life plans related to the move, such as 
placing their children in new schools. These matters can occupy much of 
the time and attention consumers might otherwise devote to shopping for 
a loan and deciding what loan to accept. Moreover, even if the consumer 
comes to understand later in the application process that an offered 
loan may not be appropriate, the consumer may not be able to reject the 
loan without risk of abrogating the sales agreement and losing a 
substantial deposit, as well as disrupting moving plans.
Limitation to Loans Secured by Principal Dwelling; Exclusion of Loans 
for Investment
    As proposed, Sec.  226.35 protections are limited to loans secured 
by the consumer's principal dwelling. The Board's primary concern is to 
ensure that consumers not lose the homes they principally occupy 
because of unfair, abusive, or deceptive lending practices. The 
inevitable costs of new regulation, including potential unintended 
consequences, can most clearly be justified when people's principal 
homes are at stake.
    A loan to a consumer to purchase or improve a second home would not 
be covered by these protections unless the loan was secured by the 
consumer's principal dwelling. Loans primarily for a real estate 
investment purpose also are not covered. This exclusion is consistent 
with TILA's focus on consumer-purpose transactions and its exclusion in 
Section 104 of credit primarily for business, commercial, or 
agricultural purposes. See 15 U.S.C. 1603(1). Real estate investors are 
expected to be more sophisticated than ordinary consumers about the 
real estate financing process and to have more experience with it, 
especially if they invest in several properties. Accordingly, the need 
to protect investors is not clear, and in any event is likely not 
sufficient to justify the potential unintended consequences of imposing 
restrictions, with civil liability if they are violated, on the 
financing of real estate investment transactions.
    The Board shares concerns that individuals who invest in 
residential real estate and do not pay their mortgage obligations put 
tenants at risk of eviction in the event of foreclosure. Regulating the 
rights of landlords and tenants, however, is traditionally a matter for 
state and local law. The Board believes that state and local law could 
better address this particular concern than a Board regulation.
Coverage of Nontraditional Mortgages
    Under the final rule, nontraditional mortgage loans, which permit 
non-amortizing payments or negatively amortizing payments, are covered 
by Sec.  226.35 if their APRs exceed the threshold. Several consumer 
and civil rights groups, and others, contended that Sec.  226.35 should 
cover nontraditional mortgage loans regardless of loan price because of 
their potential for significant payment shock and other risks that led 
the federal banking agencies to issue the Nontraditional Mortgage 
Guidance. The Board does not believe that the enhanced protections of 
Sec.  226.35 should be applied on the basis of product type, with the 
limited exception of the narrow exemptions for HELOCs and other loan 
types the Board is adopting. A rule based on product type would need to 
be reexamined frequently as new products were developed, which could 
undermine the market by making the rule less predictable. Moreover, it 
is not clear what criteria the Board would use to decide which products 
were sufficiently risky to warrant categorical coverage. The Board 
believes that other tools such as supervisory guidance provide the 
requisite flexibility to address particular product types when that 
becomes necessary.
HELOC Exemption
    The Board proposed to exempt HELOCs largely for two reasons. First, 
the Board noted that most originators of HELOCs hold them in portfolio 
rather than sell them, which aligns these originators' interests in 
loan performance more closely with their borrowers' interests. Second, 
unlike originations of higher-priced closed-end mortgage loans, HELOC 
originations are concentrated in the banking and thrift industries, 
where the federal banking agencies can use supervisory authorities to 
protect borrowers. For example, when inadequate underwriting of HELOCs 
unduly increased risks to originators and consumers several years ago, 
the agencies responded with guidance.\46\ The Board also pointed to 
TILA and Regulation Z's special protections for borrowers with HELOCs 
such as restrictions on changing plan terms.
---------------------------------------------------------------------------

    \46\ Interagency Credit Risk Guidance for Home Equity Lending, 
SR 05-11 (May 16, 2005), available at http://www.federalreserve.gov/boarddocs/srletters/2005/sr0511a1.pdf.; Addendum to Credit Risk 
Guidance for Home Equity Lending, SR 06-15 (Sept. 29, 2006), 
available at http://www.federalreserve.gov/BoardDocs/SRLetters/2006/SR0615a3.pdf.
---------------------------------------------------------------------------

    Several national trade associations and a few large lenders voiced 
strong support for excluding HELOCs, generally for the reasons the 
Board cited. Several consumer and civil rights groups disagreed, 
contending that enough HELOCs are securitized to raise doubts that the 
originator's interests are sufficiently aligned with the borrower's 
interests. They maintained that Regulation Z disclosures and 
limitations for HELOCs are not adequate to protect consumers, and 
pointed to specific cases in which unaffordable HELOCs had been 
extended. Other commenters, such as an association of state regulators, 
agreed that HELOCs should be covered. Commenters offered very few 
concrete suggestions, however, for how to determine which HELOCs would 
be covered, such as an index and threshold.
    The Board is adopting the proposal for the reasons stated. The 
Board recognizes, however, that HELOCs present a risk of circumvention. 
Creditors may seek to evade limitations on closed-end transactions by 
structuring such transactions as open-end transactions. In Sec.  
226.35(b)(5), discussed below in part IX.E, the Board prohibits 
structuring a closed-end loan as an open-end transaction for the 
purpose of evading the new rules in Sec.  226.35.
Other Exemptions Adopted
    The other proposed exclusions drew limited comment. A couple of 
commenters expressed support for excluding reverse mortgages while a 
couple of commenters opposed it. A few large lenders voiced support for 
excluding construction-only loans. A few commenters voiced support for 
the exclusion of temporary bridge loans of 12 months or less, and none 
of the commenters seemed to oppose it. The Board is adopting the 
proposed exclusions for reverse mortgages, construction-only loans, and 
temporary or bridge loans of 12 months or less.

[[Page 44539]]

    Reverse mortgages. The Board is keenly aware of consumer protection 
concerns raised by the expanding market for reverse mortgages, which 
are complex and are sometimes marketed with other complex financial 
products. Unique aspects of reverse mortgages--for example, the 
borrower's repayment ability is based on the value of the collateral 
rather than on income--suggest that they should be addressed separately 
from this final rule. The Board is reviewing this segment of the 
mortgage market in connection with its comprehensive review of 
Regulation Z to determine what measures may be required to ensure 
consumers are protected.
    Construction-only loans. Section 226.35 excludes a construction-
only loan, defined as a loan solely for the purpose of financing the 
initial construction of a dwelling, consistent with the definition of a 
``residential mortgage transaction'' in Sec.  226.2(a)(24). A 
construction-only loan does not include the permanent financing that 
replaces a construction loan. Construction-only loans do not appear to 
present the same risk of consumer abuse as other loans the proposal 
would cover. The permanent financing, or a new home-secured loan 
following construction, would be covered by proposed Sec.  226.35 
depending on its APR. Applying Sec.  226.35 to construction-only loans, 
which generally have higher interest rates than the permanent 
financing, could hinder some borrowers' access to construction 
financing without meaningfully enhancing consumer protection
    Bridge loans. HOEPA now covers certain bridge loans with rates or 
fees high enough to make them HOEPA loans. TILA Section 129(l)(1) 
provides the Board authority to exempt classes of mortgage transactions 
from HOEPA if the Board finds that the exemption is in the interest of 
the borrowing public and will apply only to products that maintain and 
strengthen homeownership and equity protection. 15 U.S.C. 1639(l)(2). 
The Board believes a narrow exemption for bridge loans from the 
restrictions of Sec.  226.35, as they apply to HOEPA loans, would be in 
borrowers' interest and support homeownership.
    The final rule, like the proposed rule, gives as an example of a 
``temporary or bridge loan'' a loan to purchase a new dwelling where 
the consumer plans to sell a current dwelling within 12 months. This is 
not the only potential bona fide example of a temporary or bridge loan. 
The Board does expect, however, that the temporary or bridge loan 
exemption will be applied narrowly and not to evade or circumvent the 
regulation. For example, a 12-month loan with a substantial balloon 
payment would not qualify for the exemption where it was clearly 
intended to lead a borrower to refinance repeatedly into a chain of 12-
month loans.
Exemptions Not Adopted
    Industry commenters proposed additional exclusions that the Board 
is not adopting.
    Government-guaranteed loans. Some commenters proposed excluding 
loans with federal guaranties such as FHA, VA, and Rural Housing 
Service. They suggested that the federal regulations that govern these 
loans are sufficient to protect consumers, and that new regulations 
under HOEPA were not only unnecessary but could cause confusion. At 
least one commenter also suggested excluding loans with state or local 
agency guaranties.
    The Board does not believe that exempting government-guaranteed 
loans from Sec.  226.35 is appropriate. It is not clear what criteria 
the Board would use to decide precisely which government programs would 
be exempted; commenters did not offer concrete suggestions. Moreover, 
such exemptions could attract to agency programs less scrupulous 
originators seeking to avoid HOEPA's civil liability, with serious 
unintended consequences for consumers as well as for the agencies and 
taxpayers.
    Jumbo loans. A few commenters proposed excluding non-conforming or 
``jumbo'' loans, that is, loans that exceed the threshold amount for 
eligibility for purchase by Fannie Mae or Freddie Mac. They cited a 
lack of evidence of widespread problems with jumbo loan performance, 
and a belief that borrowers who can afford jumbo loans are more 
sophisticated consumers and therefore better able to protect 
themselves.
    The Board does not believe excluding jumbo loans would be 
appropriate. The request is based on certain assumptions about the 
characteristics of the borrowers who take out jumbo loans. In fact, 
jumbo loans are offered in the subprime and alt-A markets and not just 
in the prime market. A categorical exemption of jumbo loans could 
therefore seriously undermine protections for consumers, especially in 
areas with above-average home prices.
    Portfolio loans. A commenter proposed excluding loans held in 
portfolio on the basis that a lender will take more care with these 
loans. Among other concerns with such an exemption is that it often 
cannot be determined as of consummation whether a loan will be held in 
portfolio or sold immediately--or, if held, for how long before being 
sold. Therefore, such an exception to the rule does not appear 
practicable and could present significant opportunities for evasion.

IX. Final Rules for Higher-Priced Mortgage Loans and HOEPA Loans

A. Overview

    This part discusses the new consumer protections the Board is 
applying to ``higher-priced mortgage loans'' and HOEPA loans. Creditors 
are prohibited from extending credit without regard to borrowers' 
ability to repay from sources other than the collateral itself. The 
final rule differs from the proposed rule in that it removes the 
proposed ``pattern or practice'' phrase and adds a presumption of 
compliance when certain underwriting procedures are followed. Creditors 
are also required to verify income and assets they rely upon to 
determine repayment ability, and to establish escrow accounts for 
property taxes and insurance. In addition, a higher-priced mortgage 
loan may not have a prepayment penalty except under certain conditions. 
These conditions are substantially narrower than those proposed.
    The Board finds that the prohibitions in the final rule are 
necessary to prevent practices that the Board finds to be unfair, 
deceptive, associated with abusive lending practices, or otherwise not 
in the interest of the borrower. See TILA Section 129(l)(2), 15 U.S.C. 
1639(l)(2), and the discussion of this statute in part V above.
    The Board is also adopting the proposed rule prohibiting a creditor 
from structuring a closed-end mortgage loan as an open-end line of 
credit for the purpose of evading the restrictions on higher-priced 
mortgage loans, which do not apply to open-end lines of credit. This 
rule is based on the authority of the Board under TILA Section 
129(l)(2) to prohibit practices that would evade Board regulations 
adopted under authority of that statute. 15 U.S.C. 1639(l)(2).

B. Disregard of Consumer's Ability To Repay--Sec. Sec.  226.34(a)(4) 
and 226.35(b)(1)

    TILA Section 129(h), 15 U.S.C. 1639(h), and Regulation Z Sec.  
226.34(a)(4) prohibit a pattern or practice of extending credit subject 
to Sec.  226.32 (HOEPA loans) based on consumers' collateral without 
regard to their repayment ability. The regulation creates a presumption 
of a violation where a creditor has a pattern or practice of failing to 
verify and document repayment ability. The Board

[[Page 44540]]

proposed to revise the prohibition on disregarding repayment ability 
and extend it, through proposed Sec.  226.35(b)(1), to higher-priced 
mortgage loans as defined in Sec.  226.35(a). The proposed revisions 
included adding several rebuttable presumptions of violations for a 
pattern or practice of failing to follow certain underwriting 
procedures, and a safe harbor.
    The final rule removes ``pattern or practice'' and therefore 
prohibits any HOEPA loan or higher-priced mortgage loan from being 
extended based on the collateral without regard to repayment ability. 
Verifying repayment ability has been made a requirement rather than a 
presumptive requirement. The proposal provided that a failure to follow 
any one of several specified underwriting procedures would create a 
presumption of a violation. In the final rule, those procedures, with 
modifications, have instead been incorporated into a presumption of 
compliance which replaces the proposed safe harbor.
Public Comment
    Mortgage lenders and their trade associations that commented 
generally, but not uniformly, support or at least do not oppose a rule 
requiring creditors to consider repayment ability. They maintain, 
however, that the rule as drafted would unduly constrain credit 
availability because of the combination of potentially significant 
damages under TILA Section 130, 15 U.S.C. 1640, and a perceived lack of 
a clear and flexible safe harbor. These commenters stated that two 
elements of the rule that the Board had intended to help preserve 
credit availability--the ``pattern or practice'' element and a safe 
harbor for a creditor having a reasonable expectation of repayment 
ability for at least seven years--would not have the intended effect. 
Many of these commenters suggested that the rule would unduly constrain 
credit unless the Board removed the presumptions of violations and 
provided a clearer and more specific safe harbor. Some of these 
commenters also requested additional safe harbors, such as for use of 
an automated underwriting system (AUS) of Fannie Mae or Freddie Mac.
    Consumer, civil rights, and community development groups, as well 
as some state and local government officials, several members of 
Congress, a federal regulator, and others argued that ``pattern or 
practice'' seriously weakened the rule and urged its removal. They 
maintain that ``pattern or practice'' would effectively prevent an 
individual borrower from bringing a claim or counter-claim based on his 
or her loan, and reduce the rule's deterrence of irresponsible lending. 
These commenters generally support the proposed presumptions of 
violations but many of them urged the Board to adopt quantitative 
standards for the proposed presumptions for failing to consider debt-
to-income ratios (DTI) and residual income levels. As discussed above, 
these commenters also would apply the rule to nontraditional mortgages 
regardless of price, and a few would apply the rule to the entire 
mortgage market including the prime market.
    The comments are discussed in more detail throughout this section 
as applicable.
Discussion
    The Board finds that disregarding a consumer's repayment ability 
when extending a higher-priced mortgage loan or HOEPA loan, or failing 
to verify the consumer's income, assets, and obligations used to 
determine repayment ability, are unfair practices. This section 
discusses the evidence from recent events of a disregard for repayment 
ability and reliance on unverified incomes in the subprime market; the 
substantial injuries that disregarding repayment ability and failing to 
verify income causes consumers; the reasons consumers cannot reasonably 
avoid these injuries; and the Board's basis for concluding that the 
injuries are not outweighed by countervailing benefits to consumers or 
competition when repayment ability is disregarded or income is not 
verified.
    Evidence of a recent widespread disregard of repayment ability. 
Approximately three-quarters of securitized originations in subprime 
pools from 2003 to 2007 were 2-28 or 3-27 ARMs with a built-in 
potential for significant payment shock at the start of the third or 
fourth year, respectively.\47\ Originations of these types of mortgages 
during 2005 and 2006 and through early 2007 have contributed 
significantly to a substantial increase in serious delinquencies and 
foreclosures. The proportion of all subprime mortgages past-due ninety 
days or more (``serious delinquency'') was about 13 percent in October 
2007, more than double the mid-2005 level.\48\ Adjustable-rate subprime 
mortgages reached a serious delinquency rate of almost 28 percent in 
May 2008, quintuple the mid-2005 level. The serious delinquency rate 
has also risen for loans in alt-A (near prime) securitized pools to 
almost 8 percent (as of April 2008) from less than 2 percent only a 
year ago. In contrast, 1.5 percent of loans in the prime-mortgage 
sector were seriously delinquent as of April 2008.
---------------------------------------------------------------------------

    \47\ In a typical case of a 2-28 discounted ARM, a $200,000 loan 
with a discounted rate of 7 percent for two years (compared to a 
fully-indexed rate of 11.5 percent) and a 10 percent maximum rate in 
the third year would start at a payment of $1,531 and jump to a 
payment of $1,939 in the third year, even if the index value did not 
increase. The rate would reach the fully-indexed rate in the fourth 
year (if the index value still did not change), and the payment 
would increase to $2,152. The example assumes an initial index of 
5.5 percent and a margin of 6 percent; assumes annual payment 
adjustments after the initial discount period; a 3 percent cap on 
the interest rate increase at the end of year 2; and a 2 percent 
annual payment adjustment cap on interest rate increases thereafter, 
with a lifetime payment adjustment cap of 6 percent (or a maximum 
rate of 13 percent).
    \48\ Delinquency rates calculated from data from First American 
LoanPerformance on mortgages in subprime securitized pools. Figures 
include loans on non-owner-occupied properties.
---------------------------------------------------------------------------

    Higher delinquencies have shown through to foreclosures. 
Foreclosures were initiated on some 1.5 million U.S. homes during 2007, 
up 53 percent from 2006, and the rate of foreclosure starts looks to be 
higher yet for 2008. Lenders initiated over 550,000 foreclosures in the 
first quarter of 2008, about 274,000 of them on subprime mortgages. 
This was significantly higher than the quarterly average of 440,000 
foreclosures in the second half of 2007 and 325,000 in the first half, 
and twice the quarterly average of 225,000 for the past six years.\49\
---------------------------------------------------------------------------

    \49\ Estimates are based on data from MBA Nat'l Delinquency 
Survey.
---------------------------------------------------------------------------

    Payment increases on 2-28 and 3-27 ARMs have not been a major cause 
of the increase in delinquencies and foreclosures because most 
delinquencies occurred before the payments were adjusted. Rather, a 
major contributor to these delinquencies was lenders' extension of 
credit on the basis of income stated on applications without 
verification.\50\ Originators had strong incentives to make these 
``stated income'' loans, and consumers had incentives to accept them. 
Because the loans could be originated more quickly, originators, who 
were paid based on volume, could increase their earnings by originating 
more of them. The share of ``low doc'' and ``no doc'' loan originations 
in the securitized subprime market rose from 20 percent in 2000, to 30 
percent in 2004, to 40 percent in 2006.\51\ The prevalence of stated 
income lending left wide room for the loan officer, mortgage broker, or 
consumer to overstate the consumer's income so the consumer could 
qualify for a larger loan

[[Page 44541]]

and the loan officer or broker could receive a larger commission. There 
is substantial anecdotal evidence that borrower incomes were commonly 
inflated.\52\
---------------------------------------------------------------------------

    \50\ See U.S. Gov't Accountability Office, GAO-08-78R, 
Information on Recent Default and Foreclosure Trends for Home 
Mortgages and Associated Economic and Market Developments 5 (2007); 
Fannie Mae, Weekly Economic Commentary (Mar. 26, 2007).
    \51\ Figures calculated from First American LoanPerformance 
data.
    \52\ See Mortgage Asset Research Inst., Inc., Eighth Periodic 
Mortgage Fraud Case Report to the Mortgage Bankers Association 
(2006) (reporting that 90 of 100 stated income loans sampled used 
inflated income when compared to tax return data); Fitch Ratings, 
Drivers of 2006 Subprime Vintage Performance (November 13, 2007) 
(Fitch 2006 Subprime Performance) (reporting that stated income 
loans with high combined loan to value ratios appear to have become 
vehicles for fraud).
---------------------------------------------------------------------------

    Lenders relying on overstated incomes to make loans could not 
accurately assess consumers' repayment ability.\53\ Evidence of this 
failure is found in the somewhat steeper increase in the rate of 
default for low/no doc loans originated when underwriting standards 
were declining in 2005 and 2006 relative to full documentation 
loans.\54\ Due in large part to creditors' reliance on inaccurate 
``stated incomes,'' lenders often failed to determine reliably that the 
consumer would be able to afford even the initial discounted payments. 
Almost 13 percent of the 2-28 ARMs originated in 2005 appear to have 
become seriously delinquent before their first reset.\55\ While some of 
these borrowers may have been able to make their payments--but stopped 
because their home values declined and they lost what little equity 
they had--others were not able to afford even their initial payments.
---------------------------------------------------------------------------

    \53\ Consumers may also have been led to pay more for their 
loans than they otherwise would. There is generally a premium for a 
stated income loan. An originator may not have sufficient incentive 
to disclose the premium on its own initiative because collecting and 
reviewing documents could slow down the origination process, reduce 
the number of loans an originator produces in a period, and, 
therefore, reduce the originator's compensation for the period. 
Consumers who are unaware of this premium are effectively deprived 
of an opportunity to shop for a potentially lower-rate loan 
requiring full documentation.
    \54\ Determined from First American LoanPerformance data. See 
also Fitch 2006 Subprime Performance (stating that lack of income 
verification, as opposed to lack of employment or down payment 
verification, caused 2006 low documentation loans delinquencies to 
be higher than earlier vintages' low documentation loans).
    \55\ Figure calculated from First American LoanPerformance data.
---------------------------------------------------------------------------

    Although payment shock on 2-28 and 3-27 ARMs did not contribute 
significantly to the substantial increase in delinquencies, there is 
reason to believe that creditors did not underwrite to a rate and 
payment that would take into account the risk to consumers of a payment 
shock. Creditors also may not have factored in the consumer's 
obligation for the expected property taxes and insurance, or the 
increasingly common ``piggyback'' second-lien loan or line of credit a 
consumer would use to finance part or all of the down payment.
    By frequently basing lending decisions on overstated incomes and 
understated obligations, creditors were in effect often extending 
credit based on the value of the collateral, that is, the consumer's 
house. Moreover, by coupling these practices with a practice of 
extending credit to borrowers with very limited equity, creditors were 
often extending credit based on an expectation that the house's value 
would appreciate rapidly.\56\ Creditors may have felt that rapid house 
price appreciation justified loosening their lending standards, but in 
some locations house price appreciation was fed by loosened standards, 
which permitted consumers to take out larger loans and bid up house 
prices. Loosened lending standards therefore made it more likely that 
the inevitable readjustment of house prices in these locations would be 
severe.
---------------------------------------------------------------------------

    \56\ Often the lender extended credit knowing that the borrower 
would have no equity after taking into account a simultaneous 
second-lien (``piggyback'') loan. According to Fitch 2006 Subprime 
Performance, first-lien loans in subprime securitized pools with 
simultaneous second liens rose from 1.1 percent in 2000 to 6.4 
percent in 2003 to 30 percent in 2006. Moreover, in some cases the 
appraisal the lender relied on overstated borrower equity because 
the lender or broker pressured the appraiser to inflate the house 
value. The prohibition against coercing appraisers is discussed 
below in part X.B.
---------------------------------------------------------------------------

    House price appreciation began to slow in 2006 and house price 
levels actually began to decline in many places in 2007. Borrowers who 
could not afford their mortgage obligations because their repayment 
ability had not been assessed properly found it more difficult to lower 
their payments by refinancing. They lacked sufficient equity to meet 
newly tightened lending standards, or they had negative equity, that 
is, they owed more than their house was worth. For the same reasons, 
many consumers also could not extinguish their mortgage obligations by 
selling their homes. Declining house prices led to sharp increases in 
serious delinquency rates in both the subprime and alt-A market 
segments, as discussed above.\57\
---------------------------------------------------------------------------

    \57\ Estimates are based on data from MBA Nat'l Delinquency 
Survey.
---------------------------------------------------------------------------

    Although the focus of Sec.  226.35 is the subprime market, it may 
cover part of the alt-A market. Disregard for repayment ability was 
often found in the alt-A market as well. Alt-A loans are made to 
borrowers who typically have higher credit scores than subprime 
borrowers, but the loans pose more risk than prime loans because they 
involve small down payments or reduced income documentation, or the 
terms of the loan are nontraditional. According to one estimate, loans 
with nontraditional terms that permitted borrowers to defer principal 
(``interest-only'') or both principal and some interest (``option 
ARM'') in exchange for higher payments later--reached 78 percent of 
alt-A originations in 2006.\58\ The combination of a variable rate with 
a deferral of principal and interest held the potential for substantial 
payment shock within five years. Yet rising delinquency rates to almost 
8 percent in 2008, from less than 1 percent in 2006, could suggest that 
lenders too often assessed repayment ability at a low interest rate and 
payment that did not adequately account for near-certain payment 
increases. In addition, these loans typically were made based on 
reduced income documentation. For example, the share of interest-only 
mortgages with low or no documentation in alt-A securitized pools 
increased from around 64 percent in 2003 to nearly 80 percent in 
2006.\59\ It is generally accepted that the reduced documentation of 
income led to a high degree of income inflation in the alt-A market 
just as it did in the subprime market.
---------------------------------------------------------------------------

    \58\ David Liu and Shumin Li, Alt-A Credit--The Other Shoe 
Drops?, The MarketPulse (First American LoanPerformance, Inc., San 
Francisco, Cal.) Dec. 2006.
    \59\ Figures calculated from First American LoanPerformance 
data.
---------------------------------------------------------------------------

    Substantial injury. A borrower who cannot afford to make the loan 
payments as well as payments for property taxes and homeowners 
insurance because the lender did not adequately assess the borrower's 
repayment ability suffers substantial injury. Missing mortgage payments 
is costly: Large late fees are charged and the borrower's credit record 
is impaired, reducing her credit options. If refinancing to a loan with 
a lower payment is an option (for example, if the borrower can obtain a 
loan with a longer maturity), refinancing can slow the rate at which 
the consumer is able to pay down principal and build equity. The 
borrower may have to tap home equity to cover the refinancing's closing 
costs or may have to accept a higher interest rate in exchange for the 
lender paying the closing costs. If refinancing is not an option, then 
the borrower and household must make sacrifices to keep the home such 
as reducing other expenditures or taking additional jobs. If keeping 
the home is not tenable, the borrower must sell it or endure 
foreclosure, the costs of which (for example, property maintenance 
costs, attorneys fees, and other fees passed on to the consumer) will 
erode any equity

[[Page 44542]]

the consumer had. The foreclosure will mar the consumer's credit record 
and make it very difficult for the consumer to become a homeowner again 
any time soon. Many borrowers end up owing the lender more than the 
house is worth, especially if their homes are sold into a declining 
market as is happening today in many parts of the country. Foreclosures 
also may force consumers to move, which is costly and disruptive. In 
addition to the financial costs of unsustainable lending practices, 
borrowers and households can suffer serious emotional hardship.
    If foreclosures due to irresponsible lending rise rapidly or reach 
high levels in a particular geographic area, then the injuries can 
extend beyond the individual borrower and household to the larger 
community. A foreclosure cluster in a neighborhood can reduce homeowner 
equity throughout the neighborhood by bringing down prices, eroding the 
asset that for many households is their largest.\60\ A significant rise 
in foreclosures can create a cycle where foreclosures bring down 
property values, reducing the ability and incentive of homeowners, 
particularly those under stress for other reasons, to retain their 
homes. Foreclosure clusters also can lower municipal tax revenues, 
reducing a locality's ability to maintain services and make capital 
investments. At the same time, revenues may be diverted to mitigating 
hazards that clusters of vacant homes can create.\61\
---------------------------------------------------------------------------

    \60\ E.g., Zhenguo Lin, et al. Spillover Effects of Foreclosures 
on Neighborhood Property Values, Journal of Real Estate Finance and 
Economics Online (Nov. 2007), available at http://www.springerlink.com/content/rk4q0p4475vr3473/fulltext.pdf.
    \61\ E.g., William C. Apgar and Mark Duda. Collateral Damage: 
The Municipal Impact of Today's Mortgage Foreclosure Boom 
(Minneapolis: Homeownership Preservation Foundation 2005).
---------------------------------------------------------------------------

    Lending without regard to repayment ability also has other 
consequences. It facilitates an abusive strategy of ``flipping'' 
borrowers in a succession of refinancings designed ostensibly to lower 
borrowers' burdensome payments that actually convert borrowers' equity 
into fees for originators without providing borrowers a benefit. 
Moreover, relaxed standards, such as those that pervaded the subprime 
market recently, may increase the incidence of abusive lending 
practices by attracting less scrupulous originators into the market 
while at the same time bringing more vulnerable borrowers into the 
market. The rapid influx of new originators that can accompany a 
relaxation of lending standards makes it more difficult for regulators 
and investors alike to distinguish responsible from irresponsible 
actors. See supra part II.
    Injury not reasonably avoidable. One might assume that borrowers 
could avoid unsustainable loans by comparing their current and expected 
incomes to their current and expected expenses, including the scheduled 
loan payments disclosed under TILA and an estimate of property taxes 
and homeowners insurance. There are several reasons, however, why 
consumers, especially in the subprime market, accept risky loans they 
will struggle or fail to repay. In some cases, originators mislead 
borrowers into entering into unaffordable loans by understating the 
payment before closing and disclosing the true payment only at closing 
(``bait and switch''). At the closing table, many borrowers may not 
notice the disclosure of the payment amount or have time to consider it 
because borrowers are typically provided with many documents to sign 
then. Borrowers who consider the disclosure may nonetheless feel 
constrained to close the loan, for a number of reasons. They may 
already have paid substantial fees and expect that more applications 
would require more fees. They may have signed agreements to purchase a 
new house and sell the current house. Or they may need to escape an 
overly burdensome payment on a current loan, or urgently need the cash 
that the loan will provide for a household emergency.
    Furthermore, many consumers in the subprime market will accept 
loans knowing they may have difficulty affording the payments because 
they reasonably believe a more affordable loan will not be available to 
them. As explained in part II.B, limited transparency of prices, 
products, and originator incentives reduces a borrower's expected 
benefit from shopping further for a better option. Moreover, taking 
more time to shop can be costly, especially for the borrower in a 
financial pinch. Thus, borrowers often make a reasoned decision to 
accept unfavorable terms.
    Furthermore, borrowers' own assessment of their repayment ability 
may be influenced by their belief that a lender would not provide 
credit to a consumer who did not have the capacity to repay. Borrowers 
could reasonably infer from a lender's approval of their applications 
that the lender had appropriately determined that they would be able to 
repay their loans. Borrowers operating under this impression may not 
independently assess their repayment ability to the extent necessary to 
protect themselves from taking on obligations they cannot repay. 
Borrowers are likely unaware of market imperfections that may reduce 
lenders' incentives to fully assess repayment ability. See part II.B. 
And borrowers would not realize that a lender was applying loose 
underwriting standards such as assessing repayment ability on the basis 
of a ``teaser'' payment. In addition, originators may sometimes 
encourage borrowers to be excessively optimistic about their ability to 
refinance should they be unable to sustain repayment. For example, they 
sometimes offer reassurances that interest rates will remain low and 
house prices will increase; borrowers may be swayed by such 
reassurances because they believe the sources are experts.
    Stated income and stated asset loans can make it even more 
difficult for a consumer to avoid an unsustainable loan. With stated 
income (or stated asset) loans, the applicant may not realize that the 
originator is inflating the applicant's income and assets to qualify 
the applicant for the loan. Applicants do not necessarily even know 
that they are being considered for stated income or stated asset loans. 
They may give the originator documents verifying their income and 
assets that the originator keeps out of the loan file because the 
documents do not demonstrate the income and assets needed to make the 
loan. Moreover, if a consumer knowingly applies for a stated income or 
stated asset loan and correctly states her income or assets, the 
originator can write an inflated figure into the application form. It 
is typical for the originator to fill out the application for the 
consumer, and the consumer may not see the written application until 
closing, when the borrower often is provided with numerous documents to 
review and sign and may not review the application form with care. The 
consumer who detects the inflated numbers at the closing table may not 
realize their importance or may face constraints that make it 
particularly difficult to walk away from the table without the loan.
    Some consumers may also overstate their income or assets with the 
encouragement of a loan originator who makes it clear that the 
consumer's actual income or assets are not high enough to qualify them 
for the loans they seek. Such originators may reassure applicants that 
this is a benign and common practice. In addition, applicants may 
inflate their incomes and assets on their own initiative in 
circumstances where the originator does not have reason to know.
    For all of these reasons, borrowers cannot reasonably avoid 
injuries from lenders' disregard of repayment ability.

[[Page 44543]]

Moreover, other consumers who are not parties to irresponsible 
transactions but suffer from their spillover effects have no ability to 
prevent these injuries.
    Injury not outweighed by countervailing benefits to consumers or to 
competition. There is no benefit to consumers or competition from loans 
that are extended without regard to consumers' ability to make even the 
initial payments. There may be some benefit to consumers from loans 
that are underwritten based on the collateral and without regard to 
consumers' ability to sustain their payments past some initial period. 
For example, a consumer who has lost her principal source of income may 
benefit from being able to risk her home and her equity in the hope 
that, before she exhausts her savings, she will obtain a new job that 
will generate sufficient income to support the payment obligation. The 
Board believes, however, that this rare benefit is outweighed by the 
substantial costs to most borrowers and communities of extending 
higher-risk loans without regard to repayment ability. (Adopting 
exceptions to the rule for hardship cases would create significant 
potential loopholes and make the rule unduly complex. The final rule 
does, however, contain an exemption for temporary or ``bridge'' loans 
of 12 months or less, though this exemption is intended to be construed 
narrowly.)
    The Board recognizes as well that stated income (or stated asset) 
lending has at least three potential benefits for consumers and 
competition. It may speed credit access for consumers who need credit 
on an emergency basis, save some consumers from expending significant 
effort to document their income, and provide access to credit for 
consumers who cannot document their incomes. The first two benefits are 
limited relative to the substantial injuries caused by lenders' relying 
on unverified incomes. The third benefit is also limited given that 
consumers who file proper tax returns can use at least these documents, 
if no others are available, to verify their incomes. Among higher-
priced mortgage loans, where risks to consumers are already elevated, 
the potential benefits to consumers of stated income/stated asset 
lending are outweighed by the potential injuries to consumers and 
competition.
Final Rule
    HOEPA and Sec.  226.34(a)(4) currently prohibit a lender from 
engaging in a pattern or practice of extending HOEPA loans 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. Section 226.34(a)(4) currently provides 
that a creditor is presumed to have violated this prohibition if it 
engages in a pattern or practice of failing to verify repayment 
ability.
    The Board proposed to extend this prohibition to higher-priced 
mortgage loans, see proposed Sec.  226.35(b)(1), and to add several 
additional rebuttable presumptions of violation as well as a safe 
harbor. Under the proposal a creditor would have been presumed to 
violate the regulation if it engaged in a pattern or practice of 
failing to consider: consumers' ability to pay the loan based on the 
interest rate specified in the regulation (Sec.  226.34(a)(4)(i)(B)); 
consumers' ability to make fully-amortizing loan payments that include 
expected property taxes and homeowners insurance (Sec.  
226.34(a)(4)(i)(C)); the ratio of borrowers' total debt obligations to 
income as of consummation (Sec.  226.34(a)(4)(i)(D)); and borrowers' 
residual income (Sec.  226.34(a)(4)(i)(E)). The proposed safe harbor 
appeared in Sec.  226.34(a)(4)(ii), which provided that a creditor does 
not violate Sec.  226.34(a)(4) if the creditor has a reasonable basis 
to believe that consumers will be able to make loan payments for at 
least seven years, considering each of the factors identified in Sec.  
226.34(a)(4)(i) and any other factors relevant to determining repayment 
ability.
    The final rule removes the ``pattern or practice'' qualification 
and therefore prohibits a creditor from extending any HOEPA loan or 
higher-priced mortgage loan based on the collateral without regard to 
repayment ability. Like the proposal, the final rule provides that 
repayment ability is determined according to current and reasonably 
expected income, employment, assets other than the collateral, current 
obligations, and mortgage-related obligations such as expected property 
tax and insurance obligations. See Sec.  226.34(a)(4) and (a)(4)(i); 
Sec.  226.35(b)(1). The final rule also shifts the proposed new 
presumptions of violations to a presumption of compliance, with 
modifications. The presumption of compliance is revised to specify a 
finite set of underwriting procedures; the reference to ``any other 
factors relevant to determining repayment ability'' has been removed. 
See Sec.  226.34(a)(4)(iii). The presumption of violation for failing 
to verify repayment ability currently in Sec.  226.34(a)(4)(i), 
however, is being finalized instead as an explicit requirement to 
verify repayment ability. See Sec.  226.34(a)(4)(ii). This section 
discusses the basic prohibition, and ensuing sections discuss the 
removal of pattern or practice, the verification requirement, and the 
presumption of compliance.
    As discussed above, the Board finds extending higher-priced 
mortgage loans or HOEPA loans based on the collateral without regard to 
the consumer's repayment ability to be an unfair practice. The final 
rule prohibits this practice. The Board also took into account state 
laws that declare extending loans to consumers who cannot repay an 
unfair practice.\62\
---------------------------------------------------------------------------

    \62\ See, e.g., Ind. Code Sec. Sec.  24-4.5-6-102, 24-4.5-6-
111(l)(3); Mass. Gen. Laws ch. 93A, ch. 183 Sec. Sec.  4, 18(a); 
W.V. Code Sec.  46A-7-109(3)(a).
---------------------------------------------------------------------------

    Section 226.34(a)(4) governs the process for extending credit; it 
is not intended to dictate which types of credit or credit terms are 
permissible and which are not. The rule does not prohibit potentially 
riskier types of loans such as loans with balloon payments, loans with 
interest-only payments, or ARMs with discounted initial rates. With 
proper underwriting, such products may be appropriate for certain 
borrowers in the subprime market. The regulation merely prohibits a 
creditor from extending such products or any other higher-priced 
mortgage loans without adequately evaluating repayment ability.
    The rule is intended to ensure that creditors do not assess 
repayment ability using overstated incomes or understated payment 
obligations. The rule explicitly requires that the creditor verify 
income and assets using reliable third party documents and, therefore, 
prohibits relying merely on an income statement from the applicant. See 
Sec.  226.34(a)(4)(ii). (This requirement is discussed in more detail 
below.) In addition, the rule requires assessing not just the 
consumer's ability to pay loan principal and interest, but also the 
consumer's ability to pay property taxes, homeowners insurance, and 
similar mortgage-related expenses. Mortgage-related expenses, such as 
homeowner's association dues or condominium or cooperative fees, are 
included because failure to pay them could result in a consumer's 
default on his or her mortgage (if, for example, failure to pay 
resulted in a senior lien on the unit that constituted a default under 
the terms of the consumer's mortgage obligations). See Sec. Sec.  
226.34(a)(4); 226.34(a)(4)(i).
    As of consummation. The final rule provides, as did the proposed 
rule, that the creditor is responsible for assessing repayment ability 
as of consummation. Two industry trade associations expressed concern 
over proposed

[[Page 44544]]

comment 34(a)(4)-2, indicating that, while a creditor would be liable 
only for what it knew or should have known as of consummation, events 
after consummation may be relevant to determining compliance. These 
commenters contend that creditors should not be held responsible for 
accurately predicting future events such as a borrower's employment 
stability or house price appreciation. One asserted that the rule would 
lead creditors to impose more stringent underwriting criteria in 
geographic areas with economies projected to decline. These commenters 
requested that the Board clarify in the commentary that post-closing 
events cannot be used to second-guess a lender's underwriting decision, 
and one requested that the commentary specifically state that a 
foreclosure does not create a presumption of a violation.
    The Board has revised the comment, renumbered as 34(a)(4)-5, to 
delete the statement that events after consummation may be relevant to 
determining whether a creditor has violated Sec.  226.34(a)(4), but 
events after consummation do not, by themselves, establish a violation. 
Post-consummation events such as a sharp increase in defaults could be 
relevant to showing a ``pattern or practice'' of disregarding repayment 
ability, but the final rule does not require proof of a pattern or 
practice. The final comment retains the proposed statement that a 
violation is not established if borrowers default because of 
significant expenses or income losses that occur after consummation. 
The Board believes it is clear from the regulation and comment that a 
default does not create a presumption of a violation.
    Income, assets, and employment. The final rule, like the proposal, 
provides that sources of repayment ability include current and 
reasonably expected income, employment, and assets other than the 
collateral. For the sake of clarity, new comment 34(a)(4)-2 indicates 
that a creditor may base its determination of repayment ability on 
current or reasonably expected income, on assets other than the 
collateral, or both. A creditor that purported to determine repayment 
ability on the basis of information other than income or assets would 
have to clearly demonstrate that this information is probative of 
repayment ability.
    The Board is not adopting the suggestion from several commenters to 
permit creditors to consider, when determining repayment ability, other 
characteristics of the borrower or the transaction such as credit score 
and loan-to-value ratio. These other characteristics may be critical to 
responsible mortgage underwriting, but they are not as probative as 
income and assets of the consumer's ability to make the scheduled 
payments on a mortgage obligation. For example, if a consumer has 
income of $3,000 per month, it is very unlikely that the consumer will 
be able to afford a monthly mortgage payment of $2,500 per month 
regardless of the consumer's credit score or loan-to-value ratio. 
Moreover, incorporating these other characteristics in the regulation 
would potentially create a major loophole for originators to discount 
the importance of income and assets to repayment ability. For the same 
reasons, the Board also is not adopting the suggestion of some 
commenters to permit a creditor to rely on any factor that the creditor 
finds relevant to determine credit or delinquency risk.
    The final rule, like the proposal, provides broad flexibility as to 
the types of income, assets, and employment a creditor may rely on. 
Specific references to seasonal and irregular employment were added to 
comment 34(a)(4)-6 (numbered 34(a)(4)-3 in the proposal) in response to 
requests from commenters. References to several different types of 
income, such as interest and dividends, were also added. These examples 
are merely illustrative, not exhaustive.
    The final rule and commentary also follow the proposal in 
permitting a lender to rely on expected income and employment, not just 
current income and employment. Expectations for improvements in 
employment or income must be reasonable and verified with third party 
documents. The commentary gives examples of expected bonuses verified 
with documents demonstrating past bonuses, and expected employment 
verified with a commitment letter from the future employer stating a 
specified salary. See comment 34(a)(4)(ii)-3. In some cases a loan may 
have a likely payment increase that would not be affordable at the 
borrower's income as of consummation. A creditor may be able to verify 
a reasonable expectation of an increase in the borrower's income that 
will make the higher payment affordable to the borrower.
    Several commenters expressed concern over language in proposed 
comment 34(a)(4)-3 indicating that creditors are required, not merely 
allowed, to consider information about expected changes in income or 
employment that would undermine repayment ability. The proposed comment 
gave as an example that a creditor must consider information indicating 
that an employed person will become unemployed. Some commenters 
contended that it is appropriate to permit lenders to consider expected 
income or employment, but inappropriate to require that they do so. 
Creditors are concerned that they would be liable for accurately 
assessing a borrower's employment stability, which may depend on 
regional economic factors.
    The final comment, renumbered as 34(a)(4)-5, is revised somewhat to 
address this concern. The revised comment indicates that a creditor 
might have knowledge of a likely reduction in income or employment and 
provides the following example: a consumer's written application 
indicates that the consumer plans to retire within twelve months or 
transition from full-time to part-time employment. As the example 
indicates, the Board does not intend to place unrealistic requirements 
on a creditor to speculate or inquire about every possible change in a 
borrower's life circumstances. The sentence ``a creditor may have 
information indicating that an employed person will become unemployed'' 
is deleted as duplicative.
    Finally, new comment 34(a)(4)-7 addresses the concern of several 
commenters that the proposal appeared to require them to make inquiries 
of borrowers or consider information about them that Regulation B, 12 
CFR part 202, would prohibit, such as a question posed solely to a 
female applicant as to whether she is likely to continue her 
employment. The comment explains that Sec.  226.34(a)(4) does not 
require or permit the creditor to make inquiries or verifications that 
would be prohibited by Regulation B.
    Obligations. The final rule, like the proposed rule, requires the 
creditor to consider the consumer's current obligations as well as 
mortgage-related obligations such as expected property tax and required 
insurance. See Sec.  226.34(a)(4)(i). The final rule does not contain 
the proposed rule's reference to ``expected obligations.'' An industry 
trade association suggested the reference would stifle communications 
between a lender and a consumer because the lender would seek to avoid 
eliciting information about the borrower's plans for future 
indebtedness, such as an intention to take out student loans to send 
children to college. The Board agrees that the proposal could stifle 
communications. This risk does not have a sufficient offsetting benefit 
because it is by nature speculative whether a mortgage borrower will 
undertake other credit obligations in the future.
    A reference to simultaneous mortgage obligations (proposed comment 
34(a)(4)(i)-2)) has been retained but

[[Page 44545]]

revised. See comment 34(a)(4)-3. Several commenters objected to the 
proposed comment. They suggested a lender has a limited ability to 
identify the existence of a simultaneous obligation with an 
unaffiliated lender if the borrower does not self-report. They asked 
that the requirement be restricted to simultaneous obligations with the 
same lender, or that it be limited to obligations the creditor knows or 
has reason to know about, or that it have a safe harbor for a lender 
that has procedures to prevent consumers from obtaining a loan from 
another creditor without the lender's knowledge. The comment has been 
revised to indicate that the regulation makes a creditor responsible 
for considering only those simultaneous obligations of which the 
creditor has knowledge.
    Exemptions. The Board is adopting the proposed exemptions from the 
rule for bridge loans, construction-only loans, reverse mortgages, and 
HELOCs. These exemptions are discussed in part VIII.H. A national bank 
and two trade associations with national bank members requested an 
additional exemption for national banks that are in compliance with OCC 
regulation 12 CFR 34.3(b). The OCC regulation prohibits national banks 
from making a mortgage loan based predominantly on the bank's 
realization of the foreclosure or liquidation value of the borrower's 
collateral without regard to the borrower's ability to repay the loan 
according to its terms. Unlike HOEPA, however, the OCC regulation does 
not authorize private actions or actions by state attorneys general 
when the regulation is violated. Thus, the Board is not adopting the 
requested exemption.
Pattern or Practice
    Based on the comments and additional information gathered by the 
Board, the Board is adopting the rule without the phrase ``pattern or 
practice.'' The rule therefore prohibits an individual HOEPA loan or 
higher-priced mortgage loan from being extended based on the collateral 
without regard to repayment ability. TILA Section 129(l)(2), 15 U.S.C. 
1638(l)(2), confers on the Board authority to revise HOEPA's 
restrictions on HOEPA loans if the Board finds that such revisions are 
necessary to prevent unfair or deceptive acts or practices in 
connection with mortgage loans. The Board so finds for the reasons 
discussed below.
    Public comment. Consumer advocates and others strongly urged the 
Board to remove the pattern or practice element. They argued that the 
burden to prove a pattern or practice is so onerous as to make it 
impracticable for an individual plaintiff to seek relief, either 
affirmatively or in recoupment. They suggested a typical plaintiff does 
not have the resources to obtain information about a lender's loans and 
loan policies sufficient to allege a pattern or practice. Moreover, 
should a plaintiff be able to allege a pattern or practice and proceed 
to the discovery stage, one legal aid organization commented based on 
direct experience that a creditor may produce a mountain of documents 
that overwhelms the plaintiff's resources and makes it impractical to 
pursue such cases. One consumer group argued that the proposed rule 
would not adequately deter abuse because, by the time a pattern or 
practice emerged, substantial harm would already have been done to 
consumers and investors. This commenter also argued that other TILA 
provisions give creditors sufficient protection against litigation 
risk, such as the cap on class action damages, the right to cure 
certain errors creditors discover on their own, and the defense for 
bona fide errors.
    Several lenders and lender trade associations expressed concern 
that ``pattern or practice'' is too vague to provide the certainty 
creditors seek and asked for more specific guidance and examples. Other 
industry commenters contended that the phrase was likely to be 
interpreted to hold lenders that originate large numbers of loans 
liable for errors in assessing repayment ability in just a small 
fraction of their originations. For example, one large lender pointed 
out that an error rate of 0.5 percent in its 400,000 HMDA-reportable 
originations in 2006 would have amounted to 2,000 loans. Several 
commenters cited cases decided under other statutes holding that a mere 
handful of instances were a pattern or practice. To address these 
concerns, two commenters requested that the phrase be changed to 
``systematic practice'' and that this new phrase be interpreted to mean 
willful or reckless disregard. Industry commenters generally preferred 
that ``pattern or practice,'' whatever its limitations, be retained as 
a form of protection against unwarranted litigation.
    Discussion. The Board believes that removing ``pattern or 
practice'' is necessary to ensure a remedy for consumers who are given 
unaffordable loans and to deter irresponsible lending, which injures 
not just individual borrowers but also their neighbors and communities. 
The Board further believes that the presumption of compliance the Board 
is adopting will provide more certainty to creditors than either 
``pattern or practice'' or the proposed safe harbor. The presumption 
will better aid creditors with compliance planning, and it will better 
help them mitigate litigation risk. In short, the Board believes that 
removing ``pattern or practice'' and providing creditors a presumption 
of compliance will be more effective to prevent unfair practices, 
remedy them when they occur, and preserve access to credit.
    Imposing the burden to prove ``pattern or practice'' on an 
individual borrower would leave many borrowers without a remedy under 
HOEPA for loans that were made without regard to repayment ability. 
Borrowers would not have a HOEPA remedy for individual, unrelated loans 
made without regard to repayment ability, of which there could be many 
in the aggregate. Even if an unaffordable loan was part of a pattern or 
practice, the individual borrower and his or her attorney would not 
necessarily have that information.\63\ By the time information about a 
particular lender's pattern or practice of unaffordable lending became 
widespread, the lender could have caused great injury to many 
borrowers, as well as to their neighbors and communities. In addition, 
imposing a ``pattern or practice'' requirement on HOEPA loans, but not 
higher-priced mortgage loans, would create an anomaly.
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    \63\ Federal rules of civil procedure require that a defendant's 
motion to dismiss be granted unless the plaintiff alleged sufficient 
facts to make a pattern or practice ``plausible.'' Bell Atlantic v. 
Twombly, 127 S. Ct. 1955 (2007). Many states follow the federal 
rules.
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    Moreover, a ``pattern or practice'' claim can be costly to litigate 
and might not be economically feasible except as part of a class 
action, which would not assure individual borrowers of adequate 
remedies. Class actions can take years to reach a settlement or trial, 
while the individual borrower who is facing foreclosure because of an 
unaffordable loan requires a speedy resolution if the borrower is to 
keep the home. Moreover, lower-income homeowners are often represented 
by legal aid organizations, which are barred from bringing class 
actions if they accept funds from the Legal Services Corporation.\64\
---------------------------------------------------------------------------

    \64\ 45 CFR 1617.3.
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    To be sure, many borrowers who would be left without a HOEPA remedy 
for an unaffordable loan may have remedies under state laws that lack a 
``pattern or practice'' requirement. In some cases, however, state law 
remedies would be inferior or unavailable. Moreover, state laws do not 
assure consumers uniform protection because these laws vary 
considerably and

[[Page 44546]]

generally may not cover federally chartered depository institutions 
(due to federal preemption) or state chartered depository institutions 
(due to specific exemptions or general ``parity laws'').
    For these reasons, imposing the burden to prove ``pattern or 
practice'' on an individual borrower would leave many borrowers with a 
lesser remedy, or without any remedy, for loans made without regard to 
repayment ability. Removing this burden would not only improve remedies 
for individual borrowers, it would also increase deterrence of 
irresponsible lending. Individual remedies impose a more immediate and 
more certain cost on violators than either class actions or actions by 
state or federal agencies, which can take years and, in the case of the 
agencies, are subject to resource constraints. Increased deterrence of 
irresponsible lending practices should benefit not just borrowers who 
might obtain higher-priced mortgage loans but also their neighbors and 
communities who would otherwise suffer the spillover effects of such 
practices.
    The Board acknowledges the legitimate concerns that lenders have 
expressed over litigation costs. As the Board indicated with the 
proposal, it proposed ``pattern or practice'' out of a concern that 
creating civil liability for an originator that fails to assess 
repayment ability on any individual loan could inadvertently cause an 
unwarranted reduction in the availability of mortgage credit to 
consumers. After further study, however, the Board believes that any 
increase in litigation risk would be justified by the substantial 
benefits of a rule that provided remedies to individual borrowers. 
While unwarranted litigation may well increase, the Board believes that 
several factors will mitigate this cost. In particular, TILA imposes a 
one-year statute of limitations on affirmative claims, after which only 
recoupment and set-off are available; HOEPA limits the strict assignee 
liability of TILA Section 131(d), 15 U.S.C. 1641(d) to HOEPA loans; 
many defaults may be caused by intervening events such as job loss 
rather than faulty underwriting; and plaintiffs (or their counsel) may 
bear a substantial cost to prove a claim of faulty underwriting, which 
would often require substantial discovery and expert witnesses. 
Creditors could further contain litigation risk by using the procedures 
specified in the regulation that earn the creditor a presumption of 
compliance.
    The Board has also considered the possibility that the statute's 
``pattern or practice'' element allows creditors an appropriate degree 
of flexibility to extend occasional collateral-based HOEPA loans to 
consumers who truly need them and clearly understand the risks 
involved. Removing ``pattern or practice'' would eliminate this 
potential consumer benefit. Based on industry comments, however, the 
benefit is more theoretical than real. While industry commenters may 
prefer retaining ``pattern or practice'' as a barrier to individual 
suits, these commenters indicated that ``pattern or practice'' is too 
vague to be useful for compliance planning. Therefore, retaining 
``pattern or practice'' would not likely lead a creditor to extend 
legitimate collateral-based loans except, perhaps, a trivial number 
such as one per year.
    The Board reached this conclusion only after exploring ways to 
provide more clarity as to the meaning of ``pattern or practice.'' 
Existing comment 34(a)(4)-2 provides that a pattern or practice depends 
on the totality of the circumstances in the particular case; can be 
established without the use of a statistical process and on the basis 
of an unwritten lending policy; and cannot be established with 
isolated, random, or accidental acts. Although this comment has been in 
effect for several years, its effectiveness is impossible to assess 
because the market for HOEPA loans shrank to near insignificance soon 
after the comment was adopted.\65\ On its face, however, the guidance 
removes little of the uncertainty surrounding the meaning of ``pattern 
or practice.'' (There is only one reported decision to interpret 
``pattern or practice'' under HOEPA, Newton v. United Companies 
Financial Corp., 24 F. Supp. 2d 444 (E.D. Pa. 1998), and it has limited 
precedential value in light of later-adopted comment 34(a)(4)-2.) The 
Board re-proposed the comment but commenters provided few concrete 
suggestions for making the rule clearer and the suggestions that were 
offered would have left a large degree of uncertainty.
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    \65\ By 2004, HOEPA loans reported under HMDA were less than one 
percent of the mortgage market. The Board does not believe the 
market's contraction can be traced to the guidance on pattern or 
practice.
---------------------------------------------------------------------------

    The Board considered other potential sources of guidance on 
``pattern or practice'' from other statutes and regulations. Case law 
is of inherently limited value for such a contextual inquiry. Moreover, 
there are published court decisions, some cited by industry commenters, 
that suggest that even a few instances could be considered to meet this 
standard.\66\ The Board also consulted informal guidance interpreting 
``pattern or practice'' under ECOA.\67\ The Board carefully considered 
how it could adapt this guidance to Sec.  226.34(a)(4). Based on its 
efforts, the Board concluded that, while additional guidance could 
reduce some uncertainty, it would necessarily leave substantial 
uncertainty. The Board further concluded that significantly more 
certainty could be provided through the ``presumption of compliance'' 
the final rule provides for following enumerated underwriting 
practices. See Sec.  226.34(a)(4)(iii), discussed below.
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    \66\ See, e.g., United States v. Balistrieri, 981 F.2d 916, 929-
30 (7th Cir. 1992); United States v. Pelzer Realty Co., Inc., 484 
F.2d 438, 445 (5th Cir. 1973).
    \67\ Board Policy Statement on Enforcement of the Equal Credit 
Opportunity and Fair Housing Acts, Q9.
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Verification of Repayment Ability
    Section 226.34(a)(4) currently contains a provision creating a 
rebuttable presumption of a violation where a lender engages in a 
pattern or practice of making HOEPA loans without verifying and 
documenting repayment ability. The Board proposed to retain this 
presumption and extend it to higher-priced mortgage loans. The final 
rule is different in two respects. First, as discussed above, the final 
rule does not contain a ``pattern or practice'' element. Second, it 
makes verifying repayment ability an affirmative requirement, rather 
than making failure to verify a presumption of a violation.
    In the final rule, the regulation applies the verification 
requirement to current obligations explicitly, see Sec.  
226.34(a)(4)(ii)(C); in the proposal, an explicit reference to 
obligations was in a staff comment. See proposed comment 
34(a)(4)(i)(A)-2, 73 FR at 1732. The requirement to verify income and 
assets in final Sec.  226.34(a)(4)(ii)(A) is essentially identical to 
the requirement of proposed Sec.  226.35(b)(2). Under Sec.  
226.34(a)(4)(ii)(A), creditors must verify assets or income, including 
expected income, relied on in approving an extension of credit using 
third-party documents that provide reasonably reliable evidence of the 
income or assets. The final rule, like that proposed, includes an 
affirmative defense for a creditor that can show that the amounts of 
the consumer's income or assets relied on were not materially greater 
than the amount the creditor could have verified at consummation.
    Public comment. Many, but by no means all, financial institutions, 
mortgage brokers, and mortgage industry trade groups that commented 
support a verification requirement. They raised concerns, however, that 
the particular requirement proposed would

[[Page 44547]]

restrict or eliminate access to credit for some borrowers, especially 
the self-employed, those who earn irregular commission- or cash-based 
incomes, and low- and moderate-income borrowers. Consumer and community 
groups and government officials generally supported the proposed 
verification requirement, with some suggesting somewhat stricter 
requirements. Many of these same commenters, however, contended the 
proposed affirmative defense would be a major loophole and urged its 
elimination. The comments are discussed in further detail below as 
applicable.
    Discussion. For the reasons discussed above, the Board finds that 
it is unfair not to verify income, assets, and obligations used to 
determine repayment ability when extending a higher-priced mortgage 
loan or HOEPA loan. The Board is finalizing the rule as proposed and 
incorporating it directly into Sec.  226.34(a)(4), where it replaces 
the proposed presumption of a violation for a creditor that has a 
pattern or practice of failing to verify repayment ability. ``Pattern 
or practice'' has been removed and the presumption has been made a 
requirement. The legal effect of this change is that the final rule, 
unlike the proposal, would rarely, if ever, permit a creditor to make 
even isolated ``no income, no asset'' loans (loans made without regard 
to income and assets) in the higher-priced mortgage loan market. For 
the reasons explained above, however, the Board does not believe this 
legal change will reduce credit availability; nor will it affect the 
availability of ``no income, no asset'' loans in the prime market.
    As discussed above, relying on inflated incomes or assets to 
determine repayment ability often amounts to disregarding repayment 
ability, which causes consumers injuries they often cannot reasonably 
avoid. By requiring verification of income and assets, the final rule 
is intended to limit these injuries by reducing the risk that higher-
priced mortgage loans will be made on the basis of inflated incomes or 
assets.\68\ The Board believes the rule is sufficiently flexible to 
keep costs to consumers, such as any additional time needed to close a 
loan or costs for obtaining documentation, at reasonable levels 
relative to the expected benefits of the rule.
---------------------------------------------------------------------------

    \68\ By requiring verification the rule also addresses the risk 
that consumers with higher-priced mortgage loans who could document 
income would unknowingly pay more for a loan that did not require 
documentation.
---------------------------------------------------------------------------

    The rule specifically authorizes a creditor to rely on W-2 forms, 
tax returns, payroll receipts, and financial institution records such 
as bank statements. These kinds of documents are sufficiently reliable 
sources of information about borrowers' income and assets that the 
Board believes it is appropriate to provide a safe harbor for their 
use. Moreover, most consumers can, or should be able to, produce one of 
these kinds of documents with little difficulty. For other consumers, 
the rule is quite flexible. It permits a creditor to rely on any third-
party document that provides reasonably reliable evidence of the income 
or assets relied on to determine repayment ability. Examples include 
check-cashing or remittance receipts or a written statement from the 
consumer's employer. See comment 34(a)(4)(ii)(A)-3. These examples are 
only illustrative, not limiting. The one type of document that is 
excluded is a statement only from the consumer.
    Many commenters suggested that the Board require creditors to 
collect the ``best and most appropriate'' documentation. The Board 
believes that the costs of such a requirement would outweigh the 
benefits. The vagueness of the suggested standard could make creditors 
reluctant to accept nontraditional forms of documentation. Nor is it 
clear how creditors would verify that a form of documentation that 
might be best or most appropriate was not available.
    The commentary has been revised to clarify several points. See 
comments 34(A)(4)(ii)(A)-3 and -4. Oral information from a third party 
would not satisfy the rule, which requires documentation. Creditors 
may, however, rely on a letter or an e-mail from the third party. 
Creditors may also rely on third party documentation the consumer 
provides directly to the creditor. Furthermore, as interpreted by the 
comments, the rule excludes documents that are not specific to the 
consumer. It would not be sufficient to look at average incomes for the 
consumer's stated profession in the region where the consumer lives or 
average salaries for employees of the consumer's employer. The 
commentary has been revised, however, to indicate that creditors may 
use third party information that aggregates individual-specific data 
about consumers' income, such as a database service used by an employer 
to centralize income verification requests, so long as the information 
is reasonably current and accurate and identifies the specific 
consumer's income.
    The rule does not require creditors that have extended credit to a 
consumer and wish to extend new credit to the same consumer to re-
collect documents that the creditor previously collected from the 
consumer, if the creditor believes the documents would not have changed 
since they were initially verified. See comment 34(a)(4)(ii)(A)-5. For 
example, if the creditor has collected the consumer's 2006 tax return 
for a May 2007 loan, and the creditor makes another loan to that 
consumer in August 2007, the creditor may rely on the 2006 tax return.
    Nor does the rule require a creditor to verify amounts of income or 
assets the creditor is not relying on to determine repayment ability. 
For example, if a creditor does not rely on a part of the consumer's 
income, such as an annual bonus, in determining repayment ability, the 
creditor would not need to verify the consumer's bonus. A creditor may 
verify an amount of income or assets less than that stated in the loan 
file if adequate to determine repayment ability. If a creditor does not 
verify sufficient amounts to support a determination that the consumer 
has the ability to pay the loan, however, then the creditor risks 
violating the regulation.
    Self-employed borrowers. The Board has sought to address 
commenters' concerns about self-employed borrowers. The rule allows for 
flexibility in underwriting standards so that creditors may adapt their 
underwriting processes to the needs of self-employed borrowers, so long 
as creditors comply with Sec.  226.34(a)(4). For example, the rule does 
not dictate how many years of tax returns or other information a 
creditor must review to determine a self-employed applicant's repayment 
ability. Nor does the rule dictate which income figure on the tax 
returns the creditor must use. The Internal Revenue Code may require or 
permit deductions from gross income, such as a deduction for capital 
depreciation, that a creditor reasonably would regard as not relevant 
to repayment ability.
    The rule is also flexible as to consumers who depend heavily on 
bonuses and commissions. If an employed applicant stated that he was 
likely to receive an annual bonus of a certain amount from the 
employer, the creditor could verify the statement with third-party 
documents showing a consumer's past annual bonuses. See comment 
34(a)(4)(ii)-1. Similarly, employees who work on commission could be 
asked to produce third-party documents showing past commissions.
    The Board is not adopting the exemption some commenters requested 
for self-employed borrowers. The exemption would give borrowers and 
originators an incentive to declare a borrower employed by a third 
party to

[[Page 44548]]

be self-employed to avoid having to verify the borrower's income. It is 
not clear how a declaration of self-employed status could be verified 
except by imposing the very burden the exemption would be meant to 
avoid, such as reviewing tax returns.
    The affirmative defense. The Board received a number of comments 
about the proposed affirmative defense for a creditor that can show 
that the amounts of the consumer's income or assets the creditor relied 
on were not materially greater than what the creditor could have 
documented at consummation. The Board's reference to this defense as a 
``safe harbor'' appears to have caused some confusion. Many commenters 
interpreted the phrase ``safe harbor'' to mean that the Board was 
proposing a specific way to comply with the rule. These commenters 
either criticized the safe harbor as insufficiently specific about how 
to comply (in the case of industry commenters) or urged that it be 
eliminated as a major loophole for avoiding verifying income and assets 
(in the case of consumer group and other commenters).
    The Board intended the provision merely as a defense for a lender 
that did not verify income as required where the failure did not cause 
injury. The provision would place the burden on the lender to prove 
that its non-compliance was immaterial. A creditor that does not verify 
income has no assurance that the defense will be available should the 
loan be challenged in court. This creditor takes a substantial risk 
that it will not be able to prove through discovery that the income was 
as stated. Therefore, the Board expects that the defense will be used 
only in limited circumstances. For example, a creditor might be able to 
use the defense when a bona fide compliance error, such as an 
occasional failure of reasonable procedures for collecting and 
retaining appropriate documents, produces litigation. The defense is 
not likely to be helpful to a creditor in the case of compliance 
examinations because there will not be an opportunity in that context 
for the creditor to determine the borrower's actual income. With this 
clarification, the Board is adopting the affirmative defense as 
proposed.
    The defense is available only where the creditor can show that the 
amounts of income and assets relied on were not materially greater than 
the amounts the creditor could have verified. The definition of 
``material'' is not based on a numerical threshold as some commenters 
suggested. Rather, the commentary has been revised to clarify that 
creditors would be required to show that, if they had relied on the 
amount of verifiable income or assets, their decision to extend credit 
and the terms of the credit would not have been different. See comment 
34(a)(4)(ii)(B)-2.
    Narrower alternatives. The Board sought comment on whether the rule 
should be narrowed to prohibit only extending credit where the creditor 
or mortgage broker engaged in, influenced the borrower to engage in, or 
knew of income or asset inflation. The vast majority of commenters who 
addressed this alternative did not support it, and the Board is not 
adopting it. Placing the burden on the borrower or supervisory agency 
to prove the creditor knew the income was inflated would undermine the 
rule's effectiveness. In the case of borrower claims or counter-claims, 
this burden would lead to costly discovery into factual questions, and 
this discovery would often produce conflicting evidence (``he said, she 
said'') that would require trial before a factfinder. A creditor 
significantly increases the risk of income inflation when it accepts a 
mere statement of income, and the creditor is in the best position to 
substantially reduce this risk at limited cost by simply requiring 
documentation. The Board believes this approach is the most effective 
and efficient way to protect not just the individual borrower but also 
the neighbors and communities that can suffer from spillover effects of 
unaffordable lending.
    Some industry commenters suggested adopting an affirmative defense 
for creditors who can show that the consumer intentionally 
misrepresented income or assets or committed fraud. The Board is not 
adopting this defense. As discussed above, a rule that provided 
creditors with a defense where no documentation was present could 
result in litigation that was costly for both sides. A defense for 
cases of consumer misrepresentation or fraud where the creditor 
documented the consumer's income or assets would be unnecessary. 
Creditors are allowed to rely on documents provided directly by the 
consumer so long as those documents provide reasonably reliable 
evidence of the consumer's income or assets. A consumer who provided 
false documentation to the creditor, and who wished to bring a claim 
against the creditor, would have to demonstrate that the creditor 
reasonably should not have relied on the document. If the only fact 
that made the document unreliable was the consumer's having provided 
false information without the creditor's knowledge, it would not have 
been unreasonable for the creditor to rely on that document.
    Obligations. The proposal essentially required a creditor to verify 
repayment ability; it provided that a pattern or practice of failing to 
verify repayment ability created a presumption of a violation. A 
proposed comment indicated that verifying repayment ability included 
verifying obligations. See proposed comment 34(a)(4)(i)(A)-2. The final 
rule explicitly includes the requirement to verify obligations in the 
regulation. See Sec.  226.34(a)(4)(ii)(C). A comment to this provision 
indicates that a credit report may be used to verify current 
obligations. A credit report, however, might not reflect certain 
obligations undertaken just before or at consummation of the 
transaction and secured by the same dwelling that secures the 
transaction (for example, a ``piggyback'' second-lien transaction used 
to finance part of the down payment on the house where the first-lien 
transaction is for home purchase). A creditor is responsible for 
considering such obligations of which the creditor has knowledge. See 
comment 34(a)(4)-3.
Presumption of Compliance
    The Board proposed to add new, rebuttable presumptions of 
violations to Sec.  226.34(a)(4) and, by incorporation, Sec.  
226.35(b)(1). These presumptions would have been for engaging in a 
pattern or practice of failing to consider: consumers' ability to pay 
the loan based on the interest rate specified in the regulation; 
consumers' ability to make fully-amortizing loan payments that include 
expected property taxes and homeowners insurance; the ratio of 
borrowers' total debt obligations to income as of consummation; and 
borrowers' residual income. See proposed Sec.  226.34(a)(4)(i)(B)-(E). 
The Board also proposed a presumption of compliance for a creditor that 
has a reasonable basis to believe that consumers will be able to make 
loan payments for at least seven years, considering each of the factors 
identified in Sec.  226.34(a)(4)(i) and any other factors relevant to 
determining repayment ability.
    The final rule removes the proposed presumptions of violation for 
failing to follow certain underwriting practices and incorporates these 
practices, with modifications, into a presumption of compliance that is 
substantially revised from that proposed. Under Sec.  
226.34(a)(4)(iii), a creditor is presumed to have complied with Sec.  
226.34(a)(4) if the creditor satisfies each of three requirements: (1) 
Verifying repayment ability; (2) determining the consumer's repayment 
ability using largest scheduled payment of principal and

[[Page 44549]]

interest in the first seven years following consummation and taking 
into account property tax and insurance obligations and similar 
mortgage-related expenses; and (3) assessing the consumer's repayment 
ability using at least one of the following measures: a ratio of total 
debt obligations to income, or the income the consumer will have after 
paying debt obligations. (The procedures for verifying repayment 
ability are required under paragraph 34(a)(4)(ii); the other procedures 
are not required.)
    Unlike the proposed presumption of compliance, the presumption of 
compliance in the final rule is not conditioned on a requirement that a 
creditor have a reasonable basis to believe that a consumer will be 
able to make loan payments for a specified period of years. Comments 
from creditors indicated this proposed requirement was not necessary 
and introduced an undue degree of compliance uncertainty. The final 
presumption of compliance, therefore, replaces this general requirement 
with the three specific procedural requirements mentioned in the 
previous paragraph.
    The creditor's presumption of compliance for following these 
procedures is not conclusive. The Board believes a conclusive 
presumption could seriously undermine consumer protection. A creditor 
could follow the procedures and still disregard repayment ability in a 
particular case or potentially in many cases. Therefore, the borrower 
may rebut the presumption with evidence that the creditor disregarded 
repayment ability despite following these procedures. For example, 
evidence of a very high debt-to-income ratio and a very limited 
residual income could be sufficient to rebut the presumption, depending 
on all of the facts and circumstances. If a creditor fails to follow 
one of the non-mandatory procedures set forth in paragraph 
34(a)(4)(iii), then the creditor's compliance is determined based on 
all of the facts and circumstances without there being a presumption of 
either compliance or violation. See comment 34(a)(4)(iii)-1.
    Largest scheduled payment in seven years. When a loan has a fixed 
rate and a fixed payment that fully amortizes the loan over its 
contractual term to maturity, there is no ambiguity about the rate and 
payment at which the lender should assess repayment ability: The lender 
will use the fixed rate and the fixed payment. But when the rate and 
payment can change, as has often been true of subprime loans, a lender 
has to choose a rate and payment at which to assess repayment ability. 
The Board proposed that a creditor would be presumed to have 
disregarded repayment ability if it had engaged in a pattern or 
practice of failing to use the fully-indexed rate (or the maximum rate 
in seven years on a step-rate loan) and the fully-amortizing payment.
    As discussed, the final rule does not contain this proposed 
presumption of violation. Instead, it provides that a creditor will 
have a presumption of compliance if, among other things, the creditor 
uses the largest scheduled payment of principal and interest in the 
first seven years. This payment could be higher, or lower, than the 
payment determined according to the fully-indexed rate and fully-
amortizing payment. The Board believes that the final rule is clearer 
and simpler than the proposal. It incorporates long-established 
principles in Regulation Z for determining a payment schedule when 
rates or payments can change, which should facilitate compliance. See 
comment 34(a)(4)(iii)(B)-1. The final rule is also more flexible than 
the proposal. Instead of requiring the creditor to use a particular 
payment, it provides the creditor who uses the largest scheduled 
payment in seven years a presumption of compliance. The creditor has 
the flexibility to use a lower payment, and no presumption of violation 
would attach; though neither would a presumption of compliance. 
Instead, compliance would be determined based on all of the facts and 
circumstances.
    Two aspects of Sec.  226.34(a)(4) help ensure that this approach 
provides consumers effective protection. First, the Board is adopting 
the proposed seven-year horizon. That is, under Sec.  
226.34(a)(4)(iii)(B) the relevant payment for underwriting is the 
largest payment in seven years. Industry commenters requested that the 
rule incorporate a time horizon of no more than five years. As these 
commenters indicated, most subprime loans, including those with fixed 
rates, have paid off (or defaulted) within five years. It is possible 
that prepayment speeds will slow, however, as subprime lending 
practices and loan terms undergo substantial changes. Moreover, the 
final rule addresses commenters' concern that the proposal seemed to 
require them to project the consumer's income, employment, and other 
circumstances for as long as seven years as a condition to obtaining a 
presumption of compliance. Under the final rule, the creditor is 
expected to underwrite based on the facts and circumstances that exist 
as of consummation. Section 226.34(a)(4)(iii)(B) sets out the payment 
to which the creditor should underwrite if it seeks to have a 
presumption of compliance. Furthermore, nothing in the regulation 
prohibits, or creates a presumption against, loan products that are 
designed to serve consumers who legitimately expect to sell or 
refinance sooner than seven years.
    A second aspect of Sec.  226.34(a)(4) that is integral to its 
balance of consumer protection and credit availability is its exclusion 
of two nontraditional types of loans from the presumption of compliance 
that can pose more risk to consumers in the subprime market. Under 
Sec.  226.34(a)(4)(iv), no presumption of compliance is available for a 
balloon-payment loan with a term shorter than seven years. If the term 
is at least seven years, the creditor that underwrites the loan based 
on the regular payments (not the balloon payment) may retain the 
presumption of compliance. If the term is less than seven years, 
compliance is determined on the basis of all of the facts and 
circumstances. This approach is simpler than some of the alternatives 
commenters recommended to address balloon-payment loans, and it better 
balances consumer protection and credit availability than other 
alternatives they suggested.\69\ Consumers are statistically very 
likely to prepay (or default) within seven years and avoid the balloon 
payment.
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    \69\ One large lender contended that balloon loans should be 
exempted from a repayment-ability rule because consumers understand 
their risks. Another recommended that balloon loans be exempted from 
the repayment ability rule if the term of the loan exceeds seven 
years for first-lien mortgages or five years for subordinate-lien 
loans. A trade association representing community banks urged that 
balloon payments be permitted so long as the creditor has a 
reasonable basis to believe the borrower will make the payments for 
the term of the loan except the final, balloon payment. This trade 
association indicated that community banks often structure the loans 
they hold in portfolio as 3- or 5-year balloon loans, typically with 
15-30 year amortization periods, to match the maturity of the loan 
to the maturity of their deposit base. A lender and a lender trade 
association recommended using on short-term balloon loans a payment 
larger than the scheduled payment but smaller than the fully-
amortizing payment, such as the payment that would correspond to an 
interest rate two percentage points higher than the rate specified 
in the presumption of compliance.
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    Loans with scheduled payments that would increase the principal 
balance (negative amortization) within the first seven years are also 
excluded from the presumption of compliance. This exclusion will help 
ensure that the presumption is available only for loans that leave the 
consumer sufficient equity after seven years to refinance. If the 
payments scheduled for the first seven years would cause the balance to 
increase, then compliance is determined

[[Page 44550]]

on all of the facts and circumstances without a presumption of 
compliance or violation.
    ``Interest-only'' loans can have a presumption of compliance. With 
these loans, after an initial period of interest-only payments the 
payment is recast to fully amortize the loan over the remaining term to 
maturity. If the period of interest-only payments is shorter than seven 
years, the creditor may retain the presumption of compliance if it uses 
the fully-amortizing payment that commences after the interest-only 
period. If the interest-only period is seven years or longer, the 
creditor may retain the presumption of compliance if it assesses 
repayment ability using the interest-only payment. Examples have been 
added to the commentary to facilitate compliance. See comment 
34(a)(4)(iii)(B)-1. Examples of variable-rate loans and a step-rate 
loan have also been added.
    Debt-to-income ratio and residual income. The proposal provided 
that a creditor would be presumed to have violated the regulation if it 
engaged in a pattern or practice of failing to consider the ratio of 
consumers' total debt obligations to consumers' income or the income 
consumers will have after paying debt obligations. A major secondary 
market participant proposed that considering total DTI and residual 
income not be an absolute prerequisite because other measures of 
income, assets, or debts may be valid methods to assess repayment 
ability. A credit union trade association contended that residual 
income is not a necessary underwriting factor if a lender uses DTI. 
Consumer and civil rights groups, however, specifically support 
including both DTI and residual income as factors, contending that 
residual income is an essential component of an affordability analysis 
for lower-income families.
    Based on the comments and its own analysis, the Board is revising 
the proposal to provide that a creditor does not have a presumption of 
compliance with respect to a particular transaction unless it uses at 
least one of the following: the consumer's ratio of total debt 
obligations to income, or the income the consumer will have after 
paying debt obligations. Thus, the final rule permits a creditor to 
retain a presumption of compliance so long as it uses at least one of 
these two measures.
    The Board believes the flexibility permitted by the final rule will 
help promote access to responsible credit without weakening consumer 
protection. The rule provides creditors flexibility to determine 
whether using both a DTI ratio and residual income increases a 
creditor's ability to predict repayment ability. If one of these 
metrics alone holds as much predictive power as the two together, as 
may be true of certain underwriting models at certain times, then 
conditioning access to a safe harbor on using both metrics could reduce 
access to credit without an offsetting increase in consumer protection. 
The Board also took into account that, at this time, residual income 
appears not to be as widely used or tested as the DTI ratio.\70\ It is 
appropriate to permit the market to develop more experience with 
residual income before considering whether to incorporate it as an 
independent requirement of a regulatory presumption of compliance.
---------------------------------------------------------------------------

    \70\ Michael E. Stone, What is Housing Affordability? The Case 
for the Residual Income Approach, 17 Housing Policy Debate 179 
(Fannie Mae 2006) (advocating use of a residual income approach but 
acknowledging that it ``is neither well known, particularly in this 
country, nor widely understood, let alone accepted'').
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    The final rule does not contain quantitative thresholds for either 
of the two metrics. The Board specifically solicited comment on whether 
it should adopt such thresholds. Industry commenters did not favor 
providing a presumption of compliance (or a presumption of a violation) 
based on a specified debt-to-income ratio. The reasons given include: 
Different investors have different guidelines for lenders to follow in 
calculating DTI; underwriters following the same procedures can 
calculate different DTIs on the same loan; borrowers may want or, in 
some high-cost areas, may need to spend more than any specified 
percentage of their income on housing and may have sufficient non-
collateral assets or residual incomes to support the loan; and loans 
with high DTIs have not necessarily had high delinquency rates. Two 
trade associations indicated they would accept a quantitative safe 
harbor if it were sufficiently flexible. Some commenters suggested a 
standard of reasonableness.
    Consumer and civil rights groups, a federal banking agency, and 
others requested that the Board set threshold levels for both DTI and 
residual income beyond which a loan would be considered unaffordable, 
subject to rebuttal by the creditor. They argued that quantitative 
thresholds for these factors would improve compliance and loan 
performance. These commenters suggested that the regulation should 
expressly recognize that, as residual income increases, borrowers can 
support higher DTI levels. They provided alternative recommendations: 
mandate the DTI and residual income levels found in the guidelines for 
loans guaranteed by the Department of Veterans Affairs, 38 CFR 36.4840; 
develop the Board's own guidelines; or impose a threshold of 50 percent 
DTI with sufficient residual income. A consumer research and advocacy 
group, however, supported the Board's proposal not to set a 
quantitative threshold. It specifically opposed a 50 percent threshold 
as too high for sustainable lending. It further maintained that any 
specific DTI threshold would not be workable because proper 
underwriting depends on too many factors, and the definition of 
``debt'' is too easily manipulated.
    The Board is concerned that making a specific DTI ratio or residual 
income level either a presumptive violation or a safe harbor could 
limit credit availability without providing adequate offsetting 
benefits. The same debt-to-income ratio can have very different 
implications for two consumers' repayment ability if the income levels 
of the consumers differ significantly. Moreover, it is not clear what 
thresholds would be appropriate. Limited data are available to the 
Board to support such a determination. Underwriting guidelines of the 
Department of Veterans Affairs may be appropriate for the limited 
segment of the mortgage market this agency is authorized to serve, but 
they are not necessarily appropriate for the large segment of the 
mortgage market this regulation will cover.
Safe Harbors and Exemptions Not Adopted
    Commenters requested several safe harbors or exemptions that the 
Board is not adopting. Many industry commenters sought a safe harbor 
for any loan approved by the automated underwriting system (AUS) of 
Fannie Mae or Freddie Mac; some sought a safe harbor for an AUS of any 
federally-regulated institution. The Board is not adopting such a safe 
harbor. Commenters did not suggest a clear and objective definition of 
an AUS that would distinguish it from other types of systems used in 
underwriting. It would not be appropriate to try to resolve this 
concern by limiting a safe harbor to the AUS's of Fannie Mae and 
Freddie Mac, as that would give them an unfair advantage in the 
marketplace. Moreover, a safe harbor for an AUS that is a ``black box'' 
and is not specifically required to comply with the regulation could 
undermine the regulation. Some industry commenters sought safe harbors 
for transactions that provide the consumer a lower rate or payment on 
the grounds that these transactions would generally benefit the 
borrower.

[[Page 44551]]

The chief example given is a refinance (without cash out) that reduces 
the consumer's current monthly payment or, in the case of an ARM, the 
payment expected upon reset. The Board does not believe that a safe 
harbor for such a transaction would benefit consumers. For example, it 
could provide an incentive to an originator to make an unaffordable 
loan to a consumer and then repeatedly refinance the loan with new 
loans offering a slightly lower payment each time.
    One state Attorney General submitted a comment supporting 
permitting an asset-based loan where the borrower has suffered a loss 
of income but reasonably anticipates improving her circumstances (e.g., 
temporary disability or illness, unemployment, or salary cut), or the 
borrower seeks a short-term loan because she must sell the home due to 
a permanent reduction in income (e.g., loss of job, or divorce from co-
borrower) or some other event (e.g., pending foreclosure or occurrence 
of natural disaster). An association of mortgage brokers also 
recommended that exceptions be made for such cases.
    The Board is not adopting safe harbors or exemptions for such 
``hardship'' cases. As discussed above, the Board recognizes that 
consumers in such situations who fully understood the risks involved 
would benefit from having the ability to address their situation by 
taking a large risk with their home equity. At the same time, the Board 
is concerned that exceptions for such cases could severely undermine 
the rule because it would be difficult, if not impossible, to 
distinguish bona fide cases from mere circumvention. For some of these 
cases, such as selling a home due to divorce or job loss (or any 
reason) and purchasing a new, presumably less expensive home, the 
carve-out for bridge loans may apply.

C. Prepayment Penalties--Sec.  226.32(d)(6) and (7); Sec.  226.35(b)(2)

    The Board proposed to apply to higher-priced mortgage loans the 
prepayment penalty restrictions that TILA Section 129(c) applies to 
HOEPA loans. Specifically, HOEPA-covered loans may only have a 
prepayment penalty if: The penalty period does not exceed five years 
from loan consummation; the penalty does not apply if there is a 
refinancing by the same creditor or its affiliate; the borrower's debt-
to-income (DTI) ratio at consummation does not exceed 50 percent; and 
the penalty is not prohibited under other applicable law. 15 U.S.C. 
1639(c); see also 12 CFR 226.32(d)(6) and (7). In addition, the Board 
proposed, for both HOEPA loans and higher-priced mortgage loans, to 
require that the penalty period expire at least sixty days before the 
first date, if any, on which the periodic payment amount may increase 
under the terms of the loan.
    Based on the comments and its own analysis, the Board is adopting 
substantially revised rules for prepayment penalties. There are two 
components to the final rule. First, the final rule prohibits a 
prepayment penalty with a higher-priced mortgage loan or HOEPA loan if 
payments can change during the four-year period following consummation. 
Second, for all other higher-priced mortgage loans and HOEPA loans--
loans whose payments may not change for four years after consummation--
the final rule limits prepayment penalty periods to a maximum of two 
years following consummation, rather than five years as proposed. In 
addition, the final rule applies to this second category of loans two 
requirements for HOEPA loans that the Board proposed to apply to 
higher-priced mortgage loans: the penalty must be permitted by other 
applicable law, and it must not apply in the case of a refinancing by 
the same creditor or its affiliate.
    The Board is not adopting the proposed rule requiring a prepayment 
penalty provision to expire at least sixty days before the first date 
on which a periodic payment amount may increase under the loan's terms. 
The final rule makes such a rule unnecessary. Under the final rule, if 
the consumer's payment may change during the first four years following 
consummation, a prepayment penalty is prohibited outright. If the 
payment is fixed for four years, the final rule limits a prepayment 
penalty period to two years, leaving the consumer a penalty-free window 
of at least two years before the payment may increase.
    In addition, for the reasons discussed below, the Board is not 
adopting the proposed rule prohibiting a prepayment penalty where a 
consumer's verified DTI ratio, as of consummation, exceeds 50 percent. 
This restriction, however, will continue to apply to HOEPA loans, as 
provided by the statute.
    Under Regulation Z, 12 CFR 226.23(a)(3), footnote 48, a HOEPA loan 
having a prepayment penalty that does not conform to the requirements 
of Sec.  226.32(d)(7) is a mortgage containing a provision prohibited 
by TILA Section 129, 15 U.S.C. 1639, and therefore is subject to the 
three-year right of the consumer to rescind. Final Sec.  226.35(b)(2), 
which the Board is adopting under the authority of Section 129(l)(2), 
15 U.S.C. 1639(l)(2), applies restrictions on prepayment penalties for 
higher-priced mortgage loans that are substantially the same as the 
restrictions that Sec.  226.32(d)(6) and (7) apply on prepayment 
penalties for HOEPA loans. Accordingly, the Board is revising footnote 
48 to clarify that a higher-priced mortgage loan (whether or not it is 
a HOEPA loan) having a prepayment penalty that does not conform to the 
requirements of Sec.  226.35(b)(2) also is subject to a three-year 
right of rescission. (The right of rescission, however, does not extend 
to home purchase loans, construction loans, or certain refinancings 
with the same creditor.)
Public Comment
    The Board received public input about the advantages and 
disadvantages of prohibiting or restricting prepayment penalties in 
testimony provided at the 2006 and 2007 hearings the Board conducted on 
mortgage lending, and in comment letters associated with these 
hearings. In the official notice of the 2007 hearing, the Board 
expressly asked for oral and written comment about the effects of a 
prohibition or restriction under HOEPA on prepayment penalties on 
consumers and on the type and terms of credit offered. 72 FR 30380, 
30382 (May 31, 2007). Most consumer and community groups, as well as 
some state and local government officials and a trade association for 
community development financial institutions, urged the Board to 
prohibit prepayment penalties with subprime loans. By contrast, most 
industry commenters opposed prohibiting prepayment penalties or 
restricting them beyond requiring that they expire sixty days before 
reset, on the grounds that a prohibition or additional restrictions 
would reduce credit availability in the subprime market. Some industry 
commenters, however, stated that a three-year maximum prepayment 
penalty period would be appropriate.
    In connection with the proposed rule, the Board asked for comment 
about the benefits and costs of prepayment penalties to consumers who 
have higher-priced mortgage loans, as well as about the costs and 
benefits of the specific restrictions proposed. Most financial 
institutions and their trade associations stated that consumers should 
be able to choose a loan with a prepayment penalty in order to lower 
their interest rate. Many of these commenters stated that prepayment 
penalties help creditors to manage prepayment risk, which in turn 
increases credit availability and lowers credit costs. Industry 
commenters generally opposed the proposed rule that would prohibit 
prepayment

[[Page 44552]]

penalties in cases where a consumer's DTI ratio exceeds 50 percent. The 
few industry commenters that addressed the proposal to require that a 
prepayment penalty not apply in the case of a refinancing by the 
creditor or its affiliate opposed the provision. These commenters 
supported, or did not oppose, the proposal to require prepayment 
penalties to expire at least sixty days before any possible payment 
increase. Several financial institutions, an industry trade 
association, and a secondary-market investor recommended that the Board 
set a three-year maximum penalty period instead of a five-year maximum.
    By contrast, many other commenters, including most consumer 
organizations, several trade associations for state banking 
authorities, a few local, state, and federal government officials, a 
credit union trade association, and a real estate agent trade 
association, supported prohibiting prepayment penalties for higher-
priced mortgage loans and HOEPA loans. Many of these commenters stated 
that the cost of prepayment penalties to subprime borrowers outweigh 
the benefits of any reductions in interest rates or up-front fees they 
may receive. These commenters stated that the Board's proposed rule 
would not address adequately the harms that prepayment penalties cause 
consumers. Several commenters recommended alternative restrictions of 
prepayment penalties with higher-priced mortgage loans and HOEPA loans 
if the Board did not prohibit such penalties, including limiting a 
prepayment penalty period to two or three years following consummation 
or prohibiting prepayment penalties with ARMs.
    Public comments are discussed in greater detail throughout this 
section.
Discussion
    For the reasons discussed below, the Board concludes that the 
fairness of prepayment penalty provisions on higher-priced mortgage 
loans and HOEPA loans depends to an important extent on the structure 
of the mortgage loan. It has been common in the subprime market to 
structure loans to have a short expected life span. This has been 
achieved by building in a significant payment increase just a few years 
after consummation. With respect to subprime loans designed to have 
shorter life spans, the injuries from prepayment provisions are 
potentially the most serious, as well as the most difficult for a 
reasonable consumer to avoid. For these loans, therefore, the Board 
concludes that the injuries caused by prepayment penalty provisions 
with subprime loans outweigh their benefits. With respect to subprime 
loans structured to have longer expected life spans, however, the Board 
concludes that the injuries from prepayment penalties are closer to 
being in balance with their benefits, warranting restrictions but not, 
at this time, a prohibition.
    Background. Prepayment risk is the risk that a loan will be repaid 
before the end of the loan term, a major risk of mortgage lending. 
Along with default risk, it is the major risk of extending mortgage 
loans. When mortgages prepay, cash flow from loan payments may not 
offset origination expenses or discounts consumers were provided on 
fees or interest rates. Moreover, prepayment when market interest rates 
are declining, which is when borrowers are more likely to prepay, 
forces investors to reinvest prepaid funds at a lower rate. 
Furthermore, prepayment by subprime borrowers whose credit risk 
declines (for example, their equity or their credit score increases) 
leaves an investor holding relatively riskier loans.
    Creditors seek to account for prepayment risk when they set loan 
interest rates and fees, and they may also seek to address prepayment 
risk with a prepayment penalty. A prepayment penalty is a fee that a 
borrower pays if he repays a mortgage within a specified period after 
origination. A prepayment penalty can amount to several thousand 
dollars. For example, a consumer who obtains a 3-27 ARM with a thirty-
year term for a loan in the amount of $200,000 with an initial rate of 
6 percent would have a principal balance of $194,936 at the end of the 
second year following consummation. If the consumer pays off the loan, 
a penalty of six months' interest on the remaining balance--close to 
six monthly payments--will cost the consumer about $5,850.\71\ A 
penalty of this magnitude reduces a borrower's likelihood of prepaying 
and assures a return for the investor if the borrower does prepay.
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    \71\ This is a typical contractual formula for calculating the 
penalty. There are other formulas for calculating the penalty, such 
as a percentage of the amount prepaid or of the outstanding loan 
balance (potentially reduced by the percentage (for example, 20 
percent) that a borrower, by law or contract, may prepay without 
penalty). As explained further below, a consumer may pay a lower 
rate in exchange for having a provision providing for a penalty of 
this magnitude.
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    Substantial injury. Prepayment penalty provisions have been very 
common on subprime loans. Almost three-quarters of loans in a large 
dataset of securitized subprime loan pools originated from 2003 through 
the first half of 2007 had a prepayment penalty provision.\72\ These 
provisions cause many consumers who pay the penalty, as well as many 
consumers who cannot, substantial injuries. The risk of injury is 
particularly high for borrowers who receive loans structured to have 
short expected life spans because of a significant expected payment 
increase.
---------------------------------------------------------------------------

    \72\ Figure calculated from First American LoanPerformance data.
---------------------------------------------------------------------------

    A borrower with a prepayment penalty provision who has reason to 
refinance while the provision is in effect must choose between paying 
the penalty or foregoing the refinance, either of which could be very 
costly. Paying the penalty could exact several thousand dollars from 
the consumer; financing the penalty through the refinance loan adds 
interest to that cost. When the consumer's credit score has improved, 
delaying the refinance until the penalty expires could mean losing or 
at least postponing an opportunity to lower the consumer's interest 
rate. Declining to pay the penalty also could mean foregoing or 
delaying a ``cash out'' loan that would consolidate several large 
unsecured debts at a lower rate or help the consumer meet a major life 
expense, such as for medical care. Borrowers who have no ability to pay 
or finance the penalty, however, have no choice but to forego or delay 
any benefits from refinancing.
    Prepayment penalty provisions also exacerbate injuries from 
unaffordable or abusive loans. In the worst case, where a consumer has 
been placed in a loan he cannot afford to pay, delaying a refinancing 
could increase the consumer's odds of defaulting and, ultimately, 
losing the house.\73\ Borrowers who were steered to loans with less 
favorable terms than they qualify for based on their credit risk face 
an ``exit tax'' for refinancing to improve their terms.
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    \73\ For the reasons set forth in part II.B., consumers in the 
subprime market have had a high risk of receiving loans they cannot 
afford to pay. The Board expects that the rule prohibiting disregard 
for repayment ability will reduce this risk substantially, but no 
rule can eliminate it. Moreover, its success depends on vigorous 
enforcement by a wide range of agencies and jurisdictions.
---------------------------------------------------------------------------

    Prepayment penalty provisions can cause more injury with loans 
designed to have short expected life spans. With these loans, borrowers 
are particularly likely to want to prepay in a short time to avoid the 
expected payment increase. Moreover, in recent years, loans designed to 
have short expected life spans have been among the most difficult for 
borrowers to afford--even before their payment increases. Borrowers 
with 2-28 and 3-27 ARMs have been much more likely to become

[[Page 44553]]

seriously delinquent than borrowers with fixed-rate subprime mortgages. 
In part, the difference reflects that borrowers receiving 2-28 and 3-27 
ARMs have had lower average credit scores and less equity in their 
homes at origination. But the large difference also suggests that these 
shorter-term loans were more likely to be marketed and underwritten in 
ways that increase the risk of unaffordability. A prepayment penalty 
provision exacerbates this injury, especially because borrowers with 
lower credit scores are the most likely to have a need to refinance to 
extract cash.
    Injury not reasonably avoidable. In the prime market, the injuries 
prepayment penalties cause are readily avoidable because lenders do not 
typically offer borrowers mortgages with prepayment penalty provisions. 
Indeed, in one large dataset of first-lien prime loans originated from 
2003 to mid-2007 just six percent of loans had these provisions.\74\ In 
a dataset of subprime securitized loans originated during the same 
period, however, close to three-quarters had a prepayment penalty 
provision.\75\ Moreover, evidence suggests that a large proportion of 
subprime borrowers with prepayment penalty provisions have paid the 
penalty. Approximately 55 percent of subprime 2-28 ARMs in this same 
dataset originated from 2000 to 2005 prepaid while the prepayment 
penalty provision was in effect.\76\ The data do not indicate how many 
consumers actually paid a penalty, or how much they paid. But the data 
suggest that a significant percentage of borrowers with subprime loans 
have paid prepayment penalties, which, as indicated above, can amount 
to several thousand dollars.
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    \74\ Figure calculated from McDash Analytics data.
    \75\ Figure calculated from First American LoanPerformance data.
    \76\ Id.
---------------------------------------------------------------------------

    These figures raise a serious question as to whether a substantial 
majority of subprime borrowers have knowingly and voluntarily taken the 
very high risk of paying a significant penalty. While subprime 
borrowers receive some rate reduction for a prepayment penalty 
provision (as discussed at more length in the next subsection), they 
also have major incentives to refinance. They often have had difficulty 
meeting their regular obligations and experienced major life 
disruptions. Many would therefore anticipate refinancing to extract 
equity to consolidate their debts or pay a major expense; nearly 90 
percent of subprime ARMs used for refinancings in recent years were 
``cash out.'' \77\ In addition, many subprime borrowers would aspire to 
refinance for a lower rate when their credit risk declines (for 
example, their credit score improves, or their equity increases).
---------------------------------------------------------------------------

    \77\ Id. It is not possible to discern from the data whether the 
cash was used only to cover the costs of refinancing or also for 
other purposes. See also Subprime Refinancing at 233 (reporting that 
49 percent of subprime refinance loans involve equity extraction, 
compared with 26 percent of prime refinance loans); Subprime 
Outcomes at 368-371 (discussing survey evidence that borrowers with 
subprime loans are more likely to have experienced major adverse 
life events (marital disruption; major medical problem; major spell 
of unemployment; major decrease of income) and often use refinancing 
for debt consolidation or home equity extraction); Subprime Lending 
Investigation at 551-52 (citing survey evidence that borrowers with 
subprime loans have increased incidence of major medical expenses, 
major unemployment spells, and major drops in income).
---------------------------------------------------------------------------

    Prepayment penalties' lack of transparency also suggests that 
prepayment penalty provisions are often not knowingly and voluntarily 
chosen by subprime borrowers whose loans have them. In the subprime 
market, information on rates and fees is not easy to obtain. See part 
II.B. Information on prepayment penalties, such as how large they can 
be or how many consumers actually pay them, is even harder to obtain. 
The lack of transparency is exacerbated by originators' incentives--
largely hidden from consumers--to ``push'' loans with prepayment 
penalty provisions and at the same time obscure or downplay these 
provisions. If the consumer seeks the lowest monthly payment--as the 
consumer in the subprime market often does--then the originator has a 
limited incentive to quote the payment for a loan without a prepayment 
penalty provision, which will tend to be at least slightly higher. 
Perhaps more importantly, lenders pay originators considerably larger 
commissions for loans with prepayment penalties, because the penalty 
assures the lender a larger revenue stream to cover the commission. The 
originator also has an incentive not to draw the consumer's attention 
to the prepayment penalty provision, in case the consumer should prefer 
a loan without it. Although the prepayment penalty provision must be 
disclosed on the post-application TILA disclosure, the consumer may not 
notice it amidst numerous other disclosures or may not appreciate its 
significance. Moreover, an unscrupulous originator may not disclose the 
penalty until closing, when the consumer's ability to negotiate terms 
is much reduced.
    Even a consumer offered a genuine choice would have difficulty 
comparing the costs of subprime loans with and without a penalty, and 
would likely choose to place more weight on the more certain and 
tangible cost of the initial monthly payment. There is a limit to the 
number of factors a consumer can reasonably be expected to consider, so 
the more complex a loan the less likely the consumer is to consider the 
prepayment penalty. For example, an FTC staff study found that 
consumers presented with mortgage loans with more complex terms were 
more likely to miss or misunderstand key terms.\78\
---------------------------------------------------------------------------

    \78\ Improving Consumer Mortgage Disclosures at 74 
(``[R]espondents had more difficulty recognizing and identifying 
mortgage cost in the complex-loan scenario. This implies that 
borrowers in the subprime market may have more difficulty 
understanding their loan terms than borrowers in the prime market. 
The difference in understanding, however, would be due largely to 
differences in the complexities of the loans, rather than the 
capabilities of the borrowers.'').
---------------------------------------------------------------------------

    These concerns are magnified with subprime loans structured to have 
short expected life spans, which will have variable rates (such as 2-28 
and 3-27 ARMs) or other terms that can increase the payment. 
Adjustable-rate mortgages are complicated for consumers even without 
prepayment penalties. A Federal Reserve staff study suggests that 
borrowers with ARMs underestimate the amount by which their interest 
rates can change.\79\ The study also suggests that the borrowers most 
likely to make this mistake have a statistically higher likelihood of 
receiving subprime mortgages (for example, they have lower incomes and 
less education).\80\ Adding a prepayment penalty provision to an 
already-complex ARM product makes it less likely the consumer will 
notice, understand, and consider this provision when making decisions. 
Moreover, the shorter the period until the likely payment increase, the 
more the consumer will have to focus attention on the adjustable-rate 
feature of the loan and the less the consumer may be able to focus on 
other features.
---------------------------------------------------------------------------

    \79\ Brian Bucks and Karen Pence, Do Borrowers Understand their 
Mortgage Terms?, Journal of Urban Economics (forthcoming 2008).
    \80\ Id.
---------------------------------------------------------------------------

    Moreover, subprime mortgage loans designed to have short expected 
life spans appear more likely than other types of subprime mortgages to 
create incentives for abusive practices. Because these loans create a 
strong incentive to refinance in a short time, they are likely to be 
favored by originators who seek to ``flip'' their clients through 
repeated refinancings to increase fee revenue; prepayment penalties are 
frequently associated with such a strategy.\81\ Moreover, 2-28 and

[[Page 44554]]

3-27 ARMs were marketed to borrowers with low credit scores as ``credit 
repair'' products, obscuring the fact that a prepayment penalty 
provision would inhibit or prevent the consumer who improved his credit 
score from refinancing at a lower rate. These loans were also 
associated more than other loan types with irresponsible underwriting 
and marketing practices that contributed to high rates of delinquency 
even before the consumer's payment increased.
---------------------------------------------------------------------------

    \81\ See generally U.S. Dep't of Hous. & Urban Dev. & U.S. Dep't 
of Treasury, Recommendations to Curb Predatory Home Mortgage Lending 
73 (2000) (``Loan flipping generally refers to repeated refinancing 
of a mortgage loan within a short period of time with little or no 
benefit to the borrower.''), available at http://www.huduser.org/publications/pdf/treasrpt.pdf.
---------------------------------------------------------------------------

    Subprime loans designed to have short expected life spans also 
attracted consumers who are more vulnerable to abusive prepayment 
penalties. Borrowers with 2-28 and 3-27 ARMs had lower credit scores 
than borrowers with any other type of subprime loan.\82\ These 
borrowers include consumers with the least financial sophistication and 
the fewest financial options. Such consumers are less likely to 
scrutinize a loan for a restriction on prepayment or negotiate the 
restriction with an originator, who in any event has an incentive to 
downplay its significance.
---------------------------------------------------------------------------

    \82\ Figures calculated from First American LoanPerformance data 
about securitized subprime pools show that the median FICO score was 
627 for fixed-rate loans and 612 for short-term hybrid ARMs (2-28 
and 3-27 ARMS).
---------------------------------------------------------------------------

    Injury not outweighed by countervailing benefits to consumers or to 
competition. The Board concludes that prepayment penalties' injuries 
outweigh their benefits in the case of higher-priced mortgage loans and 
HOEPA loans designed with planned or potential payment increases after 
just a few years. For other types of higher-priced and HOEPA loans, 
however, the Board concludes that the injuries and benefits are much 
closer to being in equipoise. Thus, as explained further in the next 
section, the final rule prohibits penalties in the first case and 
limits them to two years in the second.
    Prepayment penalties can increase market liquidity by permitting 
creditors and investors to price directly and efficiently for 
prepayment risk. This liquidity benefit is more significant in the 
subprime market than in the prime market. Prepayment in the subprime 
market is motivated by a wider variety of reasons than in the prime 
market, as discussed above, and therefore is subject to more 
uncertainty. In principle, prepayment penalty provisions allow 
creditors to charge most of the prepayment risk only to the consumers 
who actually prepay, rather than charging all of the risk in the form 
of higher interest rates or up-front fees for all consumers. The extent 
to which creditors have actually passed on lower rates and fees to 
consumers with prepayment penalty provisions in their loans is debated 
and, moreover, inherently difficult to measure. With limited 
exceptions, however, available studies, discussed at more length below, 
have shown consistently that loans with prepayment penalties carry 
lower rates or APRs than loans without prepayment penalties having 
similar credit risk characteristics.\83 \
---------------------------------------------------------------------------

    \83\ See Chris Mayer, Tomasz Piskorski, and Alexei Tchistyi, The 
Inefficiency of Refinancing: Why Prepayment Penalties Are Good for 
Risky Borrowers (Apr. 28, 2008) (Why Prepayment Penalties Are Good), 
http://www1.gsb.columbia.edu/mygsb/faculty/research/pubfiles/3065/Inefficiency%20of%20Refinancing%2Epdf; Gregory Elliehausen, Michael 
E. Staten, and Jevgenijs Steinbuks, The Effect of Prepayment 
Penalties on the Pricing of Subprime Mortgages, 60 Journal of 
Economics and Business 33 (2008) (Effect of Prepayment Penalties); 
Michael LaCour-Little, Prepayment Penalties in Residential Mortgage 
Contracts: A Cost-Benefit Analysis (Jan. 2007) (unpublished) (Cost-
Benefit Analysis); Richard F. DeMong and James E. Burroughs, 
Prepayment Fees Lead to Lower Interest Rates, Equity (Nov./Dec. 
2005), available at http://www.commerce.virginia.edu/faculty_research/faculty_homepages/DeMong/PrepaymentsandInterestRates.pdf 
(Prepayment Fees Lower Rates); but see Keith E. Ernst, Center for 
Responsible Lending, Borrowers Gain No Interest Rate Benefit from 
Prepayment Penalties on Subprime Mortgages (2005), http://www.responsiblelending.org/pdfs/rr005-PPP_Interest_Rate-0105.pdf 
(No Interest Rate Benefit).
---------------------------------------------------------------------------

    Evidence of lower rates or APRs is not sufficient to demonstrate 
that penalties provide a net benefit to consumers. Some consumers may 
not have chosen the lower rates or APRs voluntarily and may have 
preferred ex ante, had they been properly informed, to have no 
prepayment penalty provision and somewhat higher rates or fees. 
Borrowers with these provisions who hold their loans past the penalty 
period are likely better off because they have lower rates and do not 
incur a prepayment penalty; but the benefit these borrowers receive may 
be small compared to the injury suffered by the many borrowers who pay 
the penalty, or who cannot pay it and are locked into an inappropriate 
or unaffordable loan. It does appear, however, that prepayment penalty 
provisions provide some benefit to at least some consumers in the form 
of reduced rates and increased credit availability.
    In the case of higher-priced mortgage loans and HOEPA loans 
designed to have short expected life spans, the Board concludes that 
these potential benefits do not outweigh the injuries to consumers. 
Available studies generally have found reductions in interest rate or 
APR associated with subprime 2-28 ARMs and 3-27 ARMs to be minimal, 
ranging from 18 to a maximum of 29 basis points, with one study finding 
no rate reduction on such loans originated by brokers.\84\ The one 
available (but unpublished) study to compare the rate reduction to the 
cost of the penalty itself found a net cost to the consumer with 2-28 
and 3-27 ARMs.\85\ The minimal rate reductions strengthen doubt that 
the high incidence of penalty provisions was the product of informed 
consumer choice. Moreover, for the reasons discussed above, prepayment 
penalties are likely to cause the most significant, and least 
avoidable, injuries when coupled with loans designed to have short 
expected life spans, which have proved to be the riskiest loans for 
consumers. On balance, therefore, the Board believes these injuries 
outweigh potential benefits.
---------------------------------------------------------------------------

    \84\ See Effect of Prepayment Penalties 43 (finding that the 
presence of a prepayment penalty reduced risk premiums by 18 basis 
points for hybrid loans and 13 basis points for variable-rate 
loans); Prepayment Fees Lower Rates 5 (stating that, for first-lien 
subprime loans with a thirty-year term, the presence of a prepayment 
penalty reduced the APR by 29 basis points for adjustable-rate loans 
and 20 basis points for interest-only loans).
    \85\ Cost-Benefit Analysis 26 (``For the [2-28] ARM product, the 
total interest rate savings is significantly less than the amount of 
the expected prepayment penalty; for the [3-28] ARM product, the two 
values are approximately equal.'').
---------------------------------------------------------------------------

    For higher-priced mortgage loans and HOEPA loans structured to have 
longer expected life spans, however, the Board concludes that the 
injuries and benefits are closer to being in balance. Studies that 
analyze both fixed-rate mortgages and 2-28 and 3-27 ARMs show a more 
significant reduction of rates and fees for fixed-rate mortgages for 
loans with prepayment penalties, ranging from 38 basis points \86\ to 
60 basis points.\87\ Moreover, longer-term ARMs and fixed-rate 
mortgages have had significantly lower delinquency rates than 2-28 and 
3-27 ARMs, suggesting these mortgages are more likely to be affordable 
to consumers. In addition, mortgages

[[Page 44555]]

designed to have longer life spans create less opportunity for flipping 
and other abuses, and the borrowers offered these loans may be less 
vulnerable to abuse. These borrowers have had higher credit scores and 
therefore more options, and their preference for a longer-lived loan 
may imply that they have a longer-term perspective and a more realistic 
assessment of their situation. In fact, a smaller proportion of 
borrowers with subprime fixed-rate mortgages with penalty provisions 
originated between 2000 and 2005 prepaid in the first two years (about 
35 percent) than did borrowers with subprime 2-28 ARMs with penalty 
provisions (about 55 percent).\88\ Therefore, in the case of shorter 
prepayment penalty provisions on loans structured to have longer life 
spans, the Board does not conclude at this time that the injuries from 
these provisions outweigh the benefits.
---------------------------------------------------------------------------

    \86\ Effect of Prepayment Penalties 43. See also Cost-Benefit 
Analysis 24 (finding the total estimated interest rate savings for 
fixed-rate loans to be 51 basis points for retail-originated loans 
and 33 basis points for broker-originated loans).
    \87\ Prepayment Fees Lower Rates 5. See also Why Prepayment 
Penalties Are Good 25 & fig. 4 (finding that, depending on the 
borrower's FICO score, fixed-rate loans with prepayment penalties 
had interest rates that were about 50 basis points (where FICO score 
680 or higher) to about 70 basis points (where FICO score less than 
620) lower than mortgages without prepayment penalties); but see No 
Interest Rate Benefit (finding, for subprime fixed-rate loans, that 
interest rates for purchase loans with a prepayment penalty were 
between 39 and 51 basis points higher than for such loans without a 
penalty and that for refinance loans there was no statistically 
significant difference in the interest rates paid).
    \88\ Figures calculated from First American LoanPerformance 
data. About 90 percent of the penalty provisions on the fixed-rate 
loans applied for at least two years.
---------------------------------------------------------------------------

The Final Rule
    For both higher-priced mortgage loans and HOEPA loans, the final 
rule prohibits prepayment penalties if periodic payments can change 
during the first four years following loan consummation. For all other 
higher-priced mortgage loans and HOEPA loans, the final rule limits the 
prepayment penalty period to two years after loan consummation and also 
requires that a prepayment penalty not apply if the same creditor or 
its affiliate makes the refinance loan. For HOEPA loans, the final rule 
retains the current prohibition of prepayment penalties where the 
borrower's DTI ratio at consummation exceeds 50 percent; the Board is 
not adopting this prohibition for higher-priced mortgage loans. The 
final rule sets forth the foregoing prepayment penalty rules in two 
separate sections: For HOEPA loans, in Sec.  226.32(d)(7), and for 
higher-priced mortgage loans, in Sec.  226.35(b)(3).
    TILA Section 129(c)(2)(C), 15 U.S.C. 1639(c)(2)(C), limits the 
maximum prepayment penalty period with HOEPA loans to five years 
following consummation. The Board proposed to apply this HOEPA 
provision to higher-priced mortgage loans. Commenters generally stated 
that a five-year maximum prepayment period was too long. Some consumer 
organizations, an association of credit unions, and a federal banking 
regulatory agency recommended a two-year limit on prepayment penalty 
periods. A few consumer organizations recommended a one-year maximum 
length. Although a financial services trade association supported a 
five-year maximum, several financial institutions and mortgage banking 
trade associations and a government-sponsored enterprise stated that 
three years would be an appropriate maximum period for prepayment 
penalties with higher-priced mortgage loans.
    As discussed above, the Board concludes that the injuries from 
prepayment penalty provisions that consumers cannot reasonably avoid 
outweigh these provisions' benefits with respect to higher-priced 
mortgage loans and HOEPA loans structured to have short expected life 
spans. Accordingly, the final rule prohibits a prepayment penalty 
provision with a higher-priced mortgage loan or a HOEPA loan whose 
payments may change during the first four years following 
consummation.\89\ A four-year discount period is not common, but a 
three-year period was common at least until recently. Using a three-
year period in the regulation, however, might simply encourage the 
market to structure loans with discount periods of three years and one 
day. Therefore, the Board adopts a four-year period in the final rule 
as a prophylactic measure.
---------------------------------------------------------------------------

    \89\ This rule is stricter than HOEPA's statutory provision on 
prepayment penalties for HOEPA loans. This provision permits such 
penalties under certain conditions regardless of a potential payment 
change within the first four years. Section 129(l)(2) authorizes the 
Board, however, to prohibit acts or practices it finds to be unfair 
or deceptive in connection with mortgage loans--including HOEPA 
loans. Since HOEPA's restrictions on prepayment penalty provisions 
were adopted, much has changed to make these provisions more 
injurious to consumers and these injuries more difficult to avoid. 
The following risk factors became much more common in the subprime 
market: ARMs with payments that reset after just two or three years; 
securitization of subprime loans under terms that reduce the 
originator's incentive to ensure the consumer can afford the loan; 
and mortgage brokers with hidden incentives to ``push'' penalty 
provisions.
---------------------------------------------------------------------------

    The prohibition applies to loans with potential payment changes 
within four years, including potential increases and potential 
declines; the prohibition is not limited to loans where the payment can 
increase but not decline. The Board is concerned that such a limitation 
might encourage the market to develop unconventional repayment 
schedules for HOEPA loans and higher-priced mortgage loans that are 
more difficult for consumers to understand, easier for originators to 
misrepresent, or both. The final rule also refers specifically to 
periodic payments of principal or interest or both, to distinguish such 
payments from other payments, including amounts directed to escrow 
accounts. Staff commentary lists examples showing whether prepayment 
penalties are permitted or prohibited in particular circumstances where 
the amount of the periodic payment can change. The commentary also 
provides examples of changes that are not deemed payment changes for 
purposes of the rule.\90\
---------------------------------------------------------------------------

    \90\ As discussed above, the final rule sets forth the 
prepayment penalty rules in two separate sections. For HOEPA loans, 
Sec.  226.32(d)(7) lists conditions that must be met for the general 
penalty prohibition in Sec.  226.32(d)(6) not to apply. For higher-
priced mortgage loans, Sec.  226.35(b)(2) prohibits a penalty 
described in Sec.  226.32(d)(6) unless the conditions in Sec.  
226.35(b)(i) and (ii) are met. To ensure consistent interpretation 
of the separate sections, the staff commentary to Sec.  226.35(b)(2) 
cross-references the payment-change examples and exclusions in staff 
commentary to Sec.  226.32(d)(7). The examples in staff commentary 
to Sec.  226.32(d)(7)(iv) refer to a condition that final Sec.  
226.35(b)(2) does not include, however--the condition that, at 
consummation, the consumer's total monthly debt payments may not 
exceed 50 percent of the consumer's monthly gross income. The staff 
commentary to Sec.  226.35(b)(2) clarifies this difference.
---------------------------------------------------------------------------

    With respect to loans structured to have longer expected life 
spans, the Board concludes that the injuries from prepayment penalty 
provisions that are short relative to the expected life span are closer 
to being in balance with their benefits. Accordingly, for loans for 
which the payment may not change, or may change only after four or more 
years, the Board is not banning prepayment penalties. Instead, it is 
seeking to ensure the benefits of penalty provisions on these loans are 
in line with the injuries they can cause by limiting the potential for 
injury to two years from consummation.
    The Board recognizes that creditors may respond by increasing 
interest rates, up-front fees, or both, and that some subprime 
borrowers may pay more than they otherwise would, or not be able to 
obtain credit when they would prefer. The Board believes these costs 
are justified by the benefits of the rule. Based on available studies, 
the expected increase in costs on the types of loans for which penalty 
provisions are prohibited is not large. For the remaining loan types, 
reducing the allowable penalty period from the typical three years to 
two years should not lead to significant cost increases for subprime 
borrowers. Moreover, to the extent cost increases come in the form of 
higher rates or fees, they will be reflected in the APR, where they may 
be more transparent to consumers than as a prepayment penalty. Thus, it 
is not clear that the efficiency of market pricing would decline.
    The Board is not adopting the suggestion of some commenters that it 
set a maximum penalty amount. A restriction of that kind does not 
appear necessary or warranted at this time.

[[Page 44556]]

    Sixty-day window. The Board does not believe that the proposed 
requirement that a prepayment penalty period expire at least sixty days 
before a potential payment increase would adequately protect consumers 
with loans where the increase was expected shortly. As discussed, these 
loans, such as 2-28 ARMs, will tend to attract consumers who have a 
short planning horizon and intend to avoid the payment increase by 
refinancing. If provided only a brief penalty-free window to refinance 
before the increase (as proposed, a window in months 23 and 24 for a 2-
28 ARM), the consumer deciding whether to accept a loan with a penalty 
provision--assuming the consumer was provided a genuine choice--must 
predict quite precisely when he will want to refinance. If the consumer 
believes he will want to refinance in month 18 and that his credit 
score, home equity, and other indicators of credit quality will be high 
enough then to enable him to refinance, then the consumer probably 
would be better off with a loan without a penalty provision. If, 
however, the consumer believes he will not be ready or able to 
refinance until month 23 or 24 (the penalty-free window), he probably 
would be better off accepting the penalty provision. It is not 
reasonable to expect consumers in the subprime market to make such 
precise predictions. Moreover, for transactions on which prepayment 
penalties are permitted by the final rule, a sixty-day window would be 
moot because the penalty provision may not exceed two years and the 
payment on a loan with a penalty provision may not change during the 
first four years following consummation.\91\
---------------------------------------------------------------------------

    \91\ The Board sought comment on whether it should revise Sec.  
226.20(c) or draft new disclosure requirements to reconcile that 
section with the proposed requirement that a prepayment penalty 
provision expire at least sixty days prior to the date of the first 
possible payment increase. This issue is also moot.
---------------------------------------------------------------------------

    Refinance loan from same creditor. The Board is adopting with minor 
revisions the proposed requirement that a prepayment penalty not apply 
when a creditor refinances a higher-priced mortgage loan the creditor 
or its affiliate originated. HOEPA imposes this requirement in 
connection with HOEPA loans. 15 U.S.C. 1639(c)(2)(B).
    Some large financial institutions and financial institution trade 
associations that commented opposed the proposal. A large bank stated 
that the requirement would not prevent loan flipping and that mortgage 
brokers would easily circumvent the rule by directing repeat customers 
to a different creditor each time. A mortgage bankers' trade 
association and a large bank stated that the requirement would prevent 
customers from returning to the same institution with which they have 
existing relationships. Another large bank stated that the rule would 
place lenders at a competitive disadvantage when trying to refinance 
the loan of an existing customer.
    Requiring that a prepayment penalty not apply when a creditor 
refinances a loan it originated will discourage originators from 
seeking to ``flip'' a higher-priced mortgage loan. To prevent evasion 
by creditors who might direct borrowers to refinance with an affiliated 
creditor, the same-lender refinance rule covers loans by a creditor's 
affiliate. Although creditors may waive a prepayment penalty when they 
refinance a loan that they originated to a consumer, consumers who 
refinance with the same creditor may be charged a prepayment penalty 
even if a creditor or mortgage broker has told the consumer that the 
prepayment penalty would be waived in that circumstance.\92\
---------------------------------------------------------------------------

    \92\ This concern is evident, for example, in a settlement 
agreement that ACC Capital Holdings Corporation and several of its 
subsidiaries, including Ameriquest Mortgage Company (collectively, 
the Ameriquest Parties) made in 2006 with 49 states and the District 
of Columbia. The Ameriquest Parties agreed not to make false, 
misleading, or deceptive representations regarding prepayment 
penalties and specifically agreed not to represent that they will 
waive a prepayment penalty at some future date, unless that promise 
is made in writing and included in the terms of a loan agreement 
with a borrower. See, e.g., Iowa ex rel. Miller v. Ameriquest 
Mortgage Co., No. 05771 EQCE-053090 at 18 (Iowa D. Ct. 2006) (Pls. 
Pet. 5).
---------------------------------------------------------------------------

    The final rule requires that a prepayment penalty not apply where a 
creditor or its affiliate refinances a higher-priced mortgage loan that 
the creditor originated to the consumer. The final rule is based on 
TILA Section 129(c)(2)(B), 15 U.S.C. 1639(c)(2)(B), which provides that 
a HOEPA loan may contain a prepayment penalty ``if the penalty applies 
only to a prepayment made with amounts obtained by the consumer by 
means other than a refinancing by the creditor under the mortgage, or 
an affiliate of that creditor.'' The Board notes that TILA Section 
129(c)(2)(B), 15 U.S.C. 1639(c)(2)(B), applies regardless of whether 
the creditor still holds the loan at the time of a refinancing by the 
creditor or an affiliate of the creditor. In some cases, a creditor's 
assignees are the ``true creditor'' funding the loan; moreover, the 
rule prevents loan transfers designed to evade the prohibition.
    TILA Section 129(c)(2)(B) does not prohibit a creditor from 
refinancing a loan it or its affiliate originated but rather requires 
that a prepayment penalty not apply in the event of a refinancing by 
the creditor or its affiliate. To make clear that the associated 
regulation, Sec.  226.32(d)(7)(ii), does not prohibit a creditor from 
refinancing a loan that the creditor (or an affiliate of the creditor) 
originated, the Board is revising the text of that regulation somewhat. 
Final Sec.  226.32(d)(7)(ii) states that a HOEPA loan may provide for a 
prepayment penalty if the prepayment penalty provision will not apply 
if the source of the prepayment funds is a refinancing by the creditor 
or an affiliate of the creditor. This change clarifies, without 
altering, the meaning of the provision and is technical, not 
substantive, in nature. Final Sec.  226.35(b)(2)(ii)(B) applies to 
higher-priced mortgage loans rather than to HOEPA loans but mirrors 
final Sec.  226.32(d)(7)(ii) in all other respects.
    Debt-to-income ratio. Under the proposed rule, a higher-priced 
mortgage loan could not include a prepayment penalty provision if, at 
consummation, the consumer's DTI ratio exceeds 50 percent. Proposed 
comments would have given examples of funds and obligations that 
creditors commonly classify as ``debt'' and ``income'' and stated that 
creditors may, but need not, look to widely accepted governmental and 
non-governmental underwriting standards to determine how to classify 
particular funds or obligations as ``debt'' or ``income.''
    Most banking and financial services trade associations and several 
large banks stated that the Board should not prohibit prepayment 
penalties on higher-cost loans where a consumer's DTI ratio at 
consummation exceeds 50 percent. Several of these commenters stated 
that the proposed rule would disadvantage a consumer living on a fixed 
income but with significant assets, including many senior citizens. 
Some of these commenters stated that the proposed rule would 
disadvantage consumers in areas where housing prices are relatively 
high. Some consumer organizations also objected to the proposed DTI-
ratio requirement, stating that the requirement would not protect low-
income borrowers with a DTI ratio equal to or less than 50 percent but 
limited residual income.
    The Board is not adopting a specific DTI ratio in the rule 
prohibiting disregard of repayment ability. See part IX.B. For the same 
reasons, the Board is not adopting the proposed prohibition of a 
prepayment penalty for all higher-priced mortgage loans where a 
consumer's DTI ratio at consummation exceeds 50 percent. The Board is, 
however, leaving the prohibition in

[[Page 44557]]

place as it applies to HOEPA loans, as this prohibition is statutory, 
TILA Section 129(c)(2)(A)(ii), and its removal does not appear 
warranted at this time.
    This statute provides that for purposes of determining whether at 
consummation of a HOEPA loan a consumer's DTI ratio exceeds 50 percent, 
the consumer's income and expenses are to be verified by a financial 
statement signed by the consumer, by a credit report, and, in the case 
of employment income, by payment records or by verification from the 
employer of the consumer (which verification may be in the form of a 
pay stub or other payment record supplied by the consumer). The Board 
proposed to adopt a stronger standard that would require creditors to 
verify the consumer's income and expenses in accordance with 
verification rules that the Board proposed and is adopting in final 
Sec.  226.34(a)(4)(ii), together with associated commentary. Although 
the Board requested comment about the proposal to revise Sec.  
226.32(d)(7)(iii) and associated commentary, commenters did not discuss 
this proposal.
    As proposed, the Board is strengthening the standards that Sec.  
226.32(d)(7)(iii) establishes for verifying the consumer's income and 
expenses when determining whether a prepayment penalty is prohibited 
because the consumer's DTI ratio exceeds 50 percent at consummation of 
a HOEPA loan. There are three bases for adopting an income verification 
requirement that is stronger than the standard TILA Section 
129(c)(2)(A)(ii) establishes. First, under TILA Section 129(l)(2), the 
Board has a broad authority to update HOEPA's protections as needed to 
prevent unfair practices. 15 U.S.C. 1639(l)(2)(A). For the reasons 
discussed in part IX.B, the Board believes that relying solely on the 
income statement on the application is unfair to the consumer, 
regardless of whether the consumer is employed by another person, self-
employed, or unemployed. Second, the Board has a broad authority under 
TILA Section 129(l)(2) to update HOEPA's protections as needed to 
prevent their evasion. 15 U.S.C. 1639(l)(2)(A). A signed financial 
statement declaring all or most of a consumer's income to be self-
employment income or income from sources other than employment could be 
used to evade the statute. Third, establishing a single standard for 
verifying a consumer's income and obligations for HOEPA loans and 
higher-priced mortgage loans will facilitate compliance.
    For the foregoing reasons, for HOEPA loans, final Sec.  
226.32(d)(7)(iii) requires creditors to verify that the consumer's 
total monthly debt payments do not exceed 50 percent of the consumer's 
monthly gross income using the standards set forth in final Sec.  
226.34(a)(4)(ii). The Board also is revising the commentary associated 
with Sec.  226.32(d)(7)(iii) to cross-reference certain commentary 
associated with Sec.  226.34(a)(4).
    Disclosure. For reasons discussed above, the Board does not believe 
that disclosure alone is sufficient to enable consumers to avoid injury 
from a prepayment penalty. There is reason to believe, however, that 
disclosures could more effectively increase transparency.\93\ The Board 
will be conducting consumer testing to determine how to make 
disclosures more effective. As part of this process, the Board will 
consider the recommendation from some commenters that creditors who 
provide loans with prepayment penalties be required to disclose the 
terms of a loan without a prepayment penalty.
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    \93\ For example, an FTC study based on quantitative consumer 
testing using several fixed-rate loan scenarios found that improving 
a disclosure of the prepayment penalty provision increased the 
percentage of participants who could tell that they would pay a 
prepayment penalty if they refinanced. Improving Mortgage 
Disclosures 109.
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D. Escrows for Taxes and Insurance--Sec.  226.35(b)(3)

    The Board proposed in Sec.  226.35(b)(3) to require a creditor to 
establish an escrow account for property taxes and homeowners insurance 
on a higher-priced mortgage loan secured by a first lien on a principal 
dwelling. Under the proposal, a creditor may allow a consumer to cancel 
the escrow account, but no sooner than 12 months after consummation. 
The Board is adopting the rule as proposed and adding limited 
exemptions for loans on cooperative shares and, in certain cases, 
condominium units.
    The final rule requires escrows for all covered loans secured by 
site-built homes for which creditors receive applications on or after 
April 1, 2010, and for all covered loans secured by manufactured 
housing for which creditors receive applications on or after October 1, 
2010.
Public Comments
    Many community banks and mortgage brokers as well as several 
industry trade associations opposed the proposed escrow requirement. 
Many of these commenters contended that mandating escrows is not 
necessary to protect consumers. They argued that consumers are 
adequately protected by the proposed requirement to consider a 
consumer's ability to pay tax and insurance obligations under Sec.  
226.35(b)(1), and by a disclosure of estimated taxes and insurance they 
recommended the Board adopt. Commenters also contended that setting up 
an escrow infrastructure would be very expensive; creditors will either 
pass on these costs to consumers or decline to originate higher-priced 
mortgage loans.
    Individual consumers who commented also expressed concern about the 
proposal. Some consumers expressed a preference for paying their taxes 
and insurance themselves out of fear that servicers may fail to pay 
these obligations fully and on-time. Many requested that, if escrows 
are required, creditors be required to pay interest on the escrowed 
funds.
    Several industry trade associations, several large creditors and 
some mortgage brokers, however, supported the proposed escrow 
requirement. They were joined by the consumer groups, community 
development groups, and state and federal officials that commented on 
the issue. Many of these commenters argued that failure to escrow 
leaves consumers unable to afford the full cost of homeownership and 
would face expensive force-placed insurance or default, and possibly 
foreclosure. Commenters supporting the proposal differed on whether and 
under what circumstances creditors should be permitted to cancel 
escrows.
    Large creditors without escrow systems asked for 12 to 24 months to 
comply if the proposal is adopted.
Discussion
    As commenters confirmed, it is common for creditors to offer 
escrows in the prime market, but not in the subprime market. The Board 
believes that this discrepancy is not entirely the result of consumers 
in the subprime market making different choices than consumers in the 
prime market. Rather, subprime consumers, whether they would wish to 
escrow or not, face a market where competitive forces have prevented 
significant numbers of creditors from offering escrows at all. In such 
a market, consumers suffer significant injury, especially, but not 
only, those who are not experienced handling property taxes and 
insurance on their own and are therefore least able to avoid these 
injuries. The Board finds that these injuries outweigh the costs to 
consumers of offering them escrows. For these reasons, the Board finds 
that it is unfair for a creditor to make a higher-priced mortgage loan 
without presenting

[[Page 44558]]

the consumer a genuine opportunity to escrow. In order to ensure that 
the opportunity to escrow is genuine, the final rule requires that 
creditors establish escrow accounts for first-lien higher-priced 
mortgage loans for at least twelve months. The Board believes that 
consumers, creditors, and investors will all benefit from this 
requirement.
    Lack of escrow opportunities in the subprime market. Relative to 
the prime market, few creditors in the subprime market offer consumers 
the opportunity to escrow. The Board believes that, absent a rule 
requiring escrows, market forces alone are unlikely to drive 
significant numbers of creditors to begin to offer escrows in the 
subprime market. Consumers in the subprime market tend to shop based on 
monthly payment amounts, rather than on interest rates.\94\ So 
creditors who are active in the subprime market, and who can quote low 
monthly payments to a prospective borrower, have a competitive 
advantage over creditors that quote higher monthly payments. A creditor 
who does not offer the opportunity to escrow (and thus quotes monthly 
payments that do not include amounts for escrows) can quote a lower 
monthly payment than a creditor who does offer an opportunity to escrow 
(and thus quotes a higher monthly payment that includes amounts for 
escrow). Consequently, creditors in the subprime market who offer 
escrows may be at a competitive disadvantage to creditors who do not.
---------------------------------------------------------------------------

    \94\ Subprime Mortgage Investigation at 554 (``Our focus groups 
suggested that prime and subprime borrowers use quite different 
search criteria in looking for a loan. Subprime borrowers search 
primarily for loan approval and low monthly payments, while prime 
borrowers focus on getting the lowest available interest rate. These 
distinctions are quantitatively confirmed by our survey.'').
---------------------------------------------------------------------------

    Creditors who offer escrows could try to overcome this competitive 
disadvantage by advertising the availability and benefits of escrows to 
subprime consumers. Yet offering escrows entails some significant cost 
to the creditor. The creditor must either outsource servicing rights to 
third party servicers and lose servicing revenue, or make a large 
initial investment to establish an escrow infrastructure in-house. 
According to comments from some creditors, the cost to set up an escrow 
infrastructure could range between one million dollars and $16 million 
for a large creditor. While escrows improve loan performance \95\ and 
offer creditors assurance that the collateral securing the loan is 
protected, those advantages alone have not proven sufficient incentive 
to make escrowing widespread in the subprime market. Rather, if a 
creditor is to recoup its costs for offering an opportunity to escrow, 
the creditor must convince a significant number of subprime consumers 
that they would be better served by accepting a higher monthly payment 
with escrows rather than a lower monthly payment without escrows. Yet 
consumers' focus on the lowest monthly payments in the subprime market, 
and the lack of familiarity with escrows, could make it difficult to 
convince consumers to accept the higher payment. In addition, the 
creditor who offered escrows would be vulnerable to competitors' 
attempts to lure away existing borrowers by quoting a lower monthly 
payment without disclosing that the payment does not include amounts 
for escrows. Nor could a creditor who offered escrows necessarily count 
on consumers who wanted to escrow finding the creditor on their own. If 
only a small minority of creditors offer escrows, consumers would, on 
average, have to contact many creditors in order to find one that 
offers escrows and many consumers might reasonably give up the search 
before they were successful.
---------------------------------------------------------------------------

    \95\ An industry representative at the Board's 2007 hearing 
indicated that her company's internal analysis showed that escrows 
clearly improved loan performance. Home Ownership and Equity 
Protection Act (HOEPA): Public Hearing, at 66 (June 14, 2007) 
(statement of Faith Schwartz, Senior Vice President, Option One 
Mortgage Corp.), available at http://federalreserve.gov/events/publichearings/hoepa/2007/20070614/transcript.pdf. Also, the Credit 
Union National Association and California and Nevada Credit Union 
Leagues comment letters note that ``[o]verall, loans with escrow 
accounts are likely to perform better than loans without these 
accounts.''
---------------------------------------------------------------------------

    Under these conditions, creditors are unlikely to offer escrows 
unless their competitors are required to offer escrows. The Board 
believes that creditors' failure to establish a capacity to escrow is a 
collective action problem; creditors would likely be better off if 
escrows were widely available in the subprime market, but most 
creditors who have not offered escrows lack the necessary incentive to 
invest in the requisite systems unless their competitors do. This is 
the context for the Board's finding that it is unfair for a creditor to 
make a higher-priced mortgage loan without offering an escrow.
    Substantial injury. A creditor's failure to offer escrows can cause 
consumers substantial injury. The lack of escrows in the subprime 
market increases the risk that consumers will base borrowing decisions 
on unrealistically low assessments of their mortgage-related 
obligations. Brokers and loan officers operating in a market where 
escrows are not common generally quote monthly payments of only 
principal and interest. These originators have little incentive to 
disclose or emphasize additional obligations for taxes and insurance. 
Therefore, many consumers will decide whether they can afford the 
offered loan on the basis of misleadingly low payment quotes, making it 
more likely that they will obtain mortgages they cannot afford. This 
risk is particularly high for first time homebuyers, who lack 
experience with the obligations of homeownership. The risk is also 
elevated for homeowners who currently have prime loans and contribute 
to an escrow. If their circumstances change and they refinance in the 
subprime market, they may not be aware that payments quoted to them do 
not include amounts for escrow. For example, current homeowners who 
have substantial unsecured consumer debt, but who also have equity in 
their homes, can be especially vulnerable to ``loan flipping'' because 
they may find a cash-out refinance offer attractive. Yet if they 
assumed, erroneously, that the monthly payment quoted to them included 
amounts for escrows, they would not be able to evaluate the true cost 
of the loan product being offered.
    The lack of escrows in the subprime market also makes it more 
likely that certain consumers will not be able to handle their mortgage 
obligations including taxes and insurance. Subprime consumers, by 
definition, are those who have experienced some difficulty in making 
timely payments on debt obligations. For this reason, some consumers 
may prefer to escrow if offered a choice, especially if they know from 
personal experience that they have difficulty saving on their own, 
paying their bills on-time, or both. Without an escrow, these consumers 
may be at greater risk that a servicer will impose costly force-placed 
homeowners insurance or the local government will seek to foreclose to 
collect unpaid taxes. Consumers with unpaid property tax or insurance 
bills are particularly vulnerable to predatory lending practices: 
originators offering them a refinancing with ``cash out'' to cover 
their tax and insurance obligations can take advantage of their urgent 
circumstances. The consumers who cannot or will not borrow more (for 
example, because they lack the equity) face default and a forced sale 
or foreclosure.
    Injury not reasonably avoidable. Consumers cannot reasonably avoid 
the injuries that result from the lack of escrows. As described above, 
originators in the subprime market have strong incentives to quote only 
principal and interest payment amounts, and much

[[Page 44559]]

weaker incentives to inform consumers about tax and insurance 
obligations since doing so could put them at a competitive 
disadvantage. Consumers may either be left unaware of the magnitude of 
their taxes and insurance obligations, or may not realize that amounts 
for taxes and insurance are not being escrowed for them if they are 
accustomed to the prime market's practice of escrowing. And, in a 
market where few creditors offer escrows and advertise their 
availability, consumers who would prefer to escrow may give up trying 
to find a creditor who offers escrows. Given the market they face, 
subprime consumers have little ability or incentive to shop for a loan 
with escrows, and thus cannot reasonably avoid a loan that does not 
offer escrows.
    Injury not outweighed by countervailing benefit to consumers or to 
competition. The Board recognizes that creditors incur costs in 
initiating escrow capabilities and that creditors who do not escrow can 
pass their cost savings on to consumers. Creditors that offer escrows 
in-house may incur potentially substantial costs in setting up or 
acquiring the necessary systems, although they may also gain some 
additional servicing revenue. Creditors that outsource servicing of 
escrow accounts to third parties incur some cost and forgo servicing 
revenue.
    In addition, there are some potential costs to consumers. Servicers 
may at times collect more funds than needed or fail to pay property 
taxes and insurance when due, causing consumers to incur penalties and 
late fees. Congress has expressly authorized the Department of Housing 
and Urban Development (HUD) to address these problems through section 
10 of the Real Estate Settlement Procedures Act (RESPA), 12 U.S.C. 
2609, which limits amounts that may be collected for escrow accounts; 
requires servicers to provide borrowers annual statements of the escrow 
balance and payments for property taxes and homeowners insurance; and 
requires a mortgage servicer to provide information about anticipated 
activity in the escrow accounts for the coming year when it starts to 
service a loan. RESPA also provides consumers the means to resolve 
complaints by filing a ``qualified written request'' with the servicer. 
The Board expects that the number of qualified written requests may 
increase after the final rule takes effect.
    On the other hand, there is evidence, described above, that where 
escrows are used they improve loan performance to the advantage of 
creditors, investors, and consumers alike. This appears to be an 
important reason that escrows are common in the prime market and often 
required by the creditor. Loans with escrows generally perform better 
than loans without because escrows make it more likely that consumers 
will be able to pay their obligations. By contrast, when consumers are 
faced with unpaid taxes and insurance, they may need to tap into their 
home equity to pay these expenses and may become vulnerable to 
predatory lending. In the worst cases, consumers may lose their homes 
to foreclosure for failure to pay property taxes. For these reasons, 
the Board finds that the benefits from escrows outweigh the costs 
associated with requiring them.
The Final Rule
    The final rule prohibits a creditor from extending a first-lien 
higher-priced mortgage loan secured by a principal dwelling without 
escrowing property taxes, homeowners insurance, and other insurance 
obligations required by the creditor. Creditors have the option to 
allow for cancellation of escrows at the consumer's request, but no 
earlier than 12 months after consummation of the loan transaction. The 
Board is adopting an exemption for loans secured by cooperative shares 
and a partial exemption for loans secured by condominium units. The 
final rule defines ``escrow account'' by reference to the definition of 
``escrow account'' in RESPA. Moreover, RESPA's rules for administering 
escrow accounts (including how creditors handle disclosures, initial 
escrow deposits, cushions, and advances to cover shortages) apply. The 
final rule also complements the National Flood Insurance Program 
requirement that flood insurance premiums be escrowed if the creditor 
requires escrow for other obligations such as hazard insurance.\96\
---------------------------------------------------------------------------

    \96\ Congress authorized NFIP through the National Flood 
Insurance Act of 1968 (42 U.S.C. 4001), which provides property 
owners with an opportunity to purchase flood insurance protection 
made available by the federal government for buildings and their 
contents. NFIP requires all federally regulated private creditors 
and government-sponsored enterprises (GSEs) that purchase loans in 
the secondary market to ensure that a building or manufactured home 
and any applicable personal property securing a loan in a special 
flood hazard area are covered by adequate flood insurance for the 
term of the loan. The flood insurance requirements do not apply to 
creditors or servicers that are not federally regulated and that do 
not sell loans to Fannie Mae and Freddie Mac or other GSEs.
---------------------------------------------------------------------------

    The rule is intended to address the consumer injuries described 
above caused by the lack of a genuine opportunity to escrow in the 
subprime market. The rule assures a genuine opportunity to escrow by 
establishing a market that provides widespread escrows through a 
requirement that every creditor that originates higher-priced mortgage 
loans secured by a first lien on a principal dwelling establish an 
escrow with each loan. The Board proposed to limit the rule to first-
lien higher-priced mortgage loans because creditors in the prime market 
have traditionally required escrow accounts on first-lien mortgage 
loans as a means of protecting the lender's interest in the property 
securing the loan. The final rule adopts this approach. A mandatory 
escrow account on a first-lien loan ensures that funds are set aside 
for payment of property taxes and insurance premiums and eliminates the 
need to require an escrow on second lien loans. One commenter asked the 
Board to clarify in the final rule that creditors are not obligated to 
escrow payments for optional items that the consumer may choose to 
purchase at its discretion, such as an optional debt-protection 
insurance or earthquake insurance. A commentary provision has been 
added to clarify that creditors and servicers are not required to 
escrow optional insurance items chosen by the consumer and not 
otherwise required by creditor. See comment to Sec.  226.35(b)(4)(i).
    The Board recognizes that escrows can impose certain financial 
costs on both creditors and borrowers. Creditors are likely to pass on 
to consumers, either in part or entirely, the cost of setting up and 
maintaining escrow systems, whether done in-house or outsourced. The 
Board also recognizes that prohibiting consumers from canceling before 
12 months have passed will impose costs on individual consumers who 
prefer to pay property taxes and insurance premiums on their own, and 
to earn interest on funds that otherwise would be escrowed.\97\ By 
paying property taxes and insurance premiums directly, consumers are 
better able to monitor that their payments are credited on time, thus 
limiting the likelihood, and related cost, of servicing mistakes and 
abuses. In addition, homebuyers do not need as much cash at closing 
when they are not required to have an escrow account.
---------------------------------------------------------------------------

    \97\ Some states require creditors to pay interest to consumers 
for escrowed funds but most states do not have such a requirement.
---------------------------------------------------------------------------

    The Board believes, however, that the benefits of the rule outweigh 
these costs. Moreover, the rule preserves some degree of consumer 
choice by permitting a creditor to provide the consumer an option to 
cancel an escrow account 12 or more months after consummation. The 
Board considered alternatives that would avoid requiring a creditor to 
set up an escrow system,

[[Page 44560]]

or that would require a creditor to offer an escrow, but permit 
consumers to opt-out of escrows at closing. These alternatives would 
not provide consumers sufficient protection from the injuries discussed 
above, as explained in more detail below.
    Alternatives to requiring creditors to escrow. Some creditors that 
currently do not escrow oppose requiring escrows because of the 
substantial cost to set up new systems and maintain them over time. 
They suggested that narrower, less costly alternatives would protect 
consumers adequately. Most of these suggestions involved disclosure, 
such as: requiring creditors to warn consumers that they will be 
responsible for property tax and insurance obligations; estimating 
these obligations on the TILA disclosure based on recent assessments; 
and prohibiting creditors from advertising monthly payments without 
including estimated amounts for property taxes and insurance.
    The Board does not believe that these disclosures would adequately 
protect consumers from the injuries discussed above. Because many 
consumers focus on monthly payment obligations, competition would 
continue to give originators incentives to downplay tax and insurance 
obligations when they discuss payment obligations with consumers. A 
disclosure provided at origination of the estimated property tax and 
insurance premiums does not assist those consumers who need an escrow 
to ensure they save for and pay their obligations on time. Moreover, 
adding a disclosure to the many disclosures consumers already receive 
would not be sufficient to educate first time homebuyers and homeowners 
whose previous loans contained escrows who lack any real experience 
handling their own taxes and insurance. Disclosure does, however, have 
an important role to play. Under the final rule, an advertisement for 
closed-end credit secured by a first lien on a principal dwelling that 
states a monthly payment of principal and interest must prominently 
disclose that taxes and insurance premiums are not included. See Sec.  
226.24(f)(3). Moreover, the Board plans to explore revising the TILA 
disclosures to add an estimate of property tax and insurance premium 
costs to the disclosed monthly payment.
    For similar reasons, merely mandating that creditors offer escrows, 
but not that they require them, would not sufficiently address the 
injuries associated with the failure to escrow. Without a widespread 
requirement to escrow, some creditors could still press a competitive 
advantage in quoting low monthly payments that do not include amounts 
for escrows by encouraging consumers to decline the offered escrow. A 
rule that required creditors merely to offer escrows would impose 
essentially the same costs on creditors to establish escrow systems as 
would the requirement to establish escrows, but would not alter the 
competitive landscape of the subprime market in a way that would make 
widespread escrowing more likely.
    Creditors also suggested that consumers would be adequately 
protected by the final rule's requirement that creditors consider a 
consumer's ability to handle tax and insurance obligations in addition 
to principal and interest payments when originating loans. See Sec.  
226.34(a)(4). While this requirement will help ensure that consumers 
can afford their monthly payment obligations, it will not adequately 
address the injuries discussed above because creditors would continue 
to have incentives to downplay tax and insurance obligations when they 
discussed payment obligations with consumers. Nor will the rule 
requiring consideration of repayment ability sufficiently assist 
consumers in saving on their own.
    Another alternative would be to require escrows only for first time 
homebuyers or other classes of borrowers (such as previously prime 
borrowers) less likely to have experience handling tax and insurance 
obligations on their own. However, limiting the escrow requirement to 
borrowers who are unaccustomed to paying taxes and insurance on their 
own would only delay injury, rather than prevent it. For example, if 
first time homebuyers with higher-priced mortgage loans were required 
to escrow, those consumers would not gain the experience of paying 
property taxes and insurance on their own and might reasonably believe 
that escrows are standard. When those consumers went to refinance their 
loan, however, creditors could mislead them by quoting payments without 
amounts for escrow and the consumers might not be able to handle the 
tax and insurance obligations on their own.
    In addition, requiring escrows only for first time homebuyers or 
other classes of borrowers would not save a creditor the substantial 
expense of setting up an escrow system unless the creditor declined to 
extend higher-priced mortgage loans to such borrowers. The Board 
believes most creditors would not find this option practical over the 
long term. Moreover, defining the categories of covered borrowers would 
present practical challenges, require regular adjustment as the market 
changed, and complicate creditors' compliance.
    Several commenters recommended that the requirement to escrow be 
limited to higher-priced mortgage loans with a combined loan-to-value 
ratio that exceeds 80 percent. They contended that borrowers with at 
least 20 percent equity have the option to tap this equity to finance 
tax and insurance obligations. The suggested exemption could, however, 
have the unintended consequence of permitting unscrupulous originators 
to ``strip'' the equity from less experienced borrowers. As described 
above, homeowners with existing escrow accounts who want to refinance 
their loans may assume erroneously that payment quotes include escrows 
when they do not, or they may prefer the security that an escrow would 
provide if offered.
    Cancellation after consummation. The final rule permits, but does 
not require, creditors to offer consumers an option to cancel their 
escrows 12 months after consummation of the loan transaction. Based on 
the operation of escrows in the prime market, the Board anticipates 
that creditors will likely offer cancellation in exchange for a fee. 
The Board acknowledges concerns expressed by individual consumers that 
requiring them to escrow for even a relatively short time will increase 
their costs. These costs include the opportunity costs of the funds in 
escrow, particularly if the funds do not earn interest; a fee to cancel 
after 12 months; costs associated with mistakes or abuses by escrow 
agents; and the cost of saving for the deposit at consummation of two 
months or more of escrow payments that RESPA permits a creditor to 
require. Mindful of these costs, the Board considered requiring only 
that creditors offer consumers a choice to escrow either on an ``opt 
in'' or ``opt out'' basis.
    As explained above, the Board concluded that a requirement merely 
to offer the consumer a choice to escrow would not be effective to 
prevent the injuries associated with the lack of opportunity to escrow. 
A requirement to offer, not require, escrows would raise creditors' 
costs but would not eliminate their incentive to quote lower payment 
amounts without escrows and encourage borrowers to opt-out. Requiring 
creditors to disclose information about the benefits of escrowing would 
not adequately address this problem. It is likely that most consumers 
would reasonably focus their attention more on disclosures about the 
terms of the credit being offered, such as the monthly payment amount, 
rather than on information

[[Page 44561]]

about the benefits of escrowing. An originator engaged in loan flipping 
might reassure the consumer that if the consumer has any difficulty 
with the tax and insurance obligations the originator will refinance 
the loan.
    For the foregoing reasons, the Board does not believe that 
requiring creditors merely to offer escrows with higher-priced mortgage 
loans, with an opt out or opt in before consummation, would provide 
consumers sufficient protection. The Board has concluded that requiring 
creditors to impose escrows on borrowers with higher-priced mortgage 
loans, with an option to cancel only some time after consummation, 
would more effectively address the problems created by subprime 
creditors' failure to offer escrows. This approach imposes costs on 
creditors that will be passed on, at least in part, to consumers but 
the Board believes these costs are outweighed by the benefits. 
Moreover, to the extent that escrows improve loan performance and lead 
to fewer defaults, the benefits of escrows may reduce the costs 
associated with establishing and maintaining escrow accounts.
    Twelve months mandatory escrow. The final rule sets the mandatory 
period for escrows at 12 months after loan origination, at which point 
creditors may allow borrowers to opt out of escrow. Some community 
groups commented that escrows should be mandatory for a longer period 
or even the life of the loan. Several groups commented that borrowers 
should not be allowed to opt out unless they have demonstrated a record 
of timely payments. Several commenters noted that consumers should be 
allowed to opt out at loan consummation.
    The Board believes that a 12 month period appropriately balances 
consumer protection with consumer choice. For the reasons already 
explained, a mandatory period of some length is necessary to ensure 
that originators will not urge consumers to reduce their monthly 
payment by choosing not to escrow immediately at, or shortly after, 
loan consummation. Twelve months appears to be a sufficiently long 
period to render such efforts ineffectual, and to introduce consumers 
to the benefits of escrowing, as most consumers will receive bills for 
taxes and insurance in that period. Moreover, 12 months is a relatively 
short period compared to the expected life of the average loan, 
providing consumers an opportunity to handle their own taxes and 
insurance obligations after the initial escrow requirement expires.
    Although fees to cancel escrow accounts are common, a consumer who 
expects to hold the loan for a long period may find it worthwhile to 
pay the fee. The final rule neither permits nor prohibits creditors 
from imposing escrow cancellation fees and instead defers to state law 
on that issue. Similarly, the rule neither requires nor prohibits 
payment of interest on escrow accounts since some, but not all, states 
have chosen to address consumer concerns about losing the opportunity 
to invest their funds by requiring creditors to pay interest on funds 
in escrow accounts.
Exemptions for Cooperatives; Partial Exemption for Condominiums
    In response to comments and the Board's own analysis, the final 
rule does not require escrows for property taxes and insurance premiums 
for first-lien higher-priced mortgage loans secured by shares in a 
cooperative if the cooperative association pays property tax and 
insurance premiums. The final rule requires escrows for property taxes 
for first-lien higher-priced mortgage loans secured by condominium 
units but exempts from the escrow requirement insurance premiums if the 
condominium's association maintains and pays for insurance through a 
master policy.
    Cooperatives. The final rule exempts mortgage loans for 
cooperatives from the escrow requirement if the cooperative pays 
property tax and insurance premiums, and passes the costs on to 
individual unit owners based on their pro rata ownership share in the 
cooperative. A cooperative association typically owns the building, 
land, and improvements, and each unit owner holds a cooperative share 
loan based on the appraisal value of the shareholder's unit. Creditors 
typically require cooperative associations to maintain insurance 
coverage under a single package policy, commonly called an association 
master policy, for common elements, including fixtures, service 
equipment and common personal property. Creditors periodically review 
an association master policy to ensure adequate coverage.
    At loan origination, creditors inform consumers of their monthly 
cooperative association dues, which include, among other costs, the 
consumer's pro rata share for insurance and property taxes. When 
property taxes and insurance premiums are included in the monthly 
association dues, they are generally not escrowed with the lender. This 
is because the consumer's payment of the monthly association dues acts 
in a manner similar to an escrow itself. In this way, the collection of 
insurance premiums and property tax amounts on a monthly basis by a 
cooperative association ensures that taxes and insurance are paid when 
due.
    Condominiums. The final rule exempts certain higher-priced mortgage 
loans secured by condominium units from the requirement to escrow for 
homeowners insurance where the only insurance policy required by the 
creditor is the condominium association master policy. No exemption is 
provided, however, for escrows for property taxes.
    Typically, individual condominium units are taxed similarly to 
single-family homes. Generally, each unit owner pays the property tax 
for the unit and each unit is assessed its pro rata share of property 
taxes for common areas. Condominium owners who do not have escrow 
accounts receive property tax bills directly from the taxing 
jurisdiction. The final rule requires escrows for property taxes for 
all higher-priced mortgage loans secured by condominium units, 
regardless of whether creditors are required to escrow insurance 
premiums for such loans.
    Homeowners insurance for condominiums, on the other hand, can vary 
based on the condominium association's bylaws and other governing 
regulations, as well as specific creditor requirements. Generally, the 
condominium association insures the building and the common area under 
an association master policy. In some cases, the condominium 
association does not insure individual units and a separate insurance 
policy must be written for each individual unit, just as it would be 
for a single-family home. In other cases, the master policy does cover 
individual unit owners' fixtures and improvements other than personal 
property. When the condominium association insures the entire 
structure, including individual units, the condominium association pays 
the insurance premium and passes the costs on to the individual unit 
owner. Much like the cooperative arrangement described above, the 
consumer's payment of insurance premiums through condominium 
association dues acts in a manner similar to an escrow account. For 
this reason, the final rule does not require creditors to escrow 
insurance premiums for higher-priced mortgage loans secured by 
condominium units if the only insurance that the creditor requires is 
an association master policy that insures condominium units.
Manufactured Housing
    The final rule requires escrows for all covered loans secured by 
manufactured housing for which creditors receive applications on or 
after October 1, 2010

[[Page 44562]]

to allow creditors and servicers sufficient time to establish the 
capacity to escrow. Manufactured housing industry commenters requested 
that manufactured housing loans be exempted from the escrow 
requirement. They argued that manufactured housing loans are mostly 
personal property loans taxed in many local jurisdictions like other 
personal property, and that creditors and servicers do not require and 
do not offer escrows on manufactured housing loans.\98\ For reasons 
discussed in more detail below, the final rule does not exempt from the 
escrow requirement higher-priced mortgage loans secured by a first lien 
on manufactured housing used as the consumer's principal dwelling. The 
final rule applies to manufactured housing whether or not state law 
treats it as personal or real property.\99\
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    \98\ Manufactured housing creditors are currently required by 
law to escrow for property taxes in Texas. Prior to passing state 
legislation requiring escrows on manufactured housing, Texas 
legislators observed that many manufactured housing owners were 
unaware of, and unable to pay, their property tax. See Tex. SB 521, 
78th Tex. Leg., 2003, effective June 18, 2003; bill analysis 
available through the Texas Senate Research Center at http://www.legis.state.tx.us/tlodocs/78R/analysis/pdf/SB00521I.pdf.
    \99\ Regulation Z currently defines a dwelling to include 
manufactured housing. See Sec.  226.2(a)(19). Official staff 
commentary Sec.  226.2(a)(19) states that mobile homes, boats and 
trailers are dwellings if they are in fact used as residences; Sec.  
226.2(b) clarifies that the definition of ``dwelling'' includes any 
residential structure, whether or not it is real property under 
state law; Sec. Sec.  226.15(a)(1)-5 and 226.23(a)(1)-3 make clear 
that a dwelling may include structures that are considered personal 
property under state laws (e.g., mobile home, trailer or houseboat) 
and draws no distinction between personal property loans and real 
property loans.
---------------------------------------------------------------------------

    A manufactured home owner typically pays personal property taxes 
directly to the taxing authority and insurance premiums directly to the 
insurer. Manufactured housing industry commenters argued that if a 
taxing jurisdiction does not have an automated personal property tax 
system, creditors and servicers would have to service escrows on 
manufactured housing loans manually at prohibitively high cost, 
especially taking into consideration small loan size and low amount of 
property taxes for an average manufactured home.
    The Board believes, nonetheless, that problems associated with 
first-lien higher-priced mortgage loans secured by manufactured housing 
are similar to problems associated with site-built home loans discussed 
above. Large segments of manufactured housing consumers are low to 
moderate income families who may not enter the market with full 
information about the obligations associated with owning manufactured 
housing. Instead, consumers are likely to rely on the dealer or the 
manufacturer as their source for information, which can leave consumers 
vulnerable. Often, consumers obtain financing through the dealer, who 
ties the financing to the sale of the home. In addition, commissions 
and yield spread premiums may be paid to dealers for placing consumers 
in high cost loans.\100\
---------------------------------------------------------------------------

    \100\ Kevin Jewell, Market Failures Evident in Manufactured 
Housing (Jan. 2003), http://www.consumersunion.org/consumeronline/pastissues/housing/marketfailure.html.
---------------------------------------------------------------------------

    In addition, manufactured homes are usually concentrated in 
developments, such as parks, where they represent a large percentage of 
homes. Where property tax revenues are the main source of funding for 
local government services, a failure by a significant number of 
homeowners to pay property taxes could cause a reduction in local 
government services and an attendant decline in property values.
    The Board believes that homeowners of manufactured housing should 
be afforded the same consumer protections as the owners of site-built 
homes. Manufactured homes provide much needed affordable housing for 
millions of Americans who, like owners of site-built homes, risk losing 
their homes for failure to pay property taxes. Escrows for property 
taxes and insurance premiums on first-lien, higher-priced mortgage 
loans secured by manufactured homes that are consumers' principal 
dwellings are necessary to prevent creditors from understating the cost 
of homeownership, to inform consumers that their manufactured home is 
subject to property tax, and to extend an opportunity to consumers to 
escrow funds each month for payment of property tax and insurance 
premiums.
State Laws
    Several industry commenters asked the Board to clarify in the final 
rule that the escrow requirement preempts inconsistent state escrow 
laws. TILA generally preempts only inconsistent state laws. See TILA 
Section 111(a)(1), 15 U.S.C. 1610, Sec.  226.28. Several consumers 
expressed concern that the regulation would preempt state laws 
requiring creditors to pay interest on escrow accounts under certain 
conditions. The final rule does not prevent states from requiring 
creditors to pay interest on escrowed amounts. See comment Sec.  
226.35(b)(4)(i).
Effective Date
    Several industry representatives commented that the escrow 
requirement would require major system and infrastructure changes by 
creditors that do not currently have escrow capabilities. They asked 
for an extended compliance deadline of 12 to 24 months prior to the 
effective date of the final rule to allow for necessary escrow systems 
and procedures to develop. The Board recognizes that creditors and 
servicers will need some time to develop in-house escrowing 
capabilities or to outsource escrow servicing to third parties. For 
that reason, the Board agrees that an extended compliance period is 
appropriate for most covered loans secured by site-built homes. 
Therefore, the final rule is effective for first-lien higher-priced 
mortgage loans for which creditors receive applications on or after 
April 1, 2010, except for loans secured by manufactured housing. 
Recognizing that there is a limited infrastructure for escrowing on 
manufactured housing loans, and that yet additional time is needed for 
creditors and servicers to comply with the rule, the final rule is 
effective for all covered loans secured by manufactured housing for 
which creditors receive applications on or after October 1, 2010.

E. Evasion Through Spurious Open-End Credit--Sec.  226.35(b)(4)

    The exclusion of HELOCs from Sec.  226.35 is discussed in subpart 
A. above. As noted, the Board recognizes that the exclusion of HELOCs 
could lead some creditors to attempt to evade the restrictions of Sec.  
226.35 by structuring credit as open-end instead of closed-end. Section 
226.34(b) addresses this risk as to HOEPA loans by prohibiting 
creditors from structuring a transaction that does not meet the 
definition of ``open-end credit'' as a HELOC to evade HOEPA. The Board 
proposed to extend this rule to higher-priced mortgage loans and is 
adopting Sec.  226.35(b)(5). Section 226.35(b)(5) prohibits a creditor 
from structuring a closed-end transaction--that is, a transaction that 
does not meet the definition of ``open-end credit''--as a HELOC to 
evade the restrictions of Sec.  226.35. The Board is also adding 
comment 35(b)(5)-1 to provide guidance on how to apply the higher-
priced mortgage loan APR trigger in Sec.  226.35(a) to a transaction 
structured as open-end credit in violation of Sec.  226.35. Comment 
35(b)(5)-1 is substantially similar to comment 34(b)-1 which applies to 
HOEPA loans.
Public Comment
    The Board received relatively few comments on the proposed anti-
evasion rule. As discussed in subpart A. above, some commenters 
suggested applying Sec.  226.35 to HELOCs, which would

[[Page 44563]]

eliminate the need for an anti-evasion provision. By contrast, some 
creditors who supported the exclusion of HELOCs from Sec.  226.35 noted 
that the presence of the anti-evasion provision would address concerns 
about HELOCs being used to evade the rules in Sec.  226.35. However, a 
few creditors expressed concern that the anti-evasion proposal was too 
vague. One commenter stated that loans that do not meet the definition 
of open-end credit would be subject to the closed-end rules with or 
without the anti-evasion provision, and this commenter stated that 
therefore the anti-evasion provision was unnecessary and might cause 
confusion.
    The Board also requested comment on whether it should limit an 
anti-evasion rule to HELOCs secured by first-liens, where the consumer 
draws down all or most of the entire line of credit immediately after 
the account is opened. Commenters did not express support for this 
alternative, and a few explicitly opposed it.
The Final Rule
    The Board is adopting the anti-evasion provision as proposed. The 
rule is not meant to add new substantive requirements for open-end 
credit, but rather to ensure that creditors do not structure a loan 
which does not meet the definition of open-end credit as a HELOC to 
evade the requirements of Sec.  226.35. The Board recognizes that 
consumers may prefer HELOCs to closed-end home equity loans because of 
the added flexibility HELOCs provide them. The Board does not intend to 
limit consumers' ability to choose between these two ways of 
structuring home equity credit. The anti-evasion provision is intended 
to reach cases where creditors have structured loans as open-end 
``revolving'' credit, even if the features and terms or other 
circumstances demonstrate that the creditor had no reasonable 
expectation of repeat transactions under a reusable line of credit. 
Although the practice violates TILA, the new rule will subject 
creditors to HOEPA's stricter remedies if the credit carries an APR 
that exceeds Sec.  226.35's APR trigger for higher-priced mortgage 
loans.
    The Board is also adding comment 35(b)(5)-1 to provide guidance on 
how to apply the higher-priced mortgage loan APR trigger in Sec.  
226.35(a) to a transaction structured as open-end credit in violation 
of Sec.  226.35. Specifically, the comment provides guidance on how to 
determine the ``amount financed'' and the ``principal loan amount'' 
needed to determine the loan's APR. The comment provides that the 
amount of credit that would have been extended if the loan had been 
documented as a closed-end loan is a factual determination to be made 
in each case.

X. Final Rules for Mortgage Loans--Sec.  226.36

    Section 226.35, discussed above, applies certain new protections to 
higher-priced mortgage loans and HOEPA loans. In contrast, Sec.  226.36 
applies other new protections to mortgage loans generally, though only 
if secured by the consumer's principal dwelling. The final rule 
prohibits: (1) Creditors or mortgage brokers from coercing, 
influencing, or otherwise encouraging an appraiser to provide a 
misstated appraisal and (2) servicers from engaging in unfair fee and 
billing practices. The final rule neither adopts the proposal to 
require servicers to deliver a fee schedule to consumers upon request, 
nor the proposal to prohibit creditors from paying a mortgage broker 
more than the consumer had agreed in advance that the broker would 
receive. As with proposed Sec.  226.35, Sec.  226.36 does not apply to 
HELOCs.
    The Board finds that the prohibitions in the final rule are 
necessary to prevent practices that the Board finds to be unfair, 
deceptive, associated with abusive lending practices, or otherwise not 
in the interest of the borrower. See TILA Section 129(l)(2), 15 U.S.C. 
1639(l)(2), and the discussion of this statute in part V.A above. The 
Board also believes that the final rules will enhance consumers' 
informed use of credit. See TILA Sections 105(a), 102(a).

A. Creditor Payments to Mortgage Brokers--Sec.  226.36(a)

    The Board proposed to prohibit a creditor from paying a mortgage 
broker in connection with a covered transaction more than the consumer 
agreed in writing, in advance, that the broker would receive. The 
broker would also disclose that the consumer ultimately would bear the 
cost of the entire compensation even if the creditor paid any part of 
it directly; and that a creditor's payment to a broker could influence 
the broker to offer the consumer loan terms or products that would not 
be in the consumer's interest or the most favorable the consumer could 
obtain.\101\ Proposed commentary provided model language for the 
agreement and disclosures. The Board stated that it would test this 
language with consumers before determining how it would proceed on the 
proposal.
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    \101\ Creditors could demonstrate compliance with the proposed 
rule by obtaining a copy of the broker-consumer agreement and 
ensuring their payment to the broker does not exceed the amount 
stated in the agreement. The proposal would provide creditors two 
alternative means to comply, one where the creditor complies with a 
state law that provides consumers equivalent protection, and one 
where a creditor can demonstrate that its payments to a mortgage 
broker are not determined by reference to the transaction's interest 
rate.
---------------------------------------------------------------------------

    The Board tested the proposal with several dozen one-on-one 
interviews with a diverse group of consumers. On the basis of this 
testing and other information, the Board is withdrawing the proposal. 
The Board will continue to explore available options to address unfair 
acts or practices associated with originator compensation arrangements 
such as yield spread premiums. The Board is particularly concerned with 
arrangements that cause the incentives of originators to conflict with 
those of consumers, where the incentives are not transparent to 
consumers who rely on the originators for advice. As the Board 
comprehensively reviews Regulation Z, it will continue to consider 
whether disclosure or other approaches could be effective to address 
this problem.
Public Comment
    The Board received over 4700 comments on the proposal. Mortgage 
brokers, their federal and state trade associations, the Federal Trade 
Commission, and several consumer groups argued that applying the 
proposed disclosures to mortgage brokers but not to creditors' 
employees who originate mortgages (``loan officers'') would reduce 
competition in the market and harm consumers. They contended that 
disclosing a broker's compensation would cause consumers to believe, 
erroneously, that a loan arranged by a broker would cost more than a 
loan originated by a loan officer. These commenters stated that many 
brokers would unfairly be forced out of business, and consumers would 
pay higher prices, receive poorer service, or have fewer options. The 
FTC, citing its published report of consumer testing of mortgage broker 
compensation disclosures, contended that focusing consumers' attention 
on the amount of the broker's compensation could confuse consumers and, 
under some circumstances, lead them to select a more expensive loan.
    Mortgage brokers and some creditors expressed concerns that the 
proposed rule would not be practicable in cases where creditors forward 
applications to other creditors and where brokers decide to fund an 
application using a warehouse line of credit.
    Consumer advocates, members of Congress, the FDIC, and others 
stated

[[Page 44564]]

that the proposal would not address the conflict of interest between 
consumers and brokers that rate-based compensation of brokers (the 
yield spread premium) can cause. These commenters urged that the only 
effective remedy for the conflict is to ban this form of compensation. 
State regulators expressed concern that the proposed disclosures would 
not provide consumers sufficient information, and could give brokers a 
legal ``shield'' against claims they acted contrary to consumers' 
interests.
    Creditors and their trade associations, on the other hand, 
generally supported the proposal, although with a number of suggested 
modifications. These commenters agreed with the Board that yield spread 
premiums create financial incentives for brokers to steer consumers to 
less beneficial products and terms. They saw a need for regulation to 
remove or limit these incentives.
    Commenters generally did not believe the proposed alternatives for 
compliance (where a state law provides substantially equivalent 
protections or where a creditor can show that the compensation amount 
is not tied to the interest rate) were feasible. Creditors and mortgage 
brokers stated that both alternatives were vague and would be little 
used. Consumer advocates believed the alternatives would likely create 
loopholes in the rule.
    Comments on specific issues are discussed in more detail below as 
appropriate.
Discussion
    The proposal was intended to limit the potential for unfairness, 
deception, and abuse in yield spread premiums while preserving the 
ability of consumers to cover their payments to brokers through rate 
increases. Creditor payments to brokers based on the interest rate give 
brokers an incentive to provide consumers loans with higher interest 
rates. Many consumers are not aware of this incentive and may rely on 
the broker as a trusted advisor to help them navigate the complexities 
of the mortgage application process.
    The proposal sought to reduce the incentive of the broker to 
increase a consumer's rate and increase the consumer's leverage to 
negotiate with the broker. Under the proposal, creditor payments to 
brokers would be conditioned on a broker's advance commitment to a 
specified compensation amount. The proposal would require the agreement 
to be entered into before an application was submitted by a consumer or 
prior to the payment of any fee, whichever occurred earlier. Requiring 
an agreement before a fee or application would help ensure the 
compensation was set as independently as possible of loan's rate and 
other terms, and that the consumer would not feel obligated to proceed 
with the transaction. The Board also anticipated that the proposal 
would increase transparency and improve competition in the market for 
brokerage services, which could lower the price of these services, 
improve the quality of those services, or both.
    Reasons for withdrawal. Based on the Board's analysis of the 
comments, consumer testing, and other information, the Board is 
withdrawing the proposal. The Board is concerned that the proposed 
agreement and disclosures would confuse consumers and undermine their 
decision-making rather than improve it. The risks of consumer confusion 
arise from two sources. First, an institution can act as either 
creditor or broker depending on the transaction; as explained below, 
this could render the proposed disclosures inaccurate and misleading in 
some, possibly many, cases of both broker and creditor originations. 
Second, consumers who participated in one-on-one interviews about the 
proposed agreement and disclosures often concluded, erroneously, that 
brokers are categorically more expensive than creditors or that brokers 
would serve their best interests notwithstanding the conflict resulting 
from the relationship between interest rates and brokers' compensation.
    Dual roles. Mortgage brokers and creditors noted that creditors and 
brokers often play one of two roles. That is, an institution that is 
ordinarily a creditor and originates loans in its name may determine 
that it cannot approve an application based on its own underwriting 
criteria and present it to another creditor for consideration. This 
practice is known as ``brokering out.'' The institution brokering out 
an application would be a mortgage broker under the proposed rule; to 
receive compensation from the creditor, it would have to execute the 
required agreement and provide the required disclosures.
    The proposal requires a broker to enter an agreement and give 
disclosures before the consumer submits an application, but an 
institution often may not know whether it will be a broker or a 
creditor for that consumer until it receives and evaluates the 
application. An institution that is ordinarily a creditor but sometimes 
a broker would have to enter into the agreement and give the 
disclosures for all consumers that seek to apply. In many cases, 
however, the institution will originate the loan as a creditor and not 
switch to being a broker. In these cases, the agreement and 
disclosures, which describe the institution as a broker and state its 
compensation as if it were brokering the transaction, would likely 
mislead and confuse the consumer. This problem also arises, if less 
frequently, when an institution that ordinarily brokers instead acts as 
creditor on occasion. On those occasions, the disclosures also would 
likely be misleading and confusing.
    The source of the problem is the proposed requirement that the 
agreement be signed and disclosures given before the consumer has 
applied for a loan or paid a fee. The Board considered permitting post-
application execution and disclosure by institutions that perform dual 
roles. The proposed timing, however, was intended to ensure that a 
consumer would be apprised of the broker's compensation and understand 
the broker's role before becoming, or feeling, committed to working 
with the broker. Accordingly, the Board concluded that providing this 
information later in the loan transaction would seriously undermine the 
proposal's objective of empowering the consumer to shop and negotiate.
    Consumer testing. Consumer testing also suggested that at least 
some aspects of the proposal could confuse and mislead consumers. After 
publishing the proposal, a Board contractor, Macro International, Inc. 
(``Macro''), conducted in-depth one-on-one interviews with a diverse 
group of several dozen consumers who recently had obtained a mortgage 
loan.\102\ Macro developed and tested a form in which the broker would 
agree to a specified total compensation and disclose (i) that any part 
of the compensation paid by the creditor would cost the consumer a 
higher interest rate, and (ii) that creditor payments to brokers based 
on the rate create a conflict of interest between mortgage brokers and 
consumers. Throughout the testing, revisions were made to the form in 
an effort to improve comprehension. The testing revealed two 
difficulties with the forms tested.
---------------------------------------------------------------------------

    \102\ For more details on the consumer testing, see Macro's 
report, Consumer Testing of Mortgage Broker Disclosures, (July 10, 
2008), available at http://www.federalreserve.gov.
---------------------------------------------------------------------------

    First, the form's statements that the consumer would pay the broker 
through a higher rate and that the broker had a conflict of interest 
confused many participants. Many participants stated, upon reading the 
disclosure, that if they agreed to pay the compensation the broker was 
asking, then the broker

[[Page 44565]]

would be obliged to find them the lowest interest rate and best terms 
available. Many participants reached this conclusion despite the clear 
statement in the form tested that brokers can increase their 
compensation by increasing the interest rate.
    Second, many first-round participants stated or implied after 
reading the form that working through a broker would cost them more 
than working directly with a lender, which is not necessarily true. A 
new provision was added to the disclosure stating that lenders' 
employees are paid the same types of rate-based commissions as brokers 
and have the same conflict of interest. Many participants, however, 
continued to voice a belief that brokered loans must cost more than 
direct loans.
    The results of testing indicate that consumers did not sufficiently 
understand some major aspects of the proposed disclosures. On the one 
hand, the disclosures could cause consumers to believe that mortgage 
brokers have obligations to them that the law does not actually impose. 
In consumer testing, this belief seemingly resulted from the disclosure 
of the fact that the consumer would pay the broker a commission, and it 
persisted notwithstanding the accompanying disclosure of the conflict 
of interest resulting from the rate-commission relationship. On the 
other hand, the disclosures could cause consumers to believe that 
retail loans are categorically less costly than brokered loans. 
Notwithstanding an explicit statement in the tested forms that 
commissions based on interest rates also are paid to loan officers, 
many participants voiced the belief that loan officers' commissions 
would be lower than brokers' commissions. They offered different 
reasons for this conclusion, including for example that the lender and 
not the consumer would pay the loan officer's commission.
    Despite the difficulties with the disclosures observed in consumer 
testing, there were also some successes. For instance, consumers 
generally appeared to understand the language describing the potential 
conflict of interest, as noted above, even though it often was ignored 
because of seemingly conflicting information. In addition, language 
intended to convey to consumers the importance of shopping on their own 
behalf in the mortgage market appeared to be successful. These more 
encouraging results suggest that further development of a disclosure 
approach to creditor payments to mortgage originators, through 
additional consumer testing, still may have merit.
    Conclusion. The Board considered whether it could resolve the 
problems described above by applying the proposal to the retail 
channel. The Board concluded, however, that substantial additional 
testing and analysis would be required to determine whether such an 
approach would be effective. Therefore, the Board is withdrawing the 
proposal. The Board will continue to explore available options to 
address potential unfairness associated with originator compensation 
arrangements such as yield spread premiums. As the Board 
comprehensively reviews Regulation Z, it will continue to consider 
whether disclosures or other approaches could effectively remedy this 
potential unfairness without imposing unintended consequences.
Definition of Mortgage Broker
    In connection with the proposal relating to mortgage broker 
compensation and the proposal prohibiting coercion of appraisers, the 
Board proposed to define ``mortgage broker'' as a person, other than a 
creditor's employee, who for monetary gain arranges, negotiates, or 
otherwise obtains an extension of credit for a consumer. A person who 
met this definition would be considered a mortgage broker even if the 
credit obligation was initially payable to the person, unless the 
person funded the transaction from its own resources, from deposits, or 
from a bona fide warehouse line of credit. Commenters generally did not 
comment on the proposed definition.
    Defining ``mortgage broker'' is still necessary, notwithstanding 
the Board's withdrawal of the proposed regulation of creditor payments 
to mortgage brokers, as mortgage brokers are subject to the 
prohibitions on coercion of appraisers, discussed below. The Board is 
adopting the definition of mortgage broker with a minor change to 
clarify that the term ``mortgage broker'' does not include a person who 
arranges, negotiates, or otherwise obtains an extension of credit for 
him or herself.

B. Coercion of Appraisers--Sec.  226.36(b)

    The Board proposed to prohibit creditors and mortgage brokers and 
their affiliates from coercing, influencing, or otherwise encouraging 
appraisers to misstate or misrepresent the value of a consumer's 
principal dwelling. The Board also proposed to prohibit a creditor from 
extending credit when it knows or has reason to know, at or before loan 
consummation, that an appraiser has been encouraged by the creditor, a 
mortgage broker, or an affiliate of either, to misstate or misrepresent 
the value of a consumer's principal dwelling, unless the creditor acts 
with reasonable diligence to determine that the appraisal was accurate 
or extends credit based on a separate appraisal untainted by coercion. 
The Board is adopting the rule substantially as proposed. The Board has 
revised some of the proposed examples of conduct that violates the rule 
and conduct that does not violate the rule and has added commentary 
about when a misstatement of a dwelling's value is material.
Public Comment
    Consumer and community advocacy groups, appraiser trade 
associations, state appraisal boards, individual appraisers, some 
financial institutions and banking trade associations, and a few other 
commenters expressed general support for the proposed rule to prohibit 
appraiser coercion. Several of these commenters stated that the rule 
would enhance enforcement against parties that are not subject to the 
same oversight as depository institutions, such as independent mortgage 
companies and mortgage brokers. Some of the commenters who supported 
the rule also suggested including additional practices in the list of 
examples of prohibited conduct. In addition, several appraiser trade 
associations jointly recommended that the Board prohibit appraisal 
management companies from coercing appraisers.
    On the other hand, community banks, consumer banking and mortgage 
banking trade associations, and some large financial institutions 
opposed the proposed rule, stating that its adoption would lead to 
nuisance suits by borrowers who regret the amount they paid for a house 
and would make creditors liable for the actions of mortgage brokers and 
appraisers. Several of these commenters stated that the Board's rule 
would duplicate requirements set by existing laws and guidance, 
including federal regulations, interagency guidelines, state laws, and 
the Uniform Standards of Professional Appraisal Practice (USPAP). 
Further, some of these commenters stated that creditors have limited 
ability to detect undue influence and should be held liable only if 
they extend credit knowing that a violation of Sec.  226.36(b)(1) had 
occurred.
    Many commenters discussed appraisal-related agreements that Fannie 
Mae and Freddie Mac have entered into with the Attorney General of New 
York and the Office of Federal Housing Enterprise Oversight (GSE 
Appraisal Agreements), which incorporated a

[[Page 44566]]

Home Valuation Code of Conduct. These commenters urged the Board to 
coordinate with the parties to the GSE Appraisal Agreements to promote 
consistency in the standards that apply to the residential appraisal 
process.
    The comments are discussed in greater detail below.
Discussion
    The Board finds that it is an unfair practice for creditors or 
mortgage brokers to coerce, influence, or otherwise encourage an 
appraiser to misstate the value of a consumer's principal dwelling. 
Accordingly, the Board is adopting the rule substantially as proposed.
    Substantial injury. Encouraging an appraiser to overstate or 
understate the value of a consumer's dwelling causes consumers 
substantial injury. An inflated appraisal may cause consumers to 
purchase a home they otherwise would not have purchased or to pay more 
for a home than they otherwise would have paid. An inflated appraisal 
also may lead consumers to believe that they have more home equity than 
in fact they do, and to borrow or make other financial decisions based 
on this incorrect information. For example, a consumer who purchases a 
home based on an inflated appraisal may overestimate his or her ability 
to refinance and therefore may take on a riskier loan. A consumer also 
may take out more cash with a refinance or home equity loan than he or 
she would have had an appraisal not been inflated. Appraiser coercion 
thus distorts, rather than enhances, competition. Though perhaps less 
common than overstated appraisals, understated appraisals can cause 
consumers to be denied access to credit for which they qualified.
    Inflated or understated appraisals of homes concentrated in a 
neighborhood may affect appraisals of neighboring homes, because 
appraisers factor into a property valuation the value of comparable 
properties. For the same reason, understated appraisals may affect 
appraisals of neighboring properties. Therefore, inflating or deflating 
appraised value can harm consumers other than those who are party to 
the transaction with the misstated appraisal.
    Injury not reasonably avoidable. Consumers who are party to a 
consumer credit transaction cannot prevent creditors or mortgage 
brokers from influencing appraisers to misstate or misrepresent a 
dwelling's value. Creditors and mortgage brokers directly or indirectly 
select and contract with the appraisers that value a dwelling for a 
consumer credit transaction. Consumers will not necessarily be aware 
that a creditor or mortgage broker is pressuring an appraiser to 
misstate or misrepresent the value of the principal dwelling they offer 
as collateral for a loan. Furthermore, consumers who own property near 
a dwelling securing a consumer credit transaction but are not parties 
to the transaction are not in a position to know that a creditor or 
mortgage broker is coercing an appraiser to misstate a dwelling's 
value. Consumers thus cannot reasonably avoid injuries that result from 
creditors' or mortgage brokers' coercing, influencing, or encouraging 
an appraiser to misstate or misrepresent the value of a consumer's 
principal dwelling.
    Injury not outweighed by benefits to consumers or to competition. 
The Board finds that the practice of coercing, influencing, or 
otherwise encouraging appraisers to misstate or misrepresent value does 
not benefit consumers or competition. Acts or practices that promote 
the misrepresentation of the market value of a dwelling distort the 
market, and any competitive advantage a creditor or mortgage broker 
obtains through influencing an appraiser to misstate a dwelling's 
value, or that a creditor gains by knowingly originating loans based on 
a misstated appraisal, is an unfair advantage.
    For the foregoing reasons, the Board finds that it is an unfair 
practice for a creditor or mortgage broker to coerce, influence, or 
otherwise encourage an appraiser to misstate the value of a consumer's 
principal dwelling. As discussed in part V.A above, the Board has broad 
authority under TILA Section 129(l)(2) to adopt regulations that 
prohibit, in connection with mortgage loans, acts or practices that the 
Board finds to be unfair or deceptive. 15 U.S.C. 1639(l)(2). Therefore, 
the Board may adopt regulations prohibiting unfair or deceptive 
practices by mortgage brokers who are not creditors and unfair or 
deceptive practices that are ancillary to the origination process, when 
such practices are ``in connection with mortgage loans.'' Because 
appraisals play an important role in a creditor's decision to extend 
mortgage credit as well as the terms of such credit, the Board believes 
that it fits well within the Board's authority under Section 129(l)(2) 
to prohibit creditors and mortgage brokers from coercing, influencing, 
or otherwise encouraging an appraiser to misstate the value of a 
consumer's principal dwelling and creditors from extending credit based 
on an appraisal when they know that prohibited conduct has occurred. 
Therefore, the Board issues the final rule prohibiting such acts under 
TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2).
The Final Rule
    The Board requested comment on the potential costs and benefits of 
its proposed appraiser coercion regulation. Some securitization trade 
associations and financial institutions stated that creditors obtain 
appraisals for their own benefit, to determine whether to extend credit 
and the terms of credit extended. The Board recognizes that, because 
appraisals provide evidence of the collateral's sufficiency to avoid 
losses if a borrower defaults on a loan, creditors have a disincentive 
to coerce appraisers to misstate value. However, loan originators may 
believe that they stand to benefit from coercing an appraiser to 
misstate value, for example, if their compensation depends more on 
volume of loans originated than on loan performance. Despite the 
disincentives cited by some commenters, there is evidence that coercion 
of appraisers is not uncommon, and may even be widespread.\103\
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    \103\ For example, the October Research Corporation's 2007 
National Appraisal Survey (released in Dec. 2006) found that 
appraisers reported being pressured to restate, adjust, or change 
reported property values by mortgage brokers (71 percent), real 
estate agents (56 percent), consumers (35 percent), lenders (33 
percent), and appraisal management companies (25 percent).
---------------------------------------------------------------------------

    A few large banks and a financial services trade association 
suggested that the Board prohibit mortgage brokers from ordering 
appraisals, as the GSE Appraisal Agreements do. The Board declines to 
determine that any particular procedure for ordering an appraisal 
necessarily promotes false reporting of value. As discussed above, the 
Board finds that coercion of appraisers by creditors or by mortgage 
brokers is an unfair practice. Therefore, the final rule prohibits 
actions by creditors and mortgage brokers that are aimed at pressuring 
appraisers to misstate the value of a consumer's principal dwelling.
    In addition, some commenters stated that the Board's rule would be 
redundant given the existence of USPAP. USPAP, however, establishes 
uniform rules regarding preparation of appraisals and addresses the 
conduct of appraisers, not the conduct of creditors or mortgage 
brokers. The federal financial institution regulatory agencies have 
issued to the institutions they supervise regulations and guidance that 
set forth standards for the policies and procedures institutions should 
implement to enable appraisers to exercise independent judgment when

[[Page 44567]]

valuing a property.\104\ For example, these regulations prohibit staff 
and fee appraisers from having any direct or indirect interest, 
financial or otherwise, in a subject property; fee appraisers also may 
not have any such interest in the subject transaction.\105\ Unlike the 
Board's rule, however, these federal regulations do not apply to all 
institutions. Moreover, these federal rules are part of an overarching 
framework of regulation and supervision of federally insured depository 
institutions and are not necessarily appropriate for application to 
independent mortgage companies and mortgage brokers.
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    \104\ See, e.g., 12 CFR part 208 subpart E and app. C, and 12 
CFR part 225 subpart G (Board); 12 CFR part 34, subparts C and D 
(Office of the Comptroller of the Currency (OCC)); 12 CFR part 323 
and 12 CFR part 365 (FDIC); 12 CFR part 564, 12 CFR 560.100, and 12 
CFR 560.101 (Office of Thrift Supervision (OTS)); and 12 CFR 722.5 
(National Credit Union Administration (NCUA)). Applicable federal 
guidance the Board, OCC, FDIC, OTS, and NCUA have issued includes 
Independent Appraisal and Evaluation Functions, dated October 28, 
2003, and Interagency Appraisal and Evaluation Guidelines, dated 
October 27, 1994.
    \105\ 12 CFR 225.65 (Board); 12 CFR 34.45 (OCC); 12 CFR 323.5 
(FDIC); 12 CFR 564.5 (OTS); and 12 CFR 722.5 (NCUA).
---------------------------------------------------------------------------

    Some state legislatures have prohibited coercion of appraisers or 
enacted general laws against mortgage fraud that may be used to combat 
appraiser coercion.\106\ Not every state, however, has passed laws 
equivalent to the final rule. Prohibiting creditors and mortgage 
brokers from pressuring appraisers to misstate or misrepresent the 
value of a consumer's principal dwelling provides enforcement agencies 
in every state with a specific legal basis for an action alleging 
appraiser coercion. Though states are able to take enforcement action 
against certain institutions that are believed to engage in appraisal 
abuses,\107\ some state laws are preempted as to other creditors. The 
final rule, adopted under HOEPA, applies equally to all creditors.
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    \106\ See, e.g., Colo. Rev. Stat. Sec.  6-1-717; Iowa Code Sec.  
543D.18A; Ohio Rev. Code Ann. Sec. Sec.  1322.07(G), 1345.031(B), 
4763.12(E).
    \107\ For example, in 2006, 49 states and the District of 
Columbia (collectively, the Settling States) entered into a 
settlement agreement with ACC Capital Holdings Corporation and 
several of its subsidiaries, including Ameriquest Mortgage Company 
(collectively, the Ameriquest Parties). The Settling States alleged 
that the Ameriquest Parties had engaged in deceptive or misleading 
acts that resulted in the Ameriquest Parties' obtaining inflated 
appraisals of homes' value. See, e,g., Iowa ex rel Miller v. 
Ameriquest Mortgage Co., No. 05771 EQCE-053090 (Iowa D. Ct. 2006) 
(Pls. Pet. 5). To settle the complaints, the Ameriquest Parties 
agreed to abide by policies designed to ensure appraiser 
independence and accurate valuations.
---------------------------------------------------------------------------

    In response to the Board's request for comment about the proposed 
rule's provisions, commenters addressed three main topics: (1) The 
terms used to describe prohibited conduct; (2) the specific examples of 
conduct that is prohibited and conduct that is not prohibited; and (3) 
the proscription on extending credit where a creditor knows about 
prohibited conduct.
    Prohibited conduct. Some commenters recommended that the Board 
replace the phrase ``coerce, influence, or otherwise encourage'' with 
``coerce, bribe, or extort.'' These commenters stated that the words 
``influence'' and ``encourage'' are vague and subjective, whereas the 
words ``bribe'' and ``extort'' would provide bright-line standards for 
compliance. Like the proposed rule, the final rule prohibits a creditor 
or mortgage broker from coercing, influencing, or otherwise encouraging 
an appraiser to misstate the value of a dwelling. The final rule does 
not limit prohibited conduct to bribery or extortion. Creditors and 
mortgage brokers may act in ways that would not constitute bribery or 
extortion but that nevertheless improperly influence an appraiser's 
valuation of a dwelling. These actions can visit the same harm on 
consumers as do bribery or extortion, and thus they are prohibited by 
the final rule. The Board believes that commenters' concerns about the 
clarity of the terms used in the final rule can be addressed through 
the examples of conduct that is prohibited and conduct that is not 
prohibited discussed below.
    Examples of conduct prohibited and conduct not prohibited. The 
proposal offered several examples of conduct that would violate the 
rule and conduct that would not violate the rule. The Board is adopting 
the proposed examples of prohibited conduct and adding two new examples 
of prohibited conduct. The Board also is adopting all but one of the 
proposed examples of conduct that is not prohibited.
    Some commenters requested that additional actions be listed as 
examples that violate the rule, such as:
    [cir] Excluding an appraiser from a list of ``approved'' appraisers 
because the appraiser had valued properties at an amount that had 
jeopardized or prevented the consummation of loan transactions.
    [cir] Telling an appraiser a minimum acceptable appraised value.
    [cir] Providing an appraiser with the price stated in a contract of 
sale.
    [cir] Suggesting that an appraiser consider additional properties 
as comparable to the subject property, after an appraiser has submitted 
an appraisal report.

Final Sec.  226.36(b)(1) prohibits conduct that coerces, influences, or 
encourages an appraiser to misstate or misrepresent the value of a 
consumer's principal dwelling, and the list of examples the section 
provides is illustrative and not exhaustive. The Board believes that it 
is not necessary or possible to list all conceivable ways in which 
creditors or mortgage brokers could pressure appraisers to misstate a 
principal dwelling's value. However, the Board has added two examples 
to enhance the list in Sec.  226.36(b)(1). The final rule does not 
limit the ability of a creditor or broker to terminate a relationship 
with an appraiser for legitimate reasons.
    Examples of prohibited conduct. The Board is adopting the proposed 
examples of prohibited conduct and adding two examples. The first added 
example is a creditor's or broker's exclusion of an appraiser from 
consideration for future engagement due to the appraiser's failure to 
report a value that meets or exceeds a minimum threshold. This example 
is adapted from a statement in the supplementary information to the 
proposed rule. 73 FR 1701. The second added example is telling an 
appraiser a minimum reported value of a consumer's principal dwelling 
that is needed to approve the loan. This example is consistent with the 
position of the Appraisal Standards Board (ASB), which develops, 
interprets and amends USPAP, that assignments should not be contingent 
on the reporting of a predetermined opinion of value.\108\
---------------------------------------------------------------------------

    \108\ See, e.g., ASB Advisory Opinion No. 19, Unacceptable 
Assignment Conditions in Real Property Appraisal Assignments.
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    The Board is not adopting other examples of prohibited conduct 
suggested by commenters. Some commenters urged the Board to prohibit a 
creditor or mortgage broker from omitting or removing an appraiser's 
name from a list of approved appraisers, where the appraiser has not 
valued a property at the desired amount. The Board believes such 
conduct is encompassed in the examples provided in Sec.  
226.36(b)(1)(i)(B) and (C).
    Some commenters also requested that the Board add, as an example of 
a violation, a creditor's or mortgage broker's provision to an 
appraiser of the contract of sale for the principal dwelling. The Board 
is not adopting the example. USPAP Standard Rule 1-5 requires an 
appraiser to analyze all agreements of sale for a subject property, and 
Standard Rule 2-2 requires disclosure of information contained in such 
agreements or an explanation of why such information is unobtainable or 
irrelevant.

[[Page 44568]]

    Examples of conduct that is not prohibited. The final rule adopts 
the proposed examples of prohibited conduct with one change. The Board 
is not adopting proposed Sec.  226.36(b)(1)(ii)(F), which would have 
provided that the rule would not be violated when a creditor or 
mortgage broker terminates a relationship with an appraiser for 
violations of applicable federal or state law or breaches of ethical or 
professional standards. Some commenters noted that there are other 
legitimate reasons for terminating a relationship with an appraiser, 
and they requested that the Board include these as examples of conduct 
that is not prohibited so that the provision would not be read as 
implicitly prohibiting them. The Board believes that it is not feasible 
to list all of the legitimate reasons a creditor or broker might 
terminate a relationship with an appraiser. Accordingly, the Board is 
not adopting proposed Sec.  226.36(b)(1)(ii)(F).
    Some commenters suggested that the Board delete, from the examples 
of conduct that is not prohibited, asking an appraiser to consider 
additional information about a consumer's principal dwelling or about 
comparable properties. Although in some cases a post-report request 
that an appraiser consider additional information may be a subtle form 
of pressure to change a reported value, in other cases such a request 
could reflect a legitimate desire to improve an appraisal report. 
Furthermore, federal interagency guidance directs institutions to 
return deficient reports to appraisers for correction and to replace 
unreliable appraisals or evaluations prior to the final credit 
decision.\109\ Therefore, the Board is not deleting, from the examples 
of conduct that is not prohibited, asking an appraiser to consider 
additional information about a consumer's principal dwelling or about 
comparable properties. However, Sec.  226.36(b) prohibits creditors and 
mortgage brokers from making such requests in order to coerce, 
influence, or otherwise encourage an appraiser to misstate or 
misrepresent the value of a dwelling.
---------------------------------------------------------------------------

    \109\ See Interagency Appraisal and Evaluation Guidelines, SR 
94-55 (FIS) (Oct. 24, 1994) at 9.
---------------------------------------------------------------------------

    Extension of credit. As proposed, Sec.  226.36(b)(2) provided that 
a creditor is prohibited from extending credit if the creditor knows or 
has reason to know, at or before loan consummation, of a violation of 
Sec.  226.36(b)(1) (for example, by an employee of the creditor or a 
mortgage broker), unless the creditor acted with reasonable diligence 
to determine that the appraisal does not materially misstate the value 
of the consumer's principal dwelling. The proposed comment to Sec.  
226.36(b)(2) stated that a creditor is deemed to have acted with 
reasonable diligence if the creditor extends credit based on an 
appraisal other than the one subject to the restriction.
    The Board is adopting the text of Sec.  226.36(b)(2) and the 
associated commentary substantially as proposed. Some financial 
institutions and financial institution trade associations stated that 
the phrase ``reason to know'' is vague and that creditors should be 
held liable for violations only if they extend credit when they had 
actual knowledge that a violation of Sec.  226.36(b)(1) exists. The 
final rule prohibits ``a creditor who knows, at or before loan 
consummation, of a violation of Sec.  226.36(b)(1) in connection with 
an appraisal'' from extending credit based on that appraisal, unless 
the creditor acts with reasonable diligence to determine that the 
appraisal does not materially misstate or misrepresent the value of the 
consumer's principal dwelling. Although final Sec.  226.36(b)(2) does 
not include the phrase ``reason to know'' included in the proposed 
rule, the final rule's knowledge standard is not intended to permit 
willful disregard of violations of Sec.  226.36(b)(1). The Board also 
is adopting new commentary regarding how to determine whether a 
misstatement of value is material.
    Many banks asked for guidance on how to determine whether an 
appraisal ``materially'' misstates a dwelling's value. In response to 
these comments, the Board is adopting a new comment to Sec.  
226.36(b)(2) that provides that a misrepresentation or misstatement of 
a dwelling's value is not material if it does not affect the credit 
decision or the terms on which credit is extended. The Board notes that 
existing appraisal regulations and guidance may direct creditors to 
take certain steps in the event the creditor knows about problems with 
an appraisal. For example, the Interagency Appraisal and Evaluation 
Guidelines dated Oct. 28, 1994 direct institutions to return deficient 
reports to appraisers and persons performing evaluations for correction 
and to replace unreliable appraisals or evaluations prior to making a 
final credit decision. These guidelines further state that changes to 
an appraisal's estimate of value are permitted only as a result of a 
review conducted by an appropriately qualified state-licensed or -
certified appraiser in accordance with Standard III of USPAP.
    The final rule does not dictate specific due diligence procedures 
for creditors to follow when they suspect a violation of Sec.  
226.36(b)(2), however. In addition, the Board does not intend for Sec.  
226.36(b)(2) to create grounds for voiding loan agreements where 
violations are found. That is, if a creditor knows of a violation of 
Sec.  226.36(b)(1), and nevertheless extends credit in violation of 
Sec.  226(b)(2), while the creditor will have violated Sec.  
226.36(b)(2), this violation does not necessarily void the consumer's 
loan agreement with the creditor. Whether the loan agreement is void is 
a matter determined by State or other applicable law.

C. Servicing Abuses--Sec.  226.36(c)

    The Board proposed to prohibit certain practices of servicers of 
closed-end consumer credit transactions secured by a consumer's 
principal dwelling. Proposed Sec.  226.36(d) provided that no servicer 
shall: (1) Fail to credit a consumer's periodic payment as of the date 
received; (2) impose a late fee or delinquency charge where the late 
fee or delinquency charge is due only to a consumer's failure to 
include in a current payment a late fee or delinquency charge imposed 
on earlier payments; (3) fail to provide a current schedule of 
servicing fees and charges within a reasonable time of request; or (4) 
fail to provide an accurate payoff statement within a reasonable time 
of request. The final rule, redesignated as Sec.  226.36(c), adopts the 
proposals regarding prompt crediting, fee pyramiding, and payoff 
statements, and modifies and clarifies the accompanying commentary. The 
Board is not adopting the fee schedule proposal, for the reasons 
discussed below.
Public Comment
    Consumer advocacy groups, federal and state regulators and 
officials, consumers, and others strongly supported the Board's 
proposal to address servicing abuses, although some urged alternative 
measures to address servicer abuses, including requiring loss 
mitigation. Industry commenters, on the other hand, were generally 
opposed to certain aspects of the proposals, particularly the fee 
schedule. Industry commenters also urged the Board to adopt any such 
rules under its authority in TILA Section 105(a) to adopt regulations 
to carry out the purposes of TILA, and not under Section 129(l)(2). 
Commenters also requested several clarifications.
    Prompt crediting. Commenters generally favored, or did not oppose, 
the prompt crediting rule. In particular, consumer advocacy groups, 
federal and state regulators and officials, and others supported the 
rule. However, some industry commenters and others

[[Page 44569]]

requested clarification on certain implementation details. Commenters 
also disagreed about whether and how to address partial payments.
    Fee pyramiding. Commenters generally supported prohibiting late fee 
pyramiding. Several industry commenters argued, however, that a new 
rule would be unnecessary because servicers are subject to a 
prohibition on pyramiding under other regulations.
    Fee schedule. Most commenters opposed the fee schedule proposal. 
One consumer advocate group criticized the disclosure's utility where 
consumers cannot shop for and select servicers. Other consumer 
advocates urged the Board to adopt alternative measures they argued 
would be more effective to combat fee abuses. Industry commenters also 
objected to the proposal as impracticable and unnecessarily burdensome. 
Most industry commenters strongly opposed disclosure of third party 
fees, particularly because third party fees can vary greatly and may be 
indeterminable in advance.
    Payoff statements. Consumer advocates strongly supported the 
proposal to require provision of payoff statements within a reasonable 
time. The proposed commentary stated that it would be reasonable under 
normal market conditions to provide statements within three business 
days of receipt of a consumer's request. Community banks stated that 
three business days would typically be adequate. However, large 
financial institutions and their trade associations urged the Board to 
adopt a longer time period in the commentary. These commenters also 
requested other clarifications. The comments are discussed in more 
detail throughout this section, as applicable.
Discussion
    As discussed in the preamble to the proposed rule, the Board shares 
concerns about abusive servicing practices. Consumer advocates raised 
abusive mortgage servicer practices as part of the Board's 2006 and 
2007 hearings as well as in recent congressional hearings.\110\ 
Servicer abuses have also received increasing attention both in 
academia and the press.\111\ In particular, consumer advocates have 
raised concerns that some servicers may be charging consumers 
unwarranted or excessive fees (such as late fees and other ``service'' 
fees) and may be improperly submitting negative credit reports, in the 
normal course of mortgage servicing as well as in foreclosures. Some of 
these abusive fees, they contend, result from servicers' failure to 
promptly credit consumers' accounts, or when servicers pyramid late 
fees. In addition to anecdotal evidence of significant consumer 
complaints about servicing practices, abusive practices have been cited 
in a variety of court cases.\112\ In 2003, the FTC announced a $40 
million settlement with a large mortgage servicer and its affiliates to 
address allegations of abusive behavior.\113\
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    \110\ See, e.g., Comment letter of the National Consumer Law 
Center to Docket No. OP-1253 (Aug. 15, 2006) at 11; Legislative 
Proposals on Reforming Mortgage Practices, Hearing Before the H. 
Comm. On Fin. Servs., 110th Cong. 74 (2007) (Testimony of John 
Taylor, National Community Reinvestment Coalition).
    \111\ See, e.g., Paula Fitzgerald Bone, Toward a General Model 
of Consumer Empowerment and Welfare in Financial Markets with an 
Application to Mortgage Servicers, 42 Journal of Consumer Affairs 
165 (Summer 2008); Katherine M. Porter, Misbehavior and Mistake in 
Bankruptcy Mortgage Claims, University of Iowa Legal Study Research 
Paper No. 07-29 (Nov. 2007); Kevin McCoy, Hitting Home: Homeowners 
Fight for their Mortgage Rights, USA Today (June 25, 2008), 
available at http://www.usatoday.com/money/industries/banking/2008-06-25-mortgage-services-countrywide-lawsuit_N.htm; Mara Der 
Hovanesian, The ``Foreclosure Factories'' Vise, BusinessWeek.com 
(Dec. 25, 2006), available at http://www.businessweek.com/magazine/content/06_52/b4015147.htm?chan=search.
    \112\ See, e.g., Workman v. GMAC Mortg. LLC (In re Workman), 
2007 Bankr. LEXIS 3887 (Bankr. D. S.C. Nov. 21, 2007) (servicer held 
in civil contempt for, among other things, failure to promptly 
credit payments made before discharge from bankruptcy and charging 
of unauthorized late and attorneys fees); Islam v. Option One 
Mortgage Corp., 432 F. Supp. 2d 181 (D. Mass 2006) (servicer 
allegedly continued to report borrower delinquent even after 
receiving the full payoff amount for the loan); In Re Gorshstein, 
285 B.R. 118 (S.D.N.Y. 2002) (servicer sanctioned for falsely 
certifying that borrowers were delinquent); Rawlings v. Dovenmuehle 
Mortgage Inc., 64 F. Supp. 2d 1156 (M.D. Ala. 1999) (servicer failed 
for over 7 months to correct account error despite borrowers' twice 
sending copies of canceled checks evidencing payments, resulting in 
unwarranted late and other fees); Ronemus v. FTB Mortgage Servs., 
201 B.R. 458 (1996) (among other abuses, servicer failed to promptly 
credit payments and instead paid them into a ``suspense'' account, 
resulting in unwarranted late fees and unnecessary and improper 
accrual of interest on the note).
    \113\ Consent Order, United States v. Fairbanks Capital Corp., 
Civ. No. 03-12219-DPW (D. Mass Nov. 21, 2003, as modified Sept. 4, 
2007). See also Ocwen Federal Bank FSB, Supervisory Agreement, OTS 
Docket No. 04592 (Apr. 19, 2004) (settlement resolving mortgage 
servicing issues).
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    Consumer advocates have also raised concerns that consumers are 
sometimes unaware of fees charged, or unable to understand the basis 
upon which fees are charged. This may occur because servicers often do 
not disclose precise fees in advance; some consumers are not provided 
any other notice of fees (such as a monthly statement or other after-
the-fact notice); and when consumers are provided a statement or other 
fee notice, fees may not be itemized or detailed. For example, in a 
number of bankruptcy cases, servicers have improperly assessed post-
petition fees without notifying either the consumer or the court.\114\ 
Similarly, because payoff statements lack transparency (in that they do 
not provide detailed accounting information) and because consumers are 
often unaware of the exact amount owed, some servicers may assess 
inaccurate or false fees on the payoff statement.\115\
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    \114\ See, e.g., Jones v. Wells Fargo (In re Jones), 366 B.R. 
584 (E.D. La 2007) (``In this Court's experience, few, if any, 
lenders make the adjustments necessary to properly account for a 
reorganized debt repayment plan. As a result, it is common to see 
late charges, fees, and other expenses assessed to a debtor's loan 
as a result of post-petition accounting mistakes made by 
lenders.''). See also Payne v. Mortg. Elec. Reg. Sys. (In re Payne), 
2008 Bankr. LEXIS 1340 (Bankr. Kan. May 6, 2008); Sanchez v. 
Ameriquest (In re Sanchez), 372 B.R. 289 (S.D. Tx. 2007); Harris v. 
First Union Mortg. Corp. (In re Harris), 2002 Bankr. LEXIS 771 
(Bankr. D. Ala. 2002); In Re Tate, 253 B.R. 653.
    \115\ See, e.g., Maxwell v. Fairbanks Capital Corp. (In re 
Maxwell), 281 B.R. 101, 114 (D. Mass 2002) (servicer ``repeatedly 
fabricated the amount of the Debtor's obligation to it out of thin 
air'').
---------------------------------------------------------------------------

    Substantial injury. Consumers subject to the servicer practices 
described above suffer substantial injury. For example, one state 
attorney general and several consumer advocates stated that failure to 
properly credit payments is one of the most common problems consumers 
have with servicers. Servicers that do not timely credit, or that 
misapply, payments cause the consumer to incur late fees where none 
should be assessed.\116\ Even where the first late fee is properly 
assessed, servicers may apply future payments to the late fee first. 
Doing so results in future payments being deemed late even if they are, 
in fact, paid in full within the required time period, thus permitting 
the servicer to charge additional late fees--a practice commonly 
referred to as ``pyramiding'' of late fees. These practices can cause 
the account to appear to be in default, and thus can give rise to 
charging excessive or unwarranted fees to consumers, who may not even 
be aware of the default or fees if they do not receive statements. Once 
consumers are in default, these practices can make it difficult for 
consumers to catch up on payments. These practices also may improperly 
trigger negative credit reports, which can cause consumers to be denied 
other credit or pay more for such credit, and

[[Page 44570]]

require consumers to engage in time-consuming credit report correction 
efforts.
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    \116\ See, e.g. Holland v. GMAC Mortg. Corp., 2006 U.S. Dist. 
LEXIS 25723 (D. Kan. 2006) (servicer's misapplication of borrower's 
payment to the wrong account resulted in improper late fees and 
negative credit reports, despite borrower's proof of canceled 
checks); In re Payne, 2008 Bankr. LEXIS at *30 (servicer's failure 
to properly and timely account for payments and failure to 
distinguish between pre-petition and post-petition payments caused 
its accounting system and payment history to improperly show 
borrowers as delinquent in their payments).
---------------------------------------------------------------------------

    In addition, a servicer's failure to provide accurate payoff 
statements in a timely fashion can cause substantial injury to 
consumers. One state attorney general commented that its office often 
receives complaints about unreasonable delays in the provision of 
payoff statements. Consumers may want to refinance a loan to obtain a 
lower interest rate or to avoid default or foreclosure, but may be 
impeded from doing so due to inaccurate or untimely payoff statements. 
These consumers thus incur additional costs and may be subject to 
financial problems or even foreclosure. In addition to the injuries 
caused by delayed payoff statements, consumers are injured by 
inaccurate payoff statements. As described above, some servicers assess 
inaccurate or false fees on the payoff statement without the consumer's 
knowledge. Even when the consumer requests clarification, a servicer 
may provide an invalid accounting of fees or charges.\117\ Or, a 
servicer may provide the payoff statement too late in the refinancing 
process for the consumer to obtain clarification without risking losing 
his or her new loan commitment.\118\
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    \117\ See, e.g., In re Maxwell, 281 B.R. 101, 114 (D. Mass 
2002).
    \118\ See, e.g., In re Jones, 366 B.R. at 587-588 (consumer in 
bankruptcy forced to remit improper sums demanded on payoff 
statement or lose loan commitment from new lender. ``Although Debtor 
questioned the amounts [servicer] alleged were due, he was unable to 
obtain an accounting from [servicer] explaining its calculations or 
any other substantiation for the payoff.'').
---------------------------------------------------------------------------

    Injury not reasonably avoidable. The injuries caused by servicer 
abuses are not reasonably avoidable because market competition is not 
adequate to prevent abusive practices, particularly when mortgages are 
securitized and servicing rights are sold. Historically, under the 
mortgage loan process, a lender would often act as both originator and 
collector--that is, it would service its own loans. Although some 
creditors sold servicing rights, they remained vested in the customer 
service experience in part due to reputation concerns and in part 
because payment streams continued to flow directly to them. However, 
with rise of the ``originate to distribute'' model discussed in part 
II.B above, the original creditor has become removed from future direct 
involvement in a consumer's loan, and thus has less incentive and 
ability to detect or deter servicing abuses or respond to consumer 
complaints about servicing abuses. When loans are securitized, 
servicers contract directly with investors to service the loan, and 
consumers are not a party to the servicing contract.
    Today, separate servicing companies play a key role: they are 
chiefly responsible for account maintenance, including collecting 
payments, remitting amounts due to investors, handling interest rate 
adjustments on variable rate loans, and managing delinquencies and 
foreclosures. Servicers also act as the primary point of contact for 
consumers after origination, because in most cases the original 
creditor has securitized and sold the loan shortly after origination. 
In exchange for performing these services, servicers generally receive 
a fixed per-loan or monthly fee, float income, and ancillary fees--
including default charges--that consumers must pay.
    Investors are principally concerned with maximizing returns on the 
mortgage loans and are generally indifferent to the fees the servicer 
charges the consumer so long as the fees do not reduce the investor's 
return (e.g., by prompting an unwarranted foreclosure). Consumers are 
not able to choose their servicers. Consumers also are not able to 
change servicers without refinancing, which is a time-consuming, 
expensive undertaking. Moreover, if interest rates are rising, 
refinancing may only be possible if the consumer accepts a loan with a 
higher interest rate. After refinancing, consumers may find their loans 
assigned back to the same servicer as before, or to another servicer 
engaging in the same practices. As a result, servicers do not have to 
compete in any direct sense for consumers. Thus, there may not be 
sufficient market pressure on servicers to ensure competitive 
practices.\119\
---------------------------------------------------------------------------

    \119\ In one survey, J.D. Power found that consumers whose loans 
have been sold have customer satisfaction scores 32 points lower 
than those who have remained with the loan originator. J.D. Power 
and Associates Reports: USAA Ranks Highest in Customer Satisfaction 
with Primary Mortgage Servicing. Press Release (July 19, 2006), 
available at http://www.jdpower.com/corporate/news/releases/pdf/2006117.pdf.
---------------------------------------------------------------------------

    Injury not outweighed by countervailing benefits to consumers or to 
competition. The injuries described above also are not outweighed by 
any countervailing benefits to consumers or competition. Commenters did 
not cite, and the Board is not aware of, any benefit to consumers from 
delayed crediting of payments, pyramided fees, or delayed issuance of 
payoff statements.
    For these reasons, the Board finds the acts and practices 
prohibited under Sec.  226.36(c) for closed-end consumer credit 
transactions secured by a consumer's principal dwelling to be unfair. 
As described in part V.A above, TILA Section 129(l)(2) authorizes 
protections against unfair practices ``in connection with mortgage 
loans'' that the Board finds to be unfair or deceptive. 15 U.S.C. 
1639(l)(2). Therefore, the Board may take action against unfair or 
deceptive practices by non-creditors and against unfair or deceptive 
practices outside of the origination process, when such practices are 
``in connection with mortgage loans.'' The Board believes that unfair 
or deceptive servicing practices fall squarely within the purview of 
Section 129(l)(2) because servicing is an integral part of the life of 
a mortgage loan and as such is ``in connection with mortgage loans.'' 
Accordingly, the final rule prohibits certain unfair or deceptive 
servicing practices under Section 129(l)(2), 15 U.S.C. 1639(l)(2).
The Final Rule
    Section 226.36(c) prohibits three servicing practices. First, the 
rule prohibits a servicer from failing to credit a payment to a 
consumer's account as of the date received. Second, the rule prohibits 
``pyramiding'' of late fees by prohibiting a servicer from imposing a 
late fee on a consumer for making a payment that constitutes the full 
amount due and is timely, but for a previously assessed late fee. 
Third, the rule prohibits a servicer from failing to provide, within a 
reasonable time after receiving a request, an accurate statement of the 
amount currently required to pay the obligation in full, often referred 
to as a payoff statement. Under Sec.  226.36(c)(3), the term 
``servicer'' and ``servicing'' are given the same meanings as provided 
in Regulation X, 24 CFR 3500.2. As described in more detail below, the 
Board is not adopting the proposed rule that would prohibit a servicer 
from failing to provide to a consumer, within a reasonable time after 
receiving a request, a schedule of all fees and charges it imposes in 
connection with mortgage loans it services.
    The Board recognizes that servicers will incur additional costs to 
alter their systems to comply with some aspects of the final rule. For 
example, in some instances some servicers may incur costs in investing 
in systems to produce payoff statements within a shorter period of time 
than their current technology affords. As a result, some servicers 
will, directly or indirectly, pass those costs on to consumers. The 
Board believes, however, that these costs to consumers are outweighed 
by

[[Page 44571]]

the consumer benefits provided by the rules as adopted.
Prompt Crediting
    The Board proposed Sec. Sec.  226.36(d)(1)(i) and 226.36(d)(2) to 
prohibit a servicer from failing to credit payments as of the date 
received. The proposed prompt crediting rule and accompanying 
commentary are substantially similar to the existing provisions 
requiring prompt crediting of payment on open-end transactions in Sec.  
226.10. The final rule adopts, as Sec. Sec.  226.36(c)(1)(i) and 
226.36(c)(2), the rule substantially as proposed, but with revisions to 
the proposed commentary to address the questions of partial payments 
and payment cut-off times. Commentary has also been added or modified 
in response to commenters' concerns.
    Commenters generally favored, or did not oppose, the prompt 
crediting rule. In particular, consumer advocacy groups, federal and 
state regulators and officials, and others supported the rule. One 
state attorney general and several consumer advocacy groups stated that 
failure to properly credit payments is one of the most common servicing 
problems they see consumers face. However, as described in more detail 
below, some industry commenters and others requested clarification on 
certain implementation details. Commenters also generally disagreed on 
whether and how to address partial payments.
    Method and timing of payments. Section 226.36(c)(1)(i) requires a 
servicer to credit a payment to the consumer's loan account as of the 
date of receipt, except when a delay in crediting does not result in 
any charge to the consumer or in the reporting of negative information 
to a consumer reporting agency, or except as provided in Sec.  
226.36(c)(2). Many industry commenters, as well as the GSEs requested 
clarifications on the timing and method of crediting payments, and the 
final staff commentary has been revised accordingly.
    For example, final comment 36(c)(1)(i)-1 makes clear that the rule 
does not require a servicer to physically enter the payment on the date 
received, but requires only that it be credited as of the date 
received. The proposed comment explained that a servicer does not 
violate the rule if it receives a payment on or before its due date and 
enters the payment on its books or in its system after the due date if 
the entry does not result in the imposition of a late charge, 
additional interest, or similar penalty to the consumer, or in the 
reporting of negative information to a consumer reporting agency. 
Because consumers are often afforded a grace period before a late fee 
accrues, the Board has revised the comment to reference grace periods. 
The final comment thus states that a servicer that receives a payment 
on or before the due date (or within any grace period), and does not 
enter the payment on its books or in its system until after the 
payment's due date (or expiration of any grace period) does not violate 
the rule as long as the entry does not result in the imposition of a 
late charge, additional interest, or similar penalty to the consumer, 
or in the reporting of negative information to a consumer reporting 
agency. If a payment is received after the due date and any grace 
period, Sec.  226.36(c)(1)(i) does not prohibit the assessment of late 
charges or reporting negative information to a consumer reporting 
agency.
    Some industry commenters were concerned that the rule would affect 
their monthly interest accrual accounting systems. Many closed-end 
mortgage loan agreements require calculation of interest based on an 
amortization schedule where payments are deemed credited as of the due 
date, whether the payment was actually received prior to the scheduled 
due date or within any grace period. Thus, making the scheduled payment 
early does not decrease the amount of interest the consumer owes, nor 
does making the scheduled payment after the due date (but within a 
grace period) increase the interest the consumer owes. According to 
these commenters, this so-called ``monthly interest accrual 
amortization method'' provides certainty to consumers (about payments 
due) and to investors (about expected yields). The final rule is not 
intended to prohibit or alter use of this method, so long as the 
servicer recognizes on its books or in its system that payments have 
been timely made for purposes of determining late fees or triggering 
negative credit reporting.
    The final rule also adopts proposed comment 36(d)(2)-1, 
redesignated as 36(c)(2)-1, which states that the servicer may specify 
in writing reasonable requirements for making payments. One commenter 
expressed concern that late fees or negative credit reports may be 
triggered when a timely payment requires extensive research, and the 
creditor may inadvertently violate Sec.  226.36(c)(1)(i). Such research 
might be required, for example, when a check does not include the 
account number for the mortgage loan and is written by someone other 
than the consumer. However, in this scenario, the check would typically 
constitute a payment that does not conform to the servicer's reasonable 
payment requirements. If a payment is non-conforming, and the servicer 
nonetheless accepts the payment, then Sec.  226.36(c)(2) provides that 
the servicer must credit the account within five days of receipt. If 
the servicer chooses not to accept the non-conforming payment, it would 
not violate the rule by returning the check.
    Comment 36(c)(2)-1 provides examples of reasonable payment 
requirements. Although the list of examples is non-exclusive, at the 
request of several commenters, payment coupons have been added to the 
list of examples because they can assist servicers in expediting the 
crediting process to consumers' benefit.
    The Board sought comment on whether it should provide a safe harbor 
as to what constitutes a reasonable payment requirement, for example, a 
cut-off time of 5 p.m. for receipt of a mailed check. Commenters 
generally supported including safe harbors; accordingly, new comment 
32(c)(2)-2 provides that it would be reasonable to require a cut-off 
time of 5 p.m. for receipt of a mailed check at the location specified 
by the creditor for receipt of such check.
    Partial payments. The Board sought comment on whether (and if so, 
how) partial payments should be addressed in the prompt crediting rule. 
Consumer advocate and industry commenters disagreed on whether partial 
payments should be credited, if the consumer's payment covers at least 
the principal and interest due but not amounts due for escrows or late 
or other service fees. Consumer groups argued that servicers should be 
required to credit partial payments under the rule, when the payment 
would cover at least the principal and interest due. They expressed 
concern that servicers routinely place such partial payments into 
suspense accounts, triggering the accrual of late fees and other 
default fees. On the other hand, most industry commenters urged the 
Board not to require crediting of partial payments, because doing so 
would contradict the structure of uniform loan documents, would violate 
servicing agreements, would be contrary to monthly interest accrual 
accounting methods, and would require extensive systems and accounting 
changes. They also argued that crediting partial payments could cause 
the consumer's loan balance to increase. After crediting the partial 
payment, the servicer would add the remaining payment owed to the 
principal balance; thus, the principal balance would be greater than 
the amount scheduled (and the interest calculated on that larger 
principal balance that would be due would be

[[Page 44572]]

greater than the scheduled interest). As a result, subsequent regularly 
scheduled payments would no longer cover the actual outstanding 
principal and interest due.
    New comment 36(c)(1)(i)-2 makes clear that whether a partial 
payment must be credited depends on the contract between the parties. 
Specifically, the new comment states that payments should be credited 
based on the legal obligation between the creditor and consumer. The 
comment also states that the legal obligation is determined by 
applicable state law or other law. Thus, if under the terms of the 
legal obligations governing the loan, the required monthly payment 
includes principal, interest, and escrow, then consistent with those 
terms, servicers would not be required to credit payments that include 
only principal and interest payments. Concerns about partial payments 
may be addressed in part by the fee pyramiding rule, discussed below, 
which prohibits servicers from charging late fees if a payment due is 
short solely by the amount of a previously assessed late fee.
Pyramiding Late Fees
    The Board proposed to adopt a parallel approach to the existing 
prohibition on late fee pyramiding contained in the ``credit practices 
rule,'' under section 5 of the FTC Act, 15 U.S.C. 45. See, e.g., 12 CFR 
227.15 (Board's Regulation AA). Proposed Sec.  226.36(c)(1)(ii) would 
have prohibited servicers from imposing any late fee or delinquency 
charge on the consumer in connection with a payment, when the 
consumer's payment was timely and made in full but for any previously 
assessed late fees. The proposed commentary provided that the 
prohibition should be construed consistently with the credit practices 
rule. The final rule adopts the proposal and accompanying staff 
commentary.
    Commenters generally supported prohibiting fee pyramiding. Several 
commenters argued, however, that a new rule would be unnecessary 
because servicers are subject to a regulation prohibiting fee 
pyramiding, whether they are banks (12 CFR 227.15), thrifts (12 CFR 
535.4), credit unions (12 CFR 706.4) or other institutions (16 CFR 
444.4). However, the Board believes that adopting a fee pyramiding 
prohibition under TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2), would 
extend greater protections to consumers than currently provided by 
regulation. While fee pyramiding is impermissible for all entities 
under either the Board, OTS, or FTC rules, state officials are not 
granted authority under the FTC Act to bring enforcement actions 
against institutions. By bringing the fee pyramiding rule under TILA 
Section 129(l)(2), state attorneys general would be able to enforce the 
rule through TILA, where currently they may be limited to enforcing the 
rule solely through state statutes (which statutes may not be uniform). 
Accordingly, the anti-pyramiding rule adopted today would provide state 
attorneys general an additional means of enforcement against servicers, 
thus providing an additional consumer protection against an unfair 
practice.
Schedule of Fees and Charges
    Proposed 226.36(d)(1)(iii) would have required a servicer to 
provide to a consumer upon request a schedule of all specific fees and 
charges that may be imposed in connection with the servicing of the 
consumer's account, including a dollar amount and an explanation of 
each and the circumstances under which each fee may be imposed. The 
proposal would have required a fee schedule that is specific both as to 
the amount and type of each charge, to prevent servicers from 
disguising fees by lumping them together or giving them generic names. 
The proposal also would have required the disclosure of third party 
fees assessed on consumers by servicers. The rule was intended to bring 
transparency to the market, to enhance consumer understanding of 
servicer charges, and to make it more difficult for unscrupulous 
servicers to camouflage or inflate fees. The Board sought comment on 
the effectiveness of this approach, and solicited suggestions on 
alternative methods to achieve the same objective. Given servicers' 
potential difficulty in identifying the specific amount of third party 
charges prior to imposition of such charges, the Board also sought 
comment on whether the benefit of increasing the transparency of third 
party fees would outweigh the costs associated with a servicer's 
uncertainty as to such fees.
    Most commenters opposed the fee schedule proposal. One consumer 
advocate group argued that the disclosure would not help because 
consumers cannot shop for and select servicers. Other consumer 
advocates urged the Board to adopt alternative measures they argued 
would be more effective to prevent servicer abuses. Industry commenters 
also objected to the proposal as impracticable and unnecessarily 
burdensome. Some stated that they currently provide limited fee 
schedules upon request, but that they would incur a substantial time 
and cost burden to reprint schedules or add addenda when fees change. 
Many industry commenters strongly opposed disclosure of third party 
fees. These commenters argued that fees can vary greatly by geography 
(inter- and intra-state) and over the life of the loan, and are not 
within the servicer's control, particularly when the consumer is in 
default. Moreover, they stated, some charges relating to foreclosure or 
other legal actions cannot be determined in advance. For example, 
newspaper publication costs will vary depending on the newspaper and 
length of the notice required; third party service providers may charge 
varying prices based on the cost of labor, materials, and scope of work 
required.\120\ Industry commenters maintained that servicers would pass 
on to consumers the costs of the increased burden and risk incurred. At 
a minimum, they argued, the fee schedule should be limited to standard 
or common fees, such as nonsufficient fund fees or duplicate statement 
fees.
---------------------------------------------------------------------------

    \120\ See, e.g., Vikas Bajaj, Contractors Are Kept Busy 
Maintaining Abandoned Homes, N.Y. Times (May 26, 2008), available at 
http://www.nytimes.com/2008/05/27/business/27home.html?_r=1&scp=1&sq=florida+foreclosure&st=nyt&oref=slogin.
---------------------------------------------------------------------------

    The Board has considered the concerns raised by commenters and has 
concluded that the transparency benefit of the schedule does not 
sufficiently offset the burdens of producing such a schedule. Thus, the 
Board is not adopting proposed Sec.  226.36(d)(1)(iii). First, the 
transparency benefit is limited. It is not clear that consumers would 
request fee schedules sufficiently in advance of being charged any fees 
so as to provide consumers the benefit of the notice intended by the 
proposed rule. In addition, any schedules provided to consumers may be 
out of date by the time the consumer is assessed fees. Many third party 
fees would also be impractical to specify. Even if third party fees are 
simply listed as ``actual charge'' or ``market price,'' the fee 
schedules may be too long--possibly dozens of pages-- and detailed to 
be meaningful or useful to consumers. The Board considered limiting fee 
schedules to the servicer's own standard fees. However, while such 
schedules might assist consumers who are current, they would be of 
limited utility to delinquent consumers, who are often subject to 
substantial third party fees. For the foregoing reasons, the Board is 
not adopting proposed Sec.  226.36(d)(1)(iii).
    The Board solicited suggestions on alternative methods to address 
servicer charges and fees. Commenters urged the Board to consider a 
variety of alternatives to combat abusive servicing

[[Page 44573]]

practices, including prohibiting servicers from imposing fees unless 
the fee is authorized by law, agreed to in the note, and bona fide and 
reasonable; prohibiting servicers from misstating the amounts consumers 
owe; and requiring servicers to provide monthly statements to consumers 
to permit consumers to monitor charges. The Board continues to have 
concerns about transparency and abuse of servicer fees. The Board will 
continue to evaluate the issue, and may consider whether to propose 
additional rules in this area in connection with its comprehensive 
review of Regulation Z's closed-end mortgage disclosure rules.
Loan Payoff Statements
    Proposed Sec.  226.36(d)(1)(iv) would have prohibited a servicer 
from failing to provide, within a reasonable time after receiving a 
request from the consumer or any person acting on behalf of the 
consumer, an accurate statement of the full amount required to pay the 
obligation in full as of a specified date, often referred to as a 
payoff statement. The proposed commentary stated that under normal 
market conditions, three business days would be a reasonable time to 
provide the payoff statements; however, a longer time might be 
reasonable when the market is experiencing an unusually high volume of 
refinancing requests.
    Consumer advocates strongly supported the proposed rule, and most 
community banks stated that three business days would be adequate for 
production of payoff statements. However, large financial institutions 
and their trade associations urged the Board to adopt a longer time 
period in the commentary than three business days. Large financial 
institutions and their trade associations also requested clarification 
on requests from third parties, citing privacy concerns. Further, they 
urged the Board to refine the rule to provide that statements should be 
accurate when issued, because events could occur after issuance that 
would make the payoff statement inaccurate.
    The Board is adopting the rule substantially as proposed, 
renumbered as Sec.  226.36(c)(1)(iii), with clarifications and changes 
to the commentary. The Board has revised the accompanying staff 
commentary to provide that five business days would normally be a 
reasonable time to provide the statements under most circumstances, and 
to make several other clarifications in response to commenters' 
concerns.
    Servicers' delays in providing payoff statements can impede 
consumers from refinancing existing loans or otherwise clearing title 
and increase transaction costs. Promptly delivered payoff statements 
also help consumers to monitor inflated payoff claims. Thus, the Board 
is adopting a rule requiring servicers to provide an accurate payoff 
statement within a reasonable time after receiving a request.
    As noted above, the proposed commentary stated that under normal 
market conditions, three business days would be a reasonable time to 
provide the payoff statements. Large financial institutions and their 
trade associations encouraged the Board to extend the three business 
day time frame to anywhere from five business days to fifteen calendar 
days to provide servicers enough time to compile the necessary payoff 
information. While the Board notes that the commentary's time frame is 
a safe harbor and not a requirement, the Board is extending the time 
frame from three to five business days to address commenters' concerns.
    Several industry commenters also requested special time periods for 
homes in foreclosure or loss mitigation. Some argued that emergency 
circumstances (such as imminent foreclosure) require swifter servicer 
action; on the contrary, others argued that such circumstances are 
inherently complicated and require additional servicer time and effort. 
However, the Board believes five business days should provide 
sufficient time to handle most payoff requests, including most requests 
where the loan is delinquent, in bankruptcy, or the servicer has 
incurred an escrow advance. As discussed below, there may be 
circumstances under which a longer time period is reasonable; the 
response time would simply not fall under the five business day safe 
harbor.
    The commentary retains the proposal that the time frame might be 
longer in some instances. The example has been revised, however, from 
when ``the market'' is experiencing an unusually high volume of 
refinancing requests to ``the servicer.'' A particular servicer's 
experience may not correspond perfectly with general market conditions. 
The example is intended to recognize that more time may be reasonable 
where a servicer is experiencing temporary constraints on its ability 
to respond to payoff requests. The example is not intended, however, to 
enable servicers to take an unreasonable amount of time to provide 
payoff statements if it is due to a failure to devote adequate staffing 
to handling requests. The Board believes that the revised commentary 
balances servicers' operational needs with consumers' interests in 
promptly obtaining a payoff statement.
    Under the proposed rule, the servicer would be required to respond 
to the request of a person acting on behalf of the consumer. Thus, for 
example, a creditor with which a consumer is refinancing may request a 
payoff statement. Others who act on the consumer's behalf, such as a 
non-profit homeownership counselor, also may wish to obtain a payoff 
statement for the consumer. Some industry commenters expressed concern 
about the privacy implications of such a requirement, and requested 
that the Board permit additional time to confirm the consumer's 
permission prior to releasing account information. To address these 
concerns, the Board has revised the commentary to state that the 
servicer may first take reasonable measures to verify the identity of 
persons purporting to act on behalf of the consumer and to obtain the 
consumer's authorization to release information to any such persons 
before the ``reasonable time'' frame begins to run.
    Industry commenters also requested that, as in the prompt crediting 
rule, servicers be permitted to specify reasonable requirements to 
ensure payoff requests may be promptly processed. The Board believes 
clear procedures for consumer requests for loan payoff statements will 
benefit consumers, as these procedures will expedite processing of a 
consumer's request. Therefore, the Board is adding new commentary 
226.36(c)(1)(iii)-3 to clarify that the servicer may specify reasonable 
requirements for making payoff requests, such as requiring requests to 
be in writing and directed to a specific address, e-mail address or fax 
number specified by the servicer, or orally to a specified telephone 
number, or any other reasonable requirement or method. If the consumer 
does not follow these requirements, a longer time frame for responding 
to the request would be reasonable.
    Finally, industry commenters requested clarification that the 
statement must be accurate when issued. They maintained that events 
occurring after issuance of the statement cause a statement to become 
inaccurate, such as when a consumer's previous payment is returned for 
insufficient funds after the servicer has issued the loan payoff 
statement. The Board is adding new comment 226.36(c)(1)(iii)-4 to 
explain that payoff statements must be accurate when issued. The payoff 
statement amount should reflect all payments due and all fees and 
charges incurred as of the date of issuance. However, the Board 
recognizes that events occurring after issuance and

[[Page 44574]]

outside the servicer's control, such as a returned check and 
nonsufficient funds fee, or an escrow advance, may cause the payoff 
statement to become inaccurate. If the statement was accurate when it 
was issued, subsequent events that change the payoff amount do not 
result in a violation of the rule.

D. Coverage--Sec.  226.36(d)

    The Board proposed to exclude HELOCs from Sec.  226.36(d) because 
most originators of HELOCs hold them in portfolio rather than sell 
them, which aligns these originators' interests in loan performance 
more closely with their borrowers' interests, and HELOC originations 
are concentrated in the banking and thrift industries, where the 
federal banking agencies can use supervisory authorities to protect 
borrowers. As described in more detail in part IX.E above, the proposed 
exclusion of HELOCs drew criticism from several consumer and civil 
rights groups but strong support from industry commenters. For the 
reasons discussed in part VIII.H above, the Board is adopting the 
exclusion as proposed, renumbered as Sec.  226.36(d).

XI. Advertising

    The Board proposed to amend the advertising rules for open-end 
home-equity plans under Sec.  226.16, and for closed-end credit under 
Sec.  226.24, to address advertisements for home-secured loans. For 
open-end home-equity plan advertisements, the two most significant 
proposed changes related to the clear and conspicuous standard and the 
advertisement of promotional terms. For advertisements for closed-end 
credit secured by a dwelling, the three most significant proposed 
changes related to strengthening the clear and conspicuous standard for 
advertising disclosures, regulating the disclosure of rates and 
payments in advertisements to ensure that low promotional or ``teaser'' 
rates or payments are not given undue emphasis, and prohibiting certain 
acts or practices in advertisements as provided under Section 129(l)(2) 
of TILA.
    The final rule is substantially similar to the proposed rule and 
adopts, with some modifications, each of the proposed changes discussed 
above. The most significant changes are: Modifying when an 
advertisement is required to disclose certain information about tax 
implications; using the term ``promotional'' rather than 
``introductory'' to describe certain open-end credit rates or payments 
applicable for a period less than the term of the loan and removing the 
requirement that advertisements with promotional rates or payments 
state the word ``introductory;'' excluding radio and television 
advertisements for home-equity plans from the requirements regarding 
promotional rates or payments; allowing advertisements for closed-end 
credit to state that payments do not include mortgage insurance 
premiums rather than requiring advertisements to state the highest and 
lowest payment amounts; and removing the prohibition on the use of the 
term ``financial advisor'' by a for-profit mortgage broker or mortgage 
lender.
Public Comment
    Most commenters were generally supportive of the Board's proposed 
advertising rules. Lenders and their trade associations made a number 
of requests for clarification or modification of the rules, and a few 
cautioned that requiring too much information be disclosed in 
advertisements could cause creditors to avoid advertising specific 
credit terms, thereby depriving consumers of useful information. By 
contrast, consumer and community groups as well as state and local 
government officials made some suggestions for tightening the 
application of the rules. The comments are discussed in more detail 
throughout this section as applicable.

A. Advertising Rules for Open-End Home-Equity Plans--Sec.  226.16

Overview
    The Board is revising the open-end home-equity plan advertising 
rules in Sec.  226.16. As in the proposal, the two most significant 
changes relate to the clear and conspicuous standard and the 
advertisement of promotional terms in home-equity plans. Each of these 
proposed changes is summarized below.
    First, as proposed, the Board is revising the clear and conspicuous 
standard for home-equity plan advertisements, consistent with the 
approach taken in the advertising rules for consumer leases under 
Regulation M. See 12 CFR 213.7(b). New commentary provisions clarify 
how the clear and conspicuous standard applies to advertisements of 
home-equity plans with promotional rates or payments, and to Internet, 
television, and oral advertisements of home-equity plans. The rule also 
allows alternative disclosures for television and radio advertisements 
for home-equity plans by revising the Board's earlier proposal for 
open-end plans that are not home-secured to apply to home-equity plans 
as well. See 12 CFR 226.16(e) and 72 FR 32948, 33064 (June 14, 2007).
    Second, the Board is amending the regulation and commentary to 
ensure that advertisements adequately disclose not only promotional 
plan terms, but also the rates and payments that will apply over the 
term of the plan. The changes are modeled after proposed amendments to 
the advertising rules for open-end plans that are not home-secured. See 
73 FR 28866, 28892 (May 19, 2008) and 72 FR 32948, 33064 (June 14, 
2007).
    The Board is also implementing provisions of the Bankruptcy Abuse 
Prevention and Consumer Protection Act of 2005 which requires 
disclosure of the tax implications of certain home-equity plans. See 
Public Law 109-8, 119 Stat. 23. Other technical and conforming changes 
are also being made.
    The Board proposed to prohibit certain acts or practices connected 
with advertisements for closed-end mortgage credit under TILA section 
129(l)(2) and sought comment on whether it should extend any or all of 
the prohibitions contained in proposed Sec.  226.24(i) to home-equity 
plans, or whether there were other acts or practices associated with 
advertisements for home-equity plans that should be prohibited. The 
final rule does not apply the prohibitions contained in Sec.  226.24(i) 
to home-equity plans for the reasons discussed below in connection with 
the final rule for closed-end mortgage credit advertisements. See 
discussion of Sec.  226.24(i) below.
Current Statute and Regulation
    TILA Section 147, implemented by the Board in Sec.  226.16(d), 
governs advertisements of open-end home-equity plans secured by the 
consumer's principal dwelling. 15 U.S.C. 1665b. The statute applies to 
the advertisement itself, and therefore, the statutory and regulatory 
requirements apply to any person advertising an open-end credit plan, 
whether or not they meet the definition of creditor. See comment 
2(a)(2)-2. Under the statute, if an open-end credit advertisement sets 
forth, affirmatively or negatively, any of the specific terms of the 
plan, including any required periodic payment amount, then the 
advertisement must also clearly and conspicuously state: (1) Any loan 
fee the amount of which is determined as a percentage of the credit 
limit and an estimate of the aggregate amount of other fees for opening 
the account; (2) in any case in which periodic rates may be used to 
compute the finance charge, the periodic rates expressed as an annual 
percentage rate; (3) the highest annual percentage rate which may be 
imposed under the plan; and (4) any

[[Page 44575]]

other information the Board may by regulation require.
    The specific terms of an open-end plan that ``trigger'' additional 
disclosures, which are commonly known as ``triggering terms,'' are the 
payment terms of the plan, or finance charges and other charges 
required to be disclosed under Sec. Sec.  226.6(a) and 226.6(b). If an 
advertisement for a home-equity plan states a triggering term, the 
regulation requires that the advertisement also state the terms 
required by the statute. See 12 CFR 226.16(d)(1); see also comments 
16(d)-1 and -2.
Authority
    The Board is exercising the following authorities in promulgating 
final rules. TILA Section 105(a) authorizes the Board to adopt 
regulations to ensure meaningful disclosure of credit terms so that 
consumers will be able to compare available credit terms and avoid the 
uninformed use of credit. 15 U.S.C. 1604(a). TILA Section 122 
authorizes the Board to require that information, including the 
information required under Section 147, be disclosed in a clear and 
conspicuous manner. 15 U.S.C. 1632. TILA Section 147 also requires that 
information, including any other information required by regulation by 
the Board, be clearly and conspicuously set forth in such form and 
manner as the Board may by regulation require. 15 U.S.C. 1665b.
Discussion
    Clear and conspicuous standard. The Board is adopting as proposed 
new comments 16-2 to -5 to clarify how the clear and conspicuous 
standard applies to advertisements for home-equity plans.
    Comment 16-1 explains that advertisements for open-end credit are 
subject to a clear and conspicuous standard set forth in Sec.  
226.5(a)(1). The Board is not prescribing specific rules regarding the 
format of advertisements. However, new comment 16-2 elaborates on the 
requirement that certain disclosures about promotional rates or 
payments in advertisements for home-equity plans be prominent and in 
close proximity to the triggering terms in order to satisfy the clear 
and conspicuous standard when promotional rates or payments are 
advertised and the disclosure requirements of new Sec.  226.16(d)(6) 
apply. The disclosures are deemed to meet this requirement if they 
appear immediately next to or directly above or below the trigger 
terms, without any intervening text or graphical displays. Terms 
required to be disclosed with equal prominence to the promotional rate 
or payment are deemed to meet this requirement if they appear in the 
same type size as the trigger terms. A more detailed discussion of the 
requirements for promotional rates or payments is found below.
    The equal prominence and close proximity requirements of Sec.  
226.16(d)(6) apply to all visual text advertisements except for 
television advertisments. However, comment 16-2 states that electronic 
advertisements that disclose promotional rates or payments in a manner 
that complies with the Board's recently amended rule for electronic 
advertisements under Sec.  226.16(c) are deemed to satisfy the clear 
and conspicuous standard. See 72 FR 63462 (Nov. 9, 2007). Under the 
rule, if an electronic advertisement provides the required disclosures 
in a table or schedule, any statement of triggering terms elsewhere in 
the advertisement must clearly direct the consumer to the location of 
the table or schedule. For example, a triggering term in an 
advertisement on an Internet Web site may be accompanied by a link that 
directly takes the consumer to the additional information. See comment 
16(c)(1)-2.
    The Board sought comment on whether it should amend the rules for 
electronic advertisements for home-equity plans to require that all 
information about rates or payments that apply for the term of the plan 
be stated in close proximity to promotional rates or payments in a 
manner that does not require the consumer to click a link to access the 
information. The majority of commenters who addressed this issue urged 
the Board to adopt comment 16-2 as proposed. They noted that many 
electronic advertisements on the Internet are displayed in small areas, 
such as in banner advertisements or next to search engine results, and 
requiring information about the rates or payments that apply for the 
term of the plan to be in close proximity to the promotional rates or 
payments would not be practical. These commenters also suggested that 
Internet users are accustomed to clicking on links in order to find 
further information. Commenters also expressed concern about the 
practicality of requiring closely proximate disclosures in electronic 
advertisements that may be displayed on devices with small screens, 
such as on Internet-enabled cellular phones or personal digital 
assistants, that might necessitate scrolling or clicking on links in 
order to view additional information.
    The Board is adopting comment 16-2 as proposed. The Board agrees 
that requiring disclosures of information about rates or payments that 
apply for the term of the plan to be in close proximity to promotional 
rates or payments would not be practical for many electronic 
advertisements and that the requirements of Sec.  226.16(c) adequately 
ensure that consumers viewing electronic advertisements have access to 
important additional information about the terms of the advertised 
product.
    The Board is also adopting as proposed new comments to interpret 
the clear and conspicuous standards for Internet, television, and oral 
advertisements of home-equity plans. New comment 16-3 explains that 
disclosures in the context of visual text advertisements on the 
Internet must not be obscured by techniques such as graphical displays, 
shading, coloration, or other devices, and must comply with all other 
requirements for clear and conspicuous disclosures under Sec.  
226.16(d). New comment 16-4 likewise explains that textual disclosures 
in television advertisements must not be obscured by techniques such as 
graphical displays, shading, coloration, or other devices, must be 
displayed in a manner that allows the consumer to read the information, 
and must comply with all other requirements for clear and conspicuous 
disclosures under Sec.  226.16(d). The Board believes, however, that 
this rule can be applied with some flexibility to account for 
variations in the size of television screens. For example, a lender 
would not violate the clear and conspicuous standard if the print size 
used was not legible on a handheld or portable television. New comment 
16-5 explains that oral advertisements, such as by radio or television, 
must provide disclosures at a speed and volume sufficient for a 
consumer to hear and comprehend them. In this context, the word 
``comprehend'' means that the disclosures must be intelligible to 
consumers, not that advertisers must ensure that consumers understand 
the meaning of the disclosures. The Board is also allowing the use of a 
toll-free telephone number as an alternative to certain disclosures in 
radio and television advertisements.
Section 226.16(d)(2)--Discounted and Premium Rates
    If an advertisement for a variable-rate home-equity plan states an 
initial annual percentage rate that is not based on the index and 
margin used to make later rate adjustments, the advertisement must also 
state the period of time the initial rate will be in effect, and a 
reasonably current annual percentage rate that would have been in 
effect using

[[Page 44576]]

the index and margin. See 12 CFR 226.16(d)(2). The Board is adopting as 
proposed revisions to this section to require that the triggered 
disclosures be stated with equal prominence and in close proximity to 
the statement of the initial APR. The Board believes that this will 
enhance consumers' understanding of the cost of credit for the home-
equity plan being advertised.
    As proposed, new comment 16(d)-6 provides safe harbors for what 
constitutes a ``reasonably current index and margin'' as used in Sec.  
226.16(d)(2) as well as Sec.  226.16(d)(6). Under the comment, the time 
period during which an index and margin are considered reasonably 
current depends on the medium in which the advertisement was 
distributed. For direct mail advertisements, a reasonably current index 
and margin is one that was in effect within 60 days before mailing. For 
printed advertisements made available to the general public and for 
advertisements in electronic form, a reasonably current index and 
margin is one that was in effect within 30 days before printing, or 
before the advertisement was sent to a consumer's e-mail address, or 
for advertisements made on an Internet Web site, when viewed by the 
public.
Section 226.16(d)(3)-Balloon Payment
    Existing Sec.  226.16(d)(3) requires that if an advertisement for a 
home-equity plan contains a statement about any minimum periodic 
payment, the advertisement must also state, if applicable, that a 
balloon payment may result. As proposed, the Board is revising this 
section to clarify that only statements of the amount of any minimum 
periodic payment trigger the required disclosure, and to require that 
the disclosure of a balloon payment be equally prominent and in close 
proximity to the statement of a minimum periodic payment. Consistent 
with comment 5b(d)(5)(ii)-3, the Board is clarifying that the 
disclosure is triggered when an advertisement contains a statement of 
any minimum periodic payment amount and a balloon payment may result if 
only minimum periodic payments are made, even if a balloon payment is 
uncertain or unlikely. Additionally, the Board is clarifying that a 
balloon payment results if paying the minimum periodic payments would 
not fully amortize the outstanding balance by a specified date or time, 
and the consumer must repay the entire outstanding balance at such 
time.
    The final rule, as proposed, incorporates the language from 
existing comment 16(d)-7 into the text of Sec.  226.16(d)(3) with 
technical revisions. The comment is revised and renumbered as comment 
16(d)-9. The required disclosures regarding balloon payments must be 
stated with equal prominence and in close proximity to the minimum 
periodic payment. The Board believes that this will enhance consumers' 
ability to notice and understand the potential financial impact of 
making only minimum payments.
Section 226.16(d)(4)--Tax Implications
    Section 1302 of the Bankruptcy Act amends TILA Section 147(b) to 
require additional disclosures for advertisements that are disseminated 
in paper form to the public or through the Internet, relating to an 
extension of credit secured by a consumer's principal dwelling that may 
exceed the fair market value of the dwelling. Such advertisements must 
include a statement that the interest on the portion of the credit 
extension that is greater than the fair market value of the dwelling is 
not deductible for Federal income tax purposes. 15 U.S.C. 1665b(b). The 
statute also requires a statement that the consumer should consult a 
tax adviser for further information on the tax deductibility of the 
interest.
    The Bankruptcy Act also requires that disclosures be provided at 
the time of application in cases where the extension of credit may 
exceed the fair market value of the dwelling. See 15 U.S.C. 
1637a(a)(13). The Board intends to implement the application disclosure 
portion of the Bankruptcy Act during its forthcoming review of closed-
end and HELOC disclosures under TILA. However, the Board requested 
comment on the implementation of both the advertising and application 
disclosures under this provision of the Bankruptcy Act for open-end 
credit in its October 17, 2005, ANPR. 70 FR 60235, 60244 (Oct. 17, 
2005). A majority of comments on this issue addressed only the 
application disclosure requirement, but some commenters specifically 
addressed the advertising disclosure requirement. One industry 
commenter suggested that the advertising disclosure requirement apply 
only in cases where the advertised product allows for the credit to 
exceed the fair market value of the dwelling. Other industry commenters 
suggested that the requirement apply only to advertisements for 
products that are intended to exceed the fair market value of the 
dwelling.
    The Board proposed to revise Sec.  226.16(d)(4) and comment 16(d)-3 
to implement TILA Section 147(b). The Board's proposal applied the new 
requirements to advertisements for home-equity plans where the 
advertised extension of credit may, by its terms, exceed the fair 
market value of the dwelling. The Board sought comment on whether the 
new requirements should instead apply to only advertisements that state 
or imply that the creditor provides extensions of credit greater than 
the fair market value of the dwelling. Of the few commenters who 
addressed this issue, the majority were in favor of the alternative 
approach because many home-equity plans may, in some circumstances, 
allow for extensions of credit greater than the fair market value of 
the dwelling and advertisers would likely include the disclosure in 
nearly all advertisements.
    The final rule differs from the proposed rule and requires that the 
additional tax implication disclosures be given only when an 
advertisement states that extensions of credit greater than the fair 
market value of the dwelling are available. The rule does not apply to 
advertisements that merely imply that extensions of credit greater than 
the fair market value of the dwelling may occur. By limiting the 
required disclosures to only those advertisements that state that 
extensions of credit greater than the fair market value of the dwelling 
are available, the Board believes the rule will provide the required 
disclosures to consumers when they are most likely to be receptive to 
the information while avoiding overloading consumers with information 
about the tax consequences of home-equity plans when it is less likely 
to be meaningful to them.
    Comment 16(d)-3 is revised to conform to the final rule and to 
clarify when an advertisement must give the disclosures required by 
Sec.  226.16(d)-4 for all home-equity plan advertisements that refer to 
tax deductibility and when an advertisement must give the new 
disclosures relating to extensions of credit greater than the fair 
market value of the consumer's dwelling.
Section 226.16(d)(6)--Promotional Rates and Payments
    The Board proposed to add Sec.  226.16(d)(6) to address the 
advertisement of promotional (termed ``introductory'' in the proposal) 
rates and payments in advertisements for home-equity plans. The 
proposed rule provided that if an advertisement for a home-equity plan 
stated a promotional rate or payment, the advertisement must use the 
term ``introductory'' or ``intro'' in immediate proximity to each 
mention of the promotional rate or payment. The proposed rule also 
provided that such

[[Page 44577]]

advertisements must disclose the following information in a clear and 
conspicuous manner with each listing of the promotional rate or 
payment: The period of time during which the promotional rate or 
promotional payment will apply; in the case of a promotional rate, any 
annual percentage rate that will apply under the plan; and, in the case 
of a promotional payment, the amount and time periods of any payments 
that will apply under the plan. In variable-rate transactions, payments 
determined based on application of an index and margin to an assumed 
balance would be required to be disclosed based on a reasonably current 
index and margin.
    The final rule excludes radio and television advertisements for 
home-equity plans from the requirements of Sec.  226.16(d)(6). This 
modification is consistent with the approach the Board proposed, and is 
adopting, for Sec.  226.24(f) which contains similar requirements for 
advertisements for closed-end credit that is home-secured. See Sec.  
226.24(f)(1). As the Board noted in the supplementary information to 
the proposal for advertisements for home-secured closed-end loans, the 
Board does not believe it is feasible to apply the requirements of this 
section, notably the close proximity and prominence requirements, to 
oral advertisements. The Board also sought comment in connection with 
closed-end home-secured loans on whether these or different standards 
should be applied to oral advertisements for home-secured loans but 
commenters did not address this issue.
    The final rule also differs from the proposed rule in using the 
term ``promotional'' rather than ``introductory'' to describe the rates 
and payments covered by Sec.  226.16(d)(6). The final rule also does 
not adopt proposed Sec.  226.16(d)(6)(ii) and proposed comment 16(d)-
5.ii which required that advertisements with promotional rates or 
payments state the term ``introductory'' or ``intro'' in immediate 
proximity to each listing of a promotional rate or payment. Some 
industry commenters noted that consumers might be confused by the use 
of the term ``introductory'' in cases where it applied to a promotional 
rate or payment that was not the initial rate or payment.
    The Board received similar comments in response to its earlier 
proposal for open-end plans that are not home-secured, and the Board 
subsequently issued a new proposal for those plans that would use the 
term ``promotional'' rather than ``introductory'' and require that 
advertisements state the word ``introductory'' only for promotional 
rates offered in connection with an account opening. 73 FR 28866, 28892 
(May 9, 2008). The Board is adopting the term ``promotional'' rather 
than ``introductory'' in the rule, but the Board is not requiring open-
end home-equity plans to state the word ``introductory'' for 
promotional rates or payments offered in connection with the opening of 
an account. While the term ``introductory'' is common in other consumer 
credit contexts, such as credit cards, it may not be as meaningful to 
consumers in the context of advertisements for home-equity plans and 
may be confusing to some consumers in that context. The Board believes 
that the information required to be disclosed under Sec.  226.16(d)(6) 
is sufficient to inform consumers that advertised promotional terms 
will not apply for the full term of the plan.
    Commenters also expressed confusion about the distinction between 
promotional rates under Sec.  226.16(d)(6) and discounted and premium 
rates under Sec.  226.16(d)(2). While some advertised rates may be 
covered under both Sec.  226.16(d)(2) and Sec.  226.16(d)(6), each rule 
covers some rates that the other does not. The definition of a 
promotional rate under Sec.  226.16(d)(6) is not limited to initial 
rates; a rate that is not based on the index and margin used to make 
rate adjustments under the plan may be a promotional rate even if it is 
not the first rate that applies. At the same time, Sec.  226.16(d)(6) 
applies to a rate that is not based on the index and margin that will 
be used to make later rate adjustments under the plan only if that rate 
is less than a reasonably current annual percentage rate that would be 
in effect under the index and margin used to make rate adjustments. By 
contrast, Sec.  226.16(d)(2) applies to an initial annual percentage 
rate that is not based on the index and margin used to make later rate 
adjustments regardless of whether the later rate would be greater or 
less than the initial rate.
    Section 226.16(d)(6)(i)--Definitions. The Board proposed to define 
the terms ``introductory rate,'' ``introductory payment,'' and 
``introductory period'' in Sec.  226.16(d)(6)(i). The final rule uses 
the terms ``promotional rate,'' ``promotional payment,'' and 
``promotional period'' instead and the definition of ``promotional 
payment'' is clarified to refer to the minimum payments under a home-
equity plan, but the final rule is otherwise as proposed. In a 
variable-rate plan, the term ``promotional rate'' means any annual 
percentage rate applicable to a home-equity plan that is not based on 
the index and margin that will be used to make rate adjustments under 
the plan, if that rate is less than a reasonably current annual 
percentage rate that would be in effect based on the index and margin 
that will be used to make rate adjustments under the plan. The term 
``promotional payment'' means, in the case of a variable-rate plan, the 
amount of any minimum payment applicable to a home-equity plan for a 
promotional period that is not derived from the index and margin that 
will be used to determine the amount of any other minimum payments 
under the plan and, given an assumed balance, is less than any other 
minimum payment that will be in effect under the plan based on a 
reasonably current application of the index and margin that will be 
used to determine the amount of such payments. For a non-variable-rate 
plan, the term ``promotional payment'' means the amount of any minimum 
payment applicable to a home-equity plan for a promotional period if 
that payment is less than the amount of any other payments required 
under the plan given an assumed balance. The term ``promotional 
period'' means a period of time, less than the full term of the loan, 
that the promotional rate or payment may be applicable.
    As proposed, comment 16(d)-5.i clarifies how the concepts of 
promotional rates and promotional payments apply in the context of 
advertisements for variable-rate plans. Specifically, the comment 
provides that if the advertised annual percentage rate or the 
advertised payment is based on the index and margin that will be used 
to make rate or payment adjustments over the term of the loan, then 
there is no promotional rate or promotional payment. On the other hand, 
if the advertised annual percentage rate, or the advertised payment, is 
not based on the index and margin that will be used to make rate or 
payment adjustments, and a reasonably current application of the index 
and margin would result in a higher annual percentage rate or, given an 
assumed balance, a higher payment, then there is a promotional rate or 
promotional payment.
    The revisions generally assume that a single index and margin will 
be used to make rate or payment adjustments under the plan. The Board 
sought comment on whether and to what extent multiple indexes and 
margins are used in home-equity plans and whether additional or 
different rules are needed for such products. Commenters stated that 
multiple indexes and margins generally are not used within the same 
plan, but requested clarification on how the requirements of Sec.  
226.16(d)(6) would apply to advertisements that contain information 
about rates or

[[Page 44578]]

payments based on an index and margin available under the plan to 
certain consumers, such as those with certain credit scores, but where 
a different margin may be offered to other consumers. The definitions 
of promotional rate and promotional payment refer to the rates or 
payments under the advertised plan. If rate adjustments will be based 
on only one index and margin for each consumer, the fact that the 
advertised rate or payment may not be available to all borrowers does 
not make the advertised rate or payment a promotional one. However, an 
advertisement for open-end credit may state only those terms that 
actually are or will be arranged or offered by the creditor. See 12 CFR 
226.16(a).
    One banking industry trade group commenter sought an exception from 
the definition of promotional rate and promotional payment for initial 
rates that are derived by applying the index and margin used to make 
rate adjustments under the loan, but calculated in a slightly different 
manner than will be used to make later rate adjustments. For example, 
an initial rate may be calculated based on the index in effect as of 
the closing or lock-in date, rather than another date which will be 
used to make other rate adjustments under the plan such as the 15th day 
of the month preceding the anniversary of the closing date. The Board 
is not adopting an exception from the definition of promotional rate 
and promotional payment. However, the Board believes that an initial 
rate in the example described above would still be ``based on'' the 
index and margin used to make other rate adjustments under the plan and 
therefore would not be a promotional rate.
    Some industry commenters sought an exclusion from the definition of 
promotional rate and promotional payment for plans that apply different 
rates or payments to a draw period and to a repayment period. For 
example, some plans may provide for interest-only payments during a 
draw period and fully-amortizing payments during a repayment period. 
Consistent with the requirements for application disclosures under 
Sec.  226.5b, the Board is not adopting exceptions for plans with draw 
periods and repayment periods. If an advertisement states a promotional 
rate or payment offered during a draw period it must provide the 
required disclosures about the rates or payments that apply for the 
term of the plan. The Board believes that such information will help 
consumers understand the full cost of the credit over the term of the 
plan.
    Commenters also sought to exclude advertisements for plans that 
permit the consumer to repay all or part of the balance during the draw 
period at a fixed rate, rather than a variable rate, from the 
promotional rate and payment requirements. These commenters expressed 
concern that they did not know at the advertising stage whether 
consumers would choose the fixed-rate conversion option and that 
disclosing plans that offer the option as though a consumer had chosen 
it could lead to confusion. Regulation Z already requires fixed-rate 
conversion options to be disclosed in applications for variable-rate 
home-equity plans. See comment 5b(d)(5)(ii)-2. The Board believes that 
requiring information about fixed-rate conversion options to be 
disclosed in advertisements could confuse consumers about a feature 
that is optional. New comment 16(d)-5.v states that the presence of a 
fixed-rate conversion option does not, by itself, make a rate (or 
payment) a promotional one.
    Similarly, some industry commenters also sought an exception from 
the definition of promotional rate and payment for plans with 
preferred-rate provisions, where the rate will increase upon the 
occurrence of some event. For example, the consumer may be given a 
preferred rate for electing to make automated payments but that 
preferred-rate would end if the consumer later ceases that election. 
Regulation Z already requires preferred-rate provisions to be disclosed 
in applications for variable-rate home-equity plans. See comment 
5b(d)(12)(viii)-1. The Board believes that requiring information about 
preferred-rate provisions to be disclosed at the advertising stage is 
less likely to be meaningful to consumers who are usually gathering 
general rate and payment information about multiple plans and are less 
likely to focus on disclosures about preferred-rate terms and 
conditions. New comment 16(d)-5.vi states that the presence of a 
preferred-rate provision does not, by itself, make a rate (or payment) 
a promotional one.
    Comment 16(d)-5.iv, renumbered but otherwise adopted as proposed, 
clarifies how the concept of promotional payments applies in the 
context of advertisements for non-variable-rate plans. Specifically, 
the comment provides that if the advertised payment is calculated in 
the same way as other payments under the plan based on an assumed 
balance, the fact that the minimum payment could increase solely if the 
consumer made an additional draw does not make the payment a 
promotional payment. For example, if a minimum payment of $500 results 
from an assumed $10,000 draw, and the minimum payment would increase to 
$1,000 if the consumer made an additional $10,000 draw, the payment is 
not a promotional payment.
    Section 226.16(d)(6)(ii)--Stating the promotional period and post-
promotional rate or payments. Section 226.16(d)(6)(ii), renumbered and 
modified to exclude radio and television advertisements, but otherwise 
adopted as proposed, provides that if an advertisement states a 
promotional rate or promotional payment, it must also clearly and 
conspicuously disclose, with equal prominence and in close proximity to 
the promotional rate or payment, the following, as applicable: The 
period of time during which the promotional rate or promotional payment 
will apply; in the case of a promotional rate, any annual percentage 
rate that will apply under the plan; and, in the case of a promotional 
payment, the amount and time periods of any payments that will apply 
under the plan. In variable-rate transactions, payments that will be 
determined based on application of an index and margin to an assumed 
balance must be disclosed based on a reasonably current index and 
margin.
    Proposed comment 16(d)-5.iii provided safe harbors for satisfying 
the closely proximate or equally prominent requirements of proposed 
Sec.  226.16(d)(6)(iii). Specifically, the required disclosures would 
be deemed to be closely proximate to the promotional rate or payment if 
they were in the same paragraph as the promotional rate or payment. 
Information disclosed in a footnote would not be deemed to be closely 
proximate to the promotional rate or payment. Some commenters noted 
that the safe harbor definition of ``closely proximate'' in this 
comment (that the required disclosures be in the same paragraph as the 
promotional rate or payment) differed from the definition of ``closely 
proximate'' in comment 16-2 (that the required disclosures be 
immediately next to or directly above or below the promotional rate or 
payment). The Board is modifying final comment 16(d)-5.ii, as 
renumbered, to match the definition of ``closely proximate'' in comment 
16-2. However, the Board is retaining the part of the safe harbor that 
disallows the use of footnotes. Consumer testing of account-opening and 
other disclosures undertaken in conjunction with the Board's open-end 
Regulation Z proposal suggests that placing information in a footnote 
makes it much less likely that the consumer

[[Page 44579]]

will notice it. As proposed, the required disclosures will be deemed 
equally prominent with the promotional rate or payment if they are in 
the same type size as the promotional rate or payment.
    Comment 16(d)-5.iii clarifies that the requirement to disclose the 
amount and time periods of any payments that will apply under the plan 
may require the disclosure of several payment amounts, including any 
balloon payments. The comment provides an example of a home-equity plan 
with several payment amounts over the repayment period to illustrate 
the disclosure requirements. The comment has been modified from the 
proposal, in response to public comment, to add a clarification that 
the final payment need not be disclosed if it is not greater than two 
times the amount of any other minimum payments under the plan. Comment 
16(d)-6, which is discussed above, provides safe harbor definitions for 
the phrase ``reasonably current index and margin.''
    Section 226.16(d)(6)(iii)--Envelope excluded. Section 
226.16(d)(6)(iii), renumbered but otherwise adopted as proposed, 
provides that the requirements of Sec.  226.16(d)(6)(ii) do not apply 
to envelopes, or to banner advertisements and pop-up advertisements 
that are linked to an electronic application or solicitation provided 
electronically. In the Board's view, because banner advertisements and 
pop-up advertisements are used to direct consumers to more detailed 
advertisements, they are similar to envelopes in the direct mail 
context.
Section 226.16(e)--Alternative Disclosures--Television or Radio 
Advertisements
    The Board is adopting Sec.  226.16(e), as renumbered, to allow for 
alternative disclosures of the information required for home-equity 
plans under Sec.  226.16(d)(1), where applicable. The supplementary 
information to the proposal referred to these as alternative 
disclosures for oral advertisements, but the proposed regulation text 
did not limit the alternative disclosures to oral advertisements. The 
proposed regulation text was consistent with the Board's proposal for 
credit cards and other open-end plans. See proposed Sec.  226.16(f) and 
72 FR 32948, 33064 (June 14, 2007). The final rule does not limit the 
alternative disclosures to oral advertisements. The final rule does, 
however, limit Sec.  226.16(e)'s application to advertisements for 
home-equity plans and redesignates it from Sec.  226.16(f) to Sec.  
226.16(e). These changes are meant to conform the rule to the existing 
regulation, but the Board notes that its proposal for open-end plans 
that are not home-secured, if adopted, would expand the rule to allow 
for alternative disclosures for all advertisements for open-end credit. 
In addition, Sec.  226.16(e) permits an advertisement to provide either 
a toll-free telephone number or a telephone number that allows a 
consumer to reverse the telephone charges when calling for information. 
The final rule also adds new commentary clarifying the alternative 
disclosure option. This commentary was included in the Board's earlier 
proposal for credit cards and other open-end plans, and is 
substantively the same as the commentary for alternative disclosures 
for advertisements for closed-end credit under Sec.  226.24(g). See 72 
FR 32948, 33144 (June 14, 2007), and comments 24(g)-1 and 24(g)-2.
    The Board's revision follows the general format of the Board's 
earlier proposal for alternative disclosures for television and radio 
advertisements. If a triggering term is stated in the advertisement, 
one option is to state clearly and conspicuously each of the 
disclosures required by Sec. Sec.  226.16(b)(1) and (d)(1). Another 
option is for the advertisement to state clearly and conspicuously the 
APR applicable to the home-equity plan, and the fact that the rate may 
be increased after consummation, and provide a telephone number that 
the consumer may call to receive more information. Given the space and 
time constraints on television and radio advertisements, the required 
disclosures may go unnoticed by consumers or be difficult for them to 
retain. Thus, providing an alternative means of disclosure may be more 
effective in many cases given the nature of the media.
    This approach is also similar to the approach taken in the 
advertising rules for consumer leases under Regulation M, which also 
allows the use of toll-free numbers in television and radio 
advertisements. See 12 CFR 213.7(f)(1)(ii).

B. Advertising Rules for Closed-End Credit--Sec.  226.24

Overview
    The Board proposed to amend the closed-end credit advertising rules 
in Sec.  226.24 to address advertisements for home-secured loans. The 
three most significant aspects of the proposal related to strengthening 
the clear and conspicuous standard for advertising disclosures, 
regulating the disclosure of rates and payments in advertisements to 
ensure that low promotional or ``teaser'' rates or payments are not 
given undue emphasis, and prohibiting certain acts or practices in 
advertisements as provided under TILA Section 129(l)(2), 15 U.S.C. 
1639(l)(2).
    The final rule is substantially similar to the proposed rule and 
adopts, with some modifications, each of the proposed changes discussed 
above. First, the Board is adding a provision setting forth the clear 
and conspicuous standard for all closed-end advertisements and a number 
of new commentary provisions applicable to advertisements for home-
secured loans. The regulation is being revised to include a clear and 
conspicuous standard for advertising disclosures, consistent with the 
approach taken in the advertising rules for Regulation M. See 12 CFR 
213.7(b). New staff commentary provisions are added to clarify how the 
clear and conspicuous standard applies to rates or payments in 
advertisements for home-secured loans, and to Internet, television, and 
oral advertisements of home-secured loans. The final rule also adds a 
provision to allow alternative disclosures for television and radio 
advertisements that is modeled after a proposed revision to the 
advertising rules for open-end (not home-secured) plans. See 72 FR 
32948, 33064 (June 14, 2007).
    Second, the Board is amending the regulation and commentary to 
address the advertisement of rates and payments for home-secured loans. 
The revisions are designed to ensure that advertisements adequately 
disclose all rates or payments that will apply over the term of the 
loan and the time periods for which those rates or payments will apply. 
Many advertisements for home-secured loans emphasize low, promotional 
``teaser'' rates or payments that will apply for a limited period of 
time. Such advertisements often do not give consumers accurate or 
balanced information about the costs or terms of the products offered.
    The revisions also prohibit advertisements from disclosing an 
interest rate lower than the rate at which interest is accruing. 
Instead, the only rates that may be included in advertisements for 
home-secured loans are the APR and one or more simple annual rates of 
interest. Many advertisements for home-secured loans promote very low 
rates that do not appear to be the rates at which interest is accruing. 
The advertisement of interest rates lower than the rate at which 
interest is accruing is likely confusing for consumers. Taken together, 
the Board believes that the changes regarding the disclosure of rates 
and payments in advertisements for home-secured loans will enhance the

[[Page 44580]]

accuracy of advertising disclosures and benefit consumers.
    Third, pursuant to TILA Section 129(l)(2), 15 U.S.C. 1639(l)(2), 
the Board is prohibiting seven specific acts or practices in connection 
with advertisements for home-secured loans that the Board finds to be 
unfair, deceptive, associated with abusive lending practices, or 
otherwise not in the interest of the borrower.
    Bankruptcy Act changes. The Board is also making several changes to 
clarify certain provisions of the closed-end advertising rules, 
including the scope of certain triggering terms, and to implement 
provisions of the Bankruptcy Abuse Prevention and Consumer Protection 
Act of 2005 requiring disclosure of the tax implications of home-
secured loans. See Public Law 109-8, 119 Stat. 23. Technical and 
conforming changes to the closed-end advertising rules are also made.
Public Comment
    As discussed above, the Board received numerous, mostly positive, 
comments on the proposed revisions. Specific comments requesting 
modifications or clarifications to the proposed requirements for 
advertisements for closed-end home-secured credit are discussed below 
as applicable.
Current Statute and Regulation
    TILA Section 144, implemented by the Board in Sec.  226.24, governs 
advertisements of credit other than open-end plans. 15 U.S.C. 1664. 
TILA Section 144 thus applies to advertisements of closed-end credit, 
including advertisements for closed-end credit secured by a dwelling 
(also referred to as ``home-secured loans''). The statute applies to 
the advertisement itself, and therefore, the statutory and regulatory 
requirements apply to any person advertising closed-end credit, whether 
or not such person meets the definition of creditor. See comment 
2(a)(2)-2. Under the statute, if an advertisement states the rate of a 
finance charge, the advertisement must state the rate of that charge as 
an APR. In addition, closed-end credit advertisements that contain 
certain terms must also include additional disclosures. The specific 
terms of closed-end credit that ``trigger'' additional disclosures, 
which are commonly known as ``triggering terms,'' are (1) the amount of 
the downpayment, if any, (2) the amount of any installment payment, (3) 
the dollar amount of any finance charge, and (4) the number of 
installments or the period of repayment. If an advertisement for 
closed-end credit states a triggering term, then the advertisement must 
also state any downpayment, the terms of repayment, and the rate of the 
finance charge expressed as an APR. See 12 CFR 226.24(c)-(d) (as 
redesignated from Sec. Sec.  226.24(b)-(c)) and the staff commentary 
thereunder.
Authority
    The Board is exercising the following authorities in promulgating 
final rules. TILA Section 105(a) authorizes the Board to adopt 
regulations to ensure meaningful disclosure of credit terms so that 
consumers will be able to compare available credit terms and avoid the 
uninformed use of credit. 15 U.S.C. 1604(a). TILA Section 122 
authorizes the Board to require that information, including the 
information required under Section 144, be disclosed in a clear and 
conspicuous manner. 15 U.S.C. 1632. TILA Section 129(l)(2) authorizes 
the Board to prohibit acts or practices in connection with mortgage 
loans that the Board finds to be unfair or deceptive. TILA Section 
129(l)(2) also authorizes the Board to prohibit acts or practices in 
connection with the refinancing of mortgage loans that the Board finds 
to be associated with abusive lending practices, or that are otherwise 
not in the interest of the borrower. 15 U.S.C. 1639(l)(2).
Section 226.24(b)--Clear and Conspicuous Standard
    As proposed, the Board is adding a clear and conspicuous standard 
in Sec.  226.24(b) that applies to all closed-end advertising. This 
provision supplements, rather than replaces, the clear and conspicuous 
standard that applies to all closed-end credit disclosures under 
Subpart C of Regulation Z and that requires all disclosures to be in a 
reasonably understandable form. See 12 CFR 226.17(a)(1); comment 
17(a)(1)-1. The new provision provides a framework for clarifying how 
the clear and conspicuous standard applies to advertisements that are 
not in writing or in a form that the consumer may keep, or that 
emphasize promotional rates or payments.
    Existing comment 24-1 explains that advertisements for closed-end 
credit are subject to a clear and conspicuous standard based on Sec.  
226.17(a)(1). The comment is renumbered as comment 24(b)-1 and revised 
to reference the format requirements for advertisements of rates or 
payments for home-secured loans. The Board is not prescribing specific 
rules regarding the format of advertising disclosures generally. 
However, comment 24(b)-2 elaborates on the requirement that certain 
disclosures about rates or payments in advertisements for home-secured 
loans be prominent and in close proximity to other information about 
rates or payments in the advertisement in order to satisfy the clear 
and conspicuous standard and the disclosure requirements of Sec.  
226.24(f). Terms required to be disclosed in close proximity to other 
rate or payment information are deemed to meet this requirement if they 
appear immediately next to or directly above or below the trigger 
terms, without any intervening text or graphical displays. Terms 
required to be disclosed with equal prominence to other rate or payment 
information are deemed to meet this requirement if they appear in the 
same type size as other rates or payments. The requirements for 
disclosing rates or payments are discussed in more detail below.
    The equal prominence and close proximity requirements of Sec.  
226.24(f) apply to all visual text advertisements except for television 
advertisements. However, comment 24(b)-2 states that electronic 
advertisements that disclose rates or payments in a manner that 
complies with the Board's recently amended rule for electronic 
advertisements under Sec.  226.24(e) are deemed to satisfy the clear 
and conspicuous standard. See 72 FR 63462 (Nov. 9, 2007). Under the 
existing rule for electronic advertisements, if an electronic 
advertisement provides the required disclosures in a table or schedule, 
any statement of triggering terms elsewhere in the advertisement must 
clearly direct the consumer to the location of the table or schedule. 
For example, a triggering term in an advertisement on an Internet Web 
site may be accompanied by a link that takes the consumer directly to 
the additional information. See comment 24(e)-4.
    The Board sought comment on whether it should amend the rules for 
electronic advertisements for home-secured loans to require that 
information about rates or payments that apply for the term of the loan 
be stated in close proximity to other rates or payments in a manner 
that does not require the consumer to click on a link to access the 
information. The Board also solicited comment on the costs and 
practical limitations, if any, of imposing this close proximity 
requirement on electronic advertisements. The majority of commenters 
who addressed this issue urged the Board to adopt comment 24(b)-2 as 
proposed. They noted that many electronic advertisements on the 
Internet are displayed in small areas, such as in banner advertisements 
or

[[Page 44581]]

next to search engine results, and requiring information about the 
rates or payments that apply for the term of the loan in close 
proximity to all other applicable rates or payments would not be 
practical. These commenters also suggested that Internet users are 
accustomed to clicking on links in order to find further information. 
Commenters also expressed concern about the practicality of requiring 
closely proximate disclosures in electronic advertisements that may be 
displayed on devices with small screens, such as on Internet-enabled 
cellular telephones or personal digital assistants, that might 
necessitate scrolling or clicking on links in order to view additional 
information.
    The Board is adopting comment 24(b)-2 as proposed. The Board agrees 
that requiring disclosures of information about rates or payments that 
apply for the term of the loan to be in close proximity to information 
about all other rates or payments would not be practical for many 
electronic advertisements, and that the requirements of Sec.  226.24(e) 
adequately ensure that consumers viewing electronic advertisements have 
access to important additional information about the terms of the 
advertised product.
    The Board is also adopting as proposed new comments to interpret 
the clear and conspicuous standards for Internet, television, and oral 
advertisements of home-secured loans. Comment 24(b)-3 explains that 
disclosures in the context of visual text advertisements on the 
Internet must not be obscured by techniques such as graphical displays, 
shading, coloration, or other devices, and must comply with all other 
requirements for clear and conspicuous disclosures under Sec.  226.24. 
Comment 24(b)-4 likewise explains that visual text advertisements on 
television must not be obscured by techniques such as graphical 
displays, shading, coloration, or other devices, must be displayed in a 
manner that allows a consumer to read the information required to be 
disclosed, and must comply with all other requirements for clear and 
conspicuous disclosures under Sec.  226.24. The Board believes, 
however, that this rule can be applied with some flexibility to account 
for variations in the size of television screens. For example, a lender 
would not violate the clear and conspicuous standard if the print size 
used was not legible on a handheld or portable television. Comment 
24(b)-5 explains that oral advertisements, such as by radio or 
television, must provide the disclosures at a speed and volume 
sufficient for a consumer to hear and comprehend them. In this context, 
the word ``comprehend'' means that the disclosures must be intelligible 
to consumers, not that advertisers must ensure that consumers 
understand the meaning of the disclosures. Section 226.24(g) provides 
an alternative method of disclosure for television or radio 
advertisements when triggering terms are stated and is discussed more 
fully below.
Section 226.24(c)--Advertisement of Rate of Finance Charge
    Disclosure of simple annual rate or periodic rate. If an 
advertisement states a rate of finance charge, it must state the rate 
as an APR. See 12 CFR 226.24(c) (as redesignated from Sec.  226.24(b)). 
An advertisement may also state, in conjunction with and not more 
conspicuously than the APR, a simple annual rate or periodic rate that 
is applied to an unpaid balance.
    As proposed, the Board is renumbering Sec.  226.24(b) as Sec.  
226.24(c), and revising it. The revised rule provides that 
advertisements for home-secured loans shall not state any rate other 
than an APR, except that a simple annual rate that is applied to an 
unpaid balance may be stated in conjunction with, but not more 
conspicuously than, the APR. Advertisement of a periodic rate, other 
than the simple annual rate of interest, or any other rates, is no 
longer permitted in connection with home-secured loans.
    Also as proposed, comment 24(b)-2 is renumbered as comment 24(c)-2 
and revised to clarify that a simple annual rate or periodic rate is 
the rate at which interest is accruing. A rate lower than the rate at 
which interest is accruing, such as an effective rate, payment rate, or 
qualifying rate, is not a simple annual rate or periodic rate. The 
example in renumbered comment 24(c)-2 also is revised to reference 
Sec.  226.24(f), which contains requirements regarding the disclosure 
of rates and payments in advertisements for home-secured loans.
    Buydowns. As proposed, comment 24(b)-3, which addresses 
``buydowns,'' is renumbered as comment 24(c)-3 and revised. A buydown 
is where a seller or creditor offers a reduced interest rate and 
reduced payments to a consumer for a limited period of time. 
Previously, this comment provided that the seller or creditor, in the 
case of a buydown, could advertise the reduced simple interest rate, 
the limited term to which the reduced rate applies, and the simple 
interest rate applicable to the balance of the term. The advertisement 
also could show the effect of the buydown agreement on the payment 
schedule for the buydown period. The Board is revising the comment to 
explain that additional disclosures are required when an advertisement 
includes information showing the effect of the buydown agreement on the 
payment schedule. Such advertisements must provide the disclosures 
required by Sec.  226.24(d)(2) because showing the effect of the 
buydown agreement on the payment schedule is a statement about the 
amount of any payment, and thus is a triggering term. See 12 CFR 
226.24(d)(1)(iii). In these circumstances, the additional disclosures 
are necessary for consumers to understand the costs of the loan and the 
terms of repayment. Consistent with these changes, and as proposed, the 
examples of statements about buydowns that an advertisement may make 
without triggering additional disclosures are being removed.
    Effective rates. As proposed, the Board is deleting what was 
previously comment 24(b)-4. The comment had allowed the advertisement 
of three rates: the APR; the rate at which interest is accruing; and an 
interest rate lower than the rate at which interest is accruing, which 
may be referred to as an effective rate, payment rate, or qualifying 
rate. The staff commentary also contained an example of how to disclose 
the three rates.
    The Board proposed to delete this staff commentary for the reasons 
stated below. First, the disclosure of three rates is unnecessarily 
confusing for consumers and the disclosure of an interest rate lower 
than the rate at which interest is accruing does not provide meaningful 
information to consumers about the cost of credit. Second, when the 
effective rates commentary was adopted in 1982, the Board noted that 
the commentary was designed ``to address the advertisement of special 
financing involving `effective rates,' `payment rates,' or `qualifying 
rates.' '' See 47 FR 41338, 41342 (Sept. 20, 1982). At that time, when 
interest rates were quite high, these terms were used in connection 
with graduated-payment mortgages. Today, however, some advertisers 
appear to rely on this comment when advertising rates for a variety of 
home-secured loans, such as negative amortization loans and option 
ARMs. In these circumstances, the advertisement of rates lower than the 
rate at which interest is accruing for these products is not helpful to 
consumers, particularly consumers who may not fully understand how 
these non-traditional home-secured loans work.
    Some industry commenters suggested that the advertisement of rates 
lower than the rate at which interest is accruing might provide 
meaningful information to some consumers.

[[Page 44582]]

Specifically, some advertisements for negative amortization loans and 
option ARMs quote a payment amount that is based on an effective rate. 
Commenters suggested that if the corresponding effective rate itself 
was not advertised, consumers might be confused about the rate on which 
the payment was based. For the reasons stated above, the Board believes 
that consumers are likely to be confused by advertisements that state a 
rate lower than the rate at which interest is accruing. The Board is 
addressing the advertisement of payments for home-secured loans in new 
Sec.  226.24(f), discussed below, to require that advertisements 
contain information about the payments that apply for the term of the 
loan.
    Discounted variable-rate transactions. As proposed, comment 24(b)-5 
is being renumbered as comment 24(c)-4 and revised to explain that an 
advertisement for a discounted variable-rate transaction which 
advertises a reduced or discounted simple annual rate must show with 
equal prominence and in close proximity to that rate, the limited term 
to which the simple annual rate applies and the annual percentage rate 
that will apply after the term of the initial rate expires.
    The comment is also being revised to explain that additional 
disclosures are required when an advertisement includes information 
showing the effect of the discount on the payment schedule. Such 
advertisements must provide the disclosures required by Sec.  
226.24(d)(2). Showing the effect of the discount on the payment 
schedule is a statement about the number of payments or the period of 
repayment, and thus is a triggering term. See 12 CFR 226.24(d)(1)(ii). 
In these circumstances, the additional disclosures are necessary for 
consumers to understand the costs of the loan and the terms of 
repayment. Consistent with these changes, the examples of statements 
about discounted variable-rate transactions that an advertisement may 
make without triggering additional disclosures are being removed.
Section 226.24(d)--Advertisement of Terms That Require Additional 
Disclosures
    Required disclosures. As proposed, the Board is renumbering Sec.  
226.24(c) as Sec.  226.24(d) and revising it. The rule clarifies the 
meaning of the ``terms of repayment'' required to be disclosed. 
Specifically, the terms of repayment must reflect ``the repayment 
obligations over the full term of the loan, including any balloon 
payment,'' not just the repayment terms that will apply for a limited 
period of time. This revision is consistent with other changes and is 
designed to ensure that advertisements for closed-end credit, 
especially home-secured loans, adequately disclose the terms that will 
apply over the full term of the loan, not just for a limited period of 
time.
    Consistent with these changes, and as proposed, comment 24(c)(2)-2 
is renumbered as comment 24(d)(2)-2 and revised. As proposed, 
commentary regarding advertisement of loans that have a graduated-
payment feature is being removed from comment 24(d)(2)-2.
    The Board did not propose to make substantive changes to commentary 
regarding advertisements for home-secured loans where payments may vary 
because of the inclusion of mortgage insurance premiums. Under the 
existing commentary, the advertisement could state the number and 
timing of payments, the amounts of the largest and smallest of those 
payments, and the fact that other payments will vary between those 
amounts. Some industry commenters noted, however, that advertisers can 
only estimate the amounts of mortgage insurance premiums at the 
advertising stage, and that the requirement to show the largest and 
smallest of the payments that include mortgage insurance premiums may 
not be meaningful to consumers because consumers' actual payment 
amounts may vary from the advertised payment amounts. For this reason, 
the commentary is being revised to no longer require the advertisement 
to show the amount of the largest and smallest payments reflecting 
mortgage insurance premiums. Rather, the advertisement may state the 
number and timing of payments, the fact that the payments do not 
include amounts for mortgage insurance premiums, and that the actual 
payment obligation will be higher.
    In advertisements for home-secured loans with one series of low 
monthly payments followed by another series of higher monthly payments, 
comment 24(d)(2)-2.iii explains that the advertisement may state the 
number and time period of each series of payments and the amounts of 
each of those payments. However, the amount of the series of higher 
payments must be based on the assumption that the consumer makes the 
series of lower payments for the maximum allowable period of time. For 
example, if a consumer has the option of making interest-only payments 
for two years and an advertisement states the amount of the interest-
only payment, the advertisement must state the amount of the series of 
higher payments based on the assumption that the consumer makes the 
interest-only payments for the full two years. The Board believes that 
without these disclosures consumers may not fully understand the cost 
of the loan or the payment terms that may result once the higher 
payments take effect.
    As proposed, the revisions to renumbered comment 24(d)(2)-2 apply 
to all closed-end advertisements. The Board believes that the terms of 
repayment for any closed-end credit product should be disclosed for the 
full term of the loan, not just for a limited period of time. The Board 
also does not believe that this change will significantly impact 
advertising practices for closed-end credit products such as auto loans 
and installment loans that ordinarily have shorter terms than home-
secured loans.
    As proposed, new comment 24(d)(2)-3 is added to address the 
disclosure of balloon payments as part of the repayment terms. The 
commentary notes that in some transactions, a balloon payment will 
occur when the consumer only makes the minimum payments specified in an 
advertisement. A balloon payment results if paying the minimum payments 
does not fully amortize the outstanding balance by a specified date or 
time, usually the end of the term of the loan, and the consumer must 
repay the entire outstanding balance at such time. The commentary 
explains that if a balloon payment will occur if the consumer only 
makes the minimum payments specified in an advertisement, the 
advertisement must state with equal prominence and in close proximity 
to the minimum payment statement the amount and timing of the balloon 
payment that will result if the consumer makes only the minimum 
payments for the maximum period of time that the consumer is permitted 
to make such minimum payments. The Board believes that disclosure of 
the balloon payment in advertisements that promote such minimum 
payments is necessary to inform consumers about the repayment terms 
that will apply over the full term of the loan.
    As proposed, comments 24(c)(2)-3 and -4 are renumbered as comments 
24(d)(2)-4 and -5 without substantive change.
Section 226.24(e)--Catalogs or Other Multiple-Page Advertisements; 
Electronic Advertisements
    The Board is renumbering Sec.  226.24(d) as Sec.  226.24(e) and 
making technical changes to reflect the renumbering of certain sections 
of the regulation and commentary, as proposed.

[[Page 44583]]

Section 226.24(f)--Disclosure of Rates and Payments in Advertisements 
for Credit Secured by a Dwelling
    The Board proposed to add a new subsection (f) to Sec.  226.24 to 
address the disclosure of rates and payments in advertisements for 
home-secured loans. The primary purpose of these provisions is to 
ensure that advertisements do not place undue emphasis on low 
promotional ``teaser'' rates or payments, but adequately disclose the 
rates and payments that the will apply over the term of the loan. The 
final rule is adopted as proposed, but adds a number of new commentary 
provisions to clarify the rule in response to public comment.
    One banking industry trade group commenter sought an exception from 
Sec. Sec.  226.24(f)(2) and (f)(3)(i)(A) for variable-rate loans with 
initial rates that are derived by applying the index and margin used to 
make rate adjustments under the loan, but calculated in a slightly 
different manner than will be used to make later rate adjustments. For 
example, an initial rate may be calculated based on the index in effect 
as of the closing or lock-in date, rather than another date which will 
be used to make other rate adjustments under the plan such as the 15th 
day of the month preceding the anniversary of the closing date. The 
Board is not adopting an exception from Sec. Sec.  226.24(f)(2) and 
(f)(3)(i)(A). However, the Board believes that an initial rate in the 
example described above would still be ``based on'' the index and 
margin used to make other rate adjustments under the plan and therefore 
it would not, by itself, trigger the required disclosures in Sec.  
226.24(f)(2). Likewise, an advertisement need not disclose a separate 
payment amount under Sec.  226.24(f)(3)(i)(A) for payments that are 
based on the same index and margin, if even calculated differently.
    Commenters also sought to exclude advertisements for variable-rate 
loans that permit the consumer to convert the loan into a fixed rate 
loan. These commenters expressed concern that creditors do not know at 
the advertising stage whether consumers would choose the fixed-rate 
conversion option and that disclosing loans that offer the option as 
though a consumer had chosen it could lead to confusion. Regulation Z 
already requires fixed-rate conversion options be disclosed before 
consummation. See comment 19(b)(2)(vii)-3. The Board believes that 
requiring information about fixed-rate conversion options be disclosed 
in advertisements could confuse consumers about a feature that is 
optional. New comment 24(f)-1.i states that the creditor need not 
assume that a fixed-rate conversion option, by itself, means that more 
than one simple annual rate of interest will apply under Sec.  
226.24(f)(2) and the payments that would apply if a consumer opted to 
convert the loan to a fixed rate need not be disclosed as separate 
payments under Sec.  226.24(f)(3)(i)(A).
    Similarly, some industry commenters also sought an exception for 
loans with preferred-rate provisions, where the rate will increase upon 
the occurrence of some event. For example, the consumer may be given a 
preferred rate for electing to make automated payments but that 
preferred-rate would end if the consumer later ceases that election. 
Regulation Z already requires preferred-rate provisions be disclosed 
before consummation. See comment 19(b)(2)(vii)-4. The Board believes 
that requiring information about preferred-rate provisions to be 
disclosed at the advertising stage is less likely to be meaningful to 
consumers who are usually gathering general rate and payment 
information about multiple loans and are less likely to focus on 
disclosures about preferred-rate terms and conditions. New comment 
24(f)-1.ii states that the creditor need not assume a preferred-rate 
provision, by itself, means that more than one simple annual rate of 
interest will apply under Sec.  226.24(f)(2) and need not disclose as 
separate payments under Sec.  226.24(f)(3)(i)(A) the payments that 
would result upon the occurrence of the event that causes a rate 
increase under the preferred-rate provision.
    Also, comment 24(f)-1.iii excludes loan programs that offer a rate 
reduction to consumers after the occurrence of a specified event, such 
as the consumer making a series of on-time payments. Some industry 
commenters suggested, and the Board agrees, that information about 
decreases in rates or payments upon the occurrence of a specified event 
need not be disclosed with equal prominence and in close proximity to 
information about other rates and payments. The advertisement may 
disclose only the initial rate or payment and it need not disclose the 
effect of the rate reduction feature. Alternatively, the advertisement 
may also disclose the effect of the rate reduction feature, but it 
would then have to comply with the requirements of Sec.  226.24(f).
    Section 226.24(f)(1)--Scope. Section 226.24(f)(1), as proposed, 
provides that the new section applies to any advertisement for credit 
secured by a dwelling, other than television or radio advertisements, 
including promotional materials accompanying applications. The Board 
does not believe it is feasible to apply the requirements of this 
section, notably the close proximity and prominence requirements, to 
oral advertisements. The Board sought comment on whether these or 
different standards should be applied to oral advertisements for home-
secured loans but commenters did not address this issue.
    Section 226.24(f)(2)--Disclosure of rates. As proposed, Sec.  
226.24(f)(2) addresses the disclosure of rates. Under the rule, if an 
advertisement for credit secured by a dwelling states a simple annual 
rate of interest and more than one simple annual rate of interest will 
apply over the term of the advertised loan, the advertisement must 
disclose the following information in a clear and conspicuous manner: 
(a) Each simple annual rate of interest that will apply. In variable-
rate transactions, a rate determined by an index and margin must be 
disclosed based on a reasonably current index and margin; (b) the 
period of time during which each simple annual rate of interest will 
apply; and (c) the annual percentage rate for the loan. If the rate is 
variable, the annual percentage rate must comply with the accuracy 
standards in Sec. Sec.  226.17(c) and 226.22.
    Comment 24(f)-5, renumbered but otherwise as proposed, specifically 
addresses how this requirement applies in the context of advertisements 
for variable-rate transactions. For such transactions, if the simple 
annual rate that applies at consummation is based on the index and 
margin that will be used to make subsequent rate adjustments over the 
term of the loan, then there is only one simple annual rate and the 
requirements of Sec.  226.24(f)(2) do not apply. If, however, the 
simple annual rate that applies at consummation is not based on the 
index and margin that will be used to make subsequent rate adjustments 
over the term of the loan, then there is more than one simple annual 
rate and the requirements of Sec.  226.24(f)(2) apply.
    The revisions generally assume that a single index and margin will 
be used to make rate or payment adjustments under the loan. The Board 
solicited comment on whether and to what extent multiple indexes and 
margins are used in home-secured loans and whether additional or 
different rules are needed for such products. Commenters stated that 
multiple indexes and margins are not used within the same loan, but 
requested clarification on how the requirements of Sec.  226.24(f) 
apply to advertisements that contain information about rates or 
payments based on the index and margin available under the loan to 
certain consumers, such as those

[[Page 44584]]

with certain credit scores, but where a different margin may be offered 
to other consumers. Section 226.24(f) applies to advertisements for 
variable-rate loans if the simple annual rate of interest (or the 
payment) that applies at consummation is not based on the index and 
margin used to make subsequent rate (or payment) adjustments over the 
term of the loan. See comment Sec. Sec.  226.24(f)-5 and 24(f)(3)-2. If 
a loan's rate or payment adjustments will be based on only one index 
and margin for each consumer, the fact that the advertised rate or 
payment may not be available to all consumers does trigger the 
requirements of Sec.  226.24(f). However, an advertisement for open-end 
credit may state only those terms that actually are or will be arranged 
or offered by the creditor. See 12 CFR 226.24(a).
    Finally, as proposed, the rule establishes a clear and conspicuous 
standard for the disclosure of rates in advertisements for home-secured 
loans. Under this standard, the information required to be disclosed by 
Sec.  226.24(f)(2) must be disclosed with equal prominence and in close 
proximity to any advertised rate that triggered the required 
disclosures, except that the annual percentage rate may be disclosed 
with greater prominence than the other information.
    Proposed comment 24(f)-1 provided safe harbors for compliance with 
the equal prominence and close proximity standards. Specifically, the 
required disclosures would be deemed to be closely proximate to the 
advertised rate or payment if they were in the same paragraph as the 
advertised rate or payment. Information disclosed in a footnote would 
not be deemed to be closely proximate to the advertised rate or 
payment. Some commenters noted that the safe harbor definition of 
``closely proximate'' in this comment (that the required disclosures be 
in the same paragraph as the advertised rate or payment) differed from 
the definition of ``closely proximate'' in comment 24-2 (that the 
required disclosures be immediately next to or directly above or below 
the advertised rate or payment). The Board is renumbering and modifying 
final comment 24(f)-2 to match the definition of ``closely proximate'' 
in comment 24-2. However, the Board is retaining the part of the safe 
harbor that disallows the use of footnotes. Consumer testing of 
account-opening and other disclosures undertaken in conjunction with 
the Board's open-end Regulation Z proposal suggests that placing 
information in a footnote makes it much less likely that the consumer 
will notice it. As proposed, the required disclosures will be deemed 
equally prominent with the advertised rate or payment if they are in 
the same type size as the advertised rate or payment.
    Comment 24(f)-3, renumbered but otherwise as proposed, provides a 
cross-reference to comment 24(b)-2, which provides further guidance on 
the clear and conspicuous standard in this context.
    Section 226.24(f)(3)--Disclosure of payments. New Sec.  
226.24(f)(3) addresses the disclosure of payments. As under the 
proposed rule, if an advertisement for credit secured by a dwelling 
states the amount of any payment, the advertisement must disclose the 
following information in a clear and conspicuous manner: (a) The amount 
of each payment that will apply over the term of the loan, including 
any balloon payment. In variable-rate transactions, payments that will 
be determined based on application of an index and margin must be 
disclosed based on a reasonably current index and margin; (b) the 
period of time during which each payment will apply; and (c) in an 
advertisement for credit secured by a first lien on a dwelling, the 
fact that the payments do not include amounts for taxes and insurance 
premiums, if applicable, and that the actual payment obligation will be 
greater. These requirements are in addition to the disclosure 
requirements of Sec.  226.24(d).
    As proposed, comment 24(f)(3)-2 specifically addresses how this 
requirement applies in the context of advertisements for variable-rate 
transactions. For such transactions, if the payment that applies at 
consummation is based on the index and margin that will be used to make 
subsequent payment adjustments over the term of the loan, then there is 
only one payment that must be disclosed and the requirements of Sec.  
226.24(f)(3) do not apply. If, however, the payment that applies at 
consummation is not based on the index and margin that will be used to 
make subsequent payment adjustments over the term of the loan, then 
there is more than one payment that must be disclosed and the 
requirements of Sec.  226.24(f)(3) apply.
    As discussed above in regard to Sec.  226.24(f)(2), the revisions 
in Sec.  226.24(f)(3) generally assume that a single index and margin 
will be used to make rate or payment adjustments under the loan. If a 
loan's rate or payment adjustments will be based on only one index and 
margin for each consumer, the fact that the advertised rate or payment 
may not be available to all consumers does trigger the requirements of 
Sec.  226.24(f).
    The rule adopts the clear and conspicuous standard for the 
disclosure of payments in advertisements for home-secured loans as 
proposed. Under this standard, the information required to be disclosed 
under Sec.  226.24(f)(3) regarding the amounts and time periods of 
payments must be disclosed with equal prominence and in close proximity 
to any advertised payment that triggered the required disclosures. The 
information required to be disclosed under Sec.  226.24(f)(3) regarding 
the fact that taxes and insurance premiums are not included in the 
payment must be prominently disclosed and in close proximity to the 
advertised payments. The Board believes that requiring the disclosure 
about taxes and insurance premiums to be equally prominent could 
distract consumers from the key payment and time period information. As 
noted above, comment 24(f)-2 provides safe harbors for compliance with 
the equal prominence and close proximity standards. Comment 24(f)-3 
provides a cross-reference to the comment 24(b)-2, which provides 
further guidance regarding the application of the clear and conspicuous 
standard in this context.
    Comment 24(f)-4, renumbered but otherwise as proposed, clarifies 
how the rules on disclosures of rates and payments in advertisements 
apply to the use of comparisons in advertisements. This commentary 
covers both rate and payment comparisons, but in practice, comparisons 
in advertisements usually focus on payments.
    Comment 24(f)(3)-1, clarifies that the requirement to disclose the 
amounts and time periods of all payments that will apply over the term 
of the loan may require the disclosure of several payment amounts, 
including any balloon payment. The comment provides an illustrative 
example. The commentary has been modified from the proposal, in 
response to comment, to add a clarification that the final scheduled 
payment in a fully amortizing loan need not be disclosed if the final 
scheduled payment is not greater than two times the amount of any other 
regularly scheduled payment.
    Comment 24(f)-6, renumbered but otherwise as proposed, provides 
safe harbors for what constitutes a ``reasonably current index and 
margin'' as used in Sec.  226.24(f). Under the commentary, the time 
period during which an index and margin is considered reasonably 
current depends on the medium in which the advertisement was 
distributed. For direct mail advertisements, a reasonably current index 
and margin is one that

[[Page 44585]]

was in effect within 60 days before mailing. For printed advertisements 
made available to the general public and for advertisements in 
electronic form, a reasonably current index and margin is one that was 
in effect within 30 days before printing, or before the advertisement 
was sent to a consumer's e-mail address, or for advertisements made on 
an Internet Web site, when viewed by the public.
    Section 226.24(f)(4)--Envelope excluded. As proposed, Sec.  
226.24(f)(4) provides that the requirements of Sec. Sec.  226.24(f)(2) 
and (3) do not apply to envelopes or to banner advertisements and pop-
up advertisements that are linked to an electronic application or 
solicitation provided electronically. In the Board's view, banner 
advertisements and pop-up advertisements are similar to envelopes in 
the direct mail context.
Section 226.24(g)--Alternative Disclosures--Television or Radio 
Advertisements
    The Board proposed to add a new Sec.  226.24(g) to allow 
alternative disclosures to be provided in oral television and radio 
advertisements pursuant to its authority under TILA Sec. Sec.  105(a), 
122, and 144. The final rule is modified from the proposal in that it 
allows alternative disclosures not only for information provided 
orally, but also for information provided in visual text in television 
advertisements. Some commenters noted a discrepancy between the Board's 
proposed Sec.  226.24(g), which would not allow the alternative 
disclosures for visual text in television advertisements for closed-end 
credit, and proposed Sec.  226.16(f), which would allow the alternative 
disclosures for visual text in television advertisements for open-end 
credit, and urged the Board to follow the approach found in Sec.  
226.16(f). The Board believes that the same reasoning that applies to 
allowing alternative disclosures in oral radio and television 
advertisements also applies to allowing alternative disclosures for 
visual text television advertisements and the final rule is revised 
accordingly. With one modification, Sec.  226.24(g) follows the 
proposal for allowing alternative disclosures in radio and television 
advertisements. One option is to state clearly and conspicuously each 
of the disclosures required by Sec.  226.24(d)(2) if a triggering term 
is stated in the advertisement. Another option is for the advertisement 
to state clearly and conspicuously the APR applicable to the loan, and 
the fact that the rate may be increased after consummation, if 
applicable. However, instead of disclosing the required information 
about the amount or percentage of the downpayment and the terms of 
repayment, the advertisement could provide a toll-free telephone 
number, or a telephone number that allows a consumer to reverse the 
phone charges, that the consumer may call to receive more information. 
(The language from proposed comment 24(g)-1, which permitted the use of 
a telephone number that allows a consumer to reverse the phone charges, 
has been incorporated into the text of Sec.  226.24(g), and proposed 
comment 24(g)-1 has been removed.) Given the space and time constraints 
on television and radio advertisements, the required disclosures may go 
unnoticed by consumers or be difficult for them to retain. Thus, 
providing an alternative means of disclosure is more effective in many 
cases given the nature of television and radio media.
    This approach is consistent with the approach taken in the proposed 
revisions to the advertising rules for open-end plans (other than home-
secured plans). See 72 FR 32948, 33064 (June 14, 2007). This approach 
is also similar, but not identical, to the approach taken in the 
advertising rules under Regulation M. See 12 CFR 213.7(f). Section 
213.7(f)(1)(ii) of Regulation M permits a leasing advertisement made 
through television or radio to direct the consumer to a written 
advertisement in a publication of general circulation in a community 
served by the media station. The Board has not proposed this option 
because it may not provide sufficient, readily-accessible information 
to consumers who are shopping for a home-secured loan and because 
advertisers, particularly those advertising on a regional or national 
scale, are not likely to use this option.
Section 226.24(h)--Tax Implications
    Section 1302 of the Bankruptcy Act amends TILA Section 144(e) to 
address advertisements that are disseminated in paper form to the 
public or through the Internet, as opposed to by radio or television, 
and that relate to an extension of credit secured by a consumer's 
principal dwelling that may exceed the fair market value of the 
dwelling. Such advertisements must include a statement that the 
interest on the portion of the credit extension that is greater than 
the fair market value of the dwelling is not tax deductible for Federal 
income tax purposes. 15 U.S.C. 1664(e). For such advertisements, the 
statute also requires inclusion of a statement that the consumer should 
consult a tax adviser for further information on the deductibility of 
the interest.
    The Bankruptcy Act also requires that disclosures be provided at 
the time of application in cases where the extension of credit may 
exceed the fair market value of the dwelling. See 15 U.S.C. 
1638(a)(15). The Board intends to implement the application disclosure 
portion of the Bankruptcy Act during its forthcoming review of closed-
end and HELOC disclosures under TILA. However, the Board requested 
comment on the implementation of both the advertising and application 
disclosures under this provision of the Bankruptcy Act for open-end 
credit in its October 17, 2005, ANPR. 70 FR 60235, 60244 (Oct. 17, 
2005). A majority of comments on this issue addressed only the 
application disclosure requirement, but some commenters specifically 
addressed the advertising disclosure requirement. One industry 
commenter suggested that the advertising disclosure requirement apply 
only in cases where the advertised product allows for the credit to 
exceed the fair market value of the dwelling. Other industry commenters 
suggested that the requirement apply only to advertisements for 
products that are intended to exceed the fair market value of the 
dwelling.
    The Board proposed to add Sec.  226.24(h) and comment 24(h)-1 to 
implement TILA Section 144(e). The Board's proposal applied the new 
requirements to advertisements for home-secured loans where the 
advertised extension of credit may, by its terms, exceed the fair 
market value of the dwelling. The Board sought comment on whether the 
new requirements should instead apply to only advertisements that state 
or imply that the creditor provides extensions of credit greater than 
the fair market value of the dwelling. Of the few commenters who 
addressed this issue, the majority were in favor of the alternative 
approach because many home-secured loans may, in some circumstances, 
allow for extensions of credit greater than the fair market value of 
the dwelling and advertisers would likely include the disclosure in 
nearly all advertisements.
    The final rule differs from the proposed rule and requires that the 
additional tax implication disclosures be given only when an 
advertisement states that extensions of credit greater than the fair 
market value of the dwelling are available. The rule does not apply to 
advertisements that merely imply that extensions of credit greater than 
the fair market value of the dwelling may occur. By limiting the 
required disclosures to only those

[[Page 44586]]

advertisements that state that extensions of credit greater than the 
fair market value of the dwelling are available, the Board believes the 
rule will provide the required disclosures to consumers when they are 
most likely to be receptive to the information while avoiding 
overloading consumers with information about the tax consequences of 
home-secured loans when it is less likely to be meaningful to them. 
Accordingly, proposed comment 24(h)-1 is removed as no longer 
necessary.
Section 226.24(i)--Prohibited Acts or Practices in Mortgage 
Advertisements
    The Board proposed to add Sec.  226.24(i) to prohibit the following 
seven acts or practices in connection with advertisements of closed-end 
mortgage loans: (1) The use of the term ``fixed'' to refer to rates or 
payments of closed-end home loans, unless certain conditions are 
satisfied; (2) comparison advertisements between actual and 
hypothetical rates and payments, unless certain conditions are 
satisfied; (3) falsely advertising a loan as government supported or 
endorsed; (4) displaying the name of the consumer's current lender 
without disclosing that the advertising mortgage lender is not 
affiliated with such current lender; (5) claiming debt elimination when 
one debt merely replaces another debt; (6) the use of the term 
``counselor'' or ``financial advisor'' by for-profit brokers or 
lenders; and (7) foreign language advertisements that provide required 
disclosures only in English.
    Pursuant to its authority under TILA Section 129(l)(2), 15 U.S.C. 
1639(l)(2), the Board is adopting Sec.  226.24(i) substantially as 
proposed with modifications to Sec.  226.24(i)(2) to clarify that the 
information required to be disclosed in comparison advertisements is 
the information required under Sec.  226.24(f), to Sec.  226.24(i)(6) 
to withdraw the prohibition on the use of the term ``financial 
advisor,'' and other modifications to clarify the scope and intent of 
the rule. The final rule applies only to closed-end mortgage loans. 
Section 129(l)(2) of TILA gives the Board the authority to prohibit 
acts or practices in connection with mortgage loans that it finds to be 
unfair or deceptive. Section 129(l)(2) of TILA also gives the Board the 
authority to prohibit acts or practices in connection with the 
refinancing of mortgage loans that the Board finds to be associated 
with abusive lending practices, or that are otherwise not in the 
interest of the borrower. 15 U.S.C. 1639(l)(2). Through an extensive 
review of advertising copy and other outreach efforts, Board staff 
identified a number of acts or practices connected with mortgage and 
mortgage refinancing advertising that appear to be inconsistent with 
the standards set forth in Section 129(l)(2) of TILA.
    The Board has sought to craft the rules carefully to make 
compliance with the requirements sufficiently clear and has provided 
additional examples in commentary to assist compliance with this rule. 
As discussed above, the Board is not extending the seven prohibitions 
on misleading advertisements to HELOCs because it has not been provided 
with, or found, sufficient evidence demonstrating that HELOC 
advertisements contain deceptive practices similar to those found in 
advertisements for closed-end mortgage loans. However, the Board may 
consider, as part of its larger review of HELOC rules, prohibiting 
certain misleading or deceptive practices if warranted. The Board notes 
that closed-end mortgage loan advertisements (as well as HELOCs) must 
continue to comply with all applicable state and federal laws, 
including Section 5 of the FTC Act.\121\
---------------------------------------------------------------------------

    \121\ 15 U.S.C. 41 et seq.
---------------------------------------------------------------------------

    Public comment. The Board specifically sought comment on the 
appropriateness of the seven proposed prohibitions; whether the Board 
should prohibit any additional misleading or deceptive acts or 
practices; and whether the prohibitions should be extended to 
advertisements for open-end home equity lines of credit (HELOCs).
    Consumer and community advocacy groups, associations of state 
regulators, federal agencies, and most industry commenters supported 
the Board's efforts to address misleading advertising acts and 
practices. Many creditors and their trade associations, however, urged 
the Board to use its authority under TILA Section 105(a), 15 U.S.C. 
1604(a), rather than Section 129(l)(2), 15 U.S.C. 1639(l)(2), to 
prohibit certain advertising acts or practices for closed-end mortgage 
loans. These commenters expressed concern that promulgating the 
prohibitions under Section 129(l)(2) may expose creditors to extensive 
private legal action for inadvertent technical violations.
    Commenters were divided on whether to extend the proposed 
prohibitions to HELOCs. Many community banks agreed with the Board that 
the misleading or deceptive acts often associated with mortgage and 
mortgage refinancing advertisements do not occur in HELOC 
advertisements. Some consumer groups and state regulators, however, 
urged the Board to extend all of the prohibitions to HELOCs. One large 
creditor offered specific suggestions on how to extend the prohibitions 
to HELOCs, while another sought extension of only the prohibition on 
the misleading use of the current lender's name. Few commenters 
suggested that the Board consider any additional prohibitions on 
misleading advertising either for closed-end mortgage loans or HELOCs. 
A more detailed discussion of the comments is provided below.
    Section 226.24(i)(1)--Misleading advertising for ``fixed'' rates, 
payments or loans. Proposed Sec.  226.24(i)(1) prohibited the use of 
the term ``fixed'' in advertisements for credit secured by a dwelling, 
unless certain conditions are satisfied, in three different scenarios: 
(i) Advertisements for variable-rate transactions; (ii) advertisements 
for non-variable-rate transactions in which the interest rate can 
increase; and (iii) advertisements that promote both variable-rate 
transactions and non-variable-rate transactions. The proposed rule 
prohibited the use of the term ``fixed'' in advertisements for 
variable-rate transactions, unless two conditions are satisfied. First, 
the phrase ``Adjustable-Rate Mortgage'' or ``Variable-Rate Mortgage'' 
must appear in the advertisement before the first use of the word 
``fixed'' and be at least as conspicuous as every use of the word 
``fixed.'' Second, each use of the word ``fixed'' must be accompanied 
by an equally prominent and closely proximate statement of the time 
period for which the rate or payment is fixed and the fact that the 
rate may vary or the payment may increase after that period.
    The proposed rule also prohibited the use of the term ``fixed'' to 
refer to the payment in advertisements solely for non-variable-rate 
transactions where the payment will increase (for example, fixed-rate 
mortgage transactions with an initial lower payment that will 
increase), unless each use of the word ``fixed'' to refer to the 
payment is accompanied by an equally prominent and closely proximate 
statement of the time period for which the payment is fixed and the 
fact that the payment will increase after that period.
    Finally, the proposed rule prohibited the use of the term ``fixed'' 
in advertisements that promote both variable-rate transactions and non-
variable-rate transactions, unless certain conditions are satisfied. 
First, the phrase ``Adjustable-Rate Mortgage,'' ``Variable-Rate 
Mortgage,'' or ``ARM'' must appear in the advertisement with equal 
prominence as any use of the word ``fixed.'' Second, each use of the 
term ``fixed'' to refer to a rate, payment, or to the credit 
transaction, must clearly refer solely to transactions for which rates 
are

[[Page 44587]]

fixed and, if used to refer to a payment, be accompanied by an equally 
prominent and closely proximate statement of the time period for which 
the payment is fixed and the fact that the payment will increase after 
that period. Third, if the term ``fixed'' refers to the variable-rate 
transactions, it must be accompanied by an equally prominent and 
closely proximate statement of a time period for which the rate or 
payment is fixed, and the fact that the rate may vary or the payment 
may increase after that period.
    Many creditors and their trade associations argued that the 
proposed prohibition contained many formatting and language 
requirements, and therefore could easily generate liability for 
technical, inadvertent errors. These commenters opposed the possible 
risk of civil liability for violations of this proposed rule and 
instead, urged the Board to use its authority under TILA Section 
105(a), 15 U.S.C. 1604(a). One mortgage banking group suggested that if 
the Board promulgated the rule it should not prescribe detailed 
formatting rules but rather state that compliance with the rules 
governing trigger terms in Sec.  226.24 satisfies compliance with this 
rule. Another bank commented that requiring disclosure after each use 
of the word ``fixed'' is excessive and suggested that the disclosure be 
required only once after the first use of the word.
    In contrast, a number of consumer groups, as well as the FDIC and 
associations of state regulators, urged the Board to prohibit the use 
of the word ``fixed'' in advertisements for variable-rate mortgages, 
including ones that have a fixed-rate for a specified time period. They 
argued that the word ``fixed'' is confusing to consumers when used to 
reference any loan other than those that have rates (or payments) fixed 
for their entire term.
    The Board is adopting the prohibition on the use of the term 
``fixed'' to refer to rates or payments of closed-end home-secured 
loans as proposed with a modification to Sec.  226.24(i)(1)(ii) to 
clarify application of the rule to non-variable-rate transactions. 
Based on its review of advertising copy, the Board finds that some 
advertisements do not adequately disclose that the interest rate or 
payment amounts are ``fixed'' only for a limited period of time, rather 
than for the full term of the loan. For example, some advertisements 
reviewed prominently refer to a ``30-Year Fixed Rate Loan'' or ``Fixed 
Pay Rate Loan'' on the first page. A footnote on the last page of the 
advertisements discloses in small type that the loan product is a 
payment option ARM in which the fully indexed rate and fully amortizing 
payment will be applied after the first five years.
    The Board concludes that these types of advertisements are 
associated with abusive lending practices and also deceptive under the 
three-part test for deception set forth in Part V.A above.\122\ The use 
of the word ``fixed'' in these advertisements is likely to mislead 
consumers into believing that the advertised product is a fixed-rate 
mortgage with rates and payments that will not change during the term 
of the loan. Consumers often shop for loans based on whether the term 
is fixed or not. Indeed, some credit counselors often encourage 
consumers to shop only for fixed-rate mortgages. Therefore, information 
about a mortgage loan's monthly payment or interest rate is important 
to consumers. As a result, the length of time for which the payment or 
interest rate will remain fixed is likely to affect a consumer's 
decision about whether to apply for a loan product.
---------------------------------------------------------------------------

    \122\ There must be a representation, omission or practice that 
is likely to mislead the consumer; the act or practice is examined 
from the perspective of a consumer acting reasonably in the 
circumstances; and the representation, omission, or practice must be 
material--that is, it must be likely to affect the consumer's 
conduct or decision with regard to a product or service.
---------------------------------------------------------------------------

    The final rule does not, however, prohibit use of the word 
``fixed'' in advertisements for home-secured loans where the use of the 
term is not misleading. Advertisements that refer to a rate or payment, 
or to the credit transaction, as ``fixed'' are appropriate when used to 
denote a fixed-rate mortgage in which the rate or payment amounts do 
not change over the full term of the loan. Use of the term ``fixed'' 
also is appropriate in an advertisement where the interest rate or 
payment may increase solely because the loan product features a 
preferred-rate or fixed-rate conversion provision (see comment 24(f)-1 
for further guidance), or where the final scheduled payment in a fully 
amortizing loan is not greater than twice the amount of other regularly 
scheduled payments. The Board does not intend that this rule apply to 
the use of the word ``fixed'' in advertisements for home-secured loans 
that refers to fees or settlements costs.
    The final rule does not ban the use of the term ``fixed'' in 
advertisements for variable rate products. The term ``fixed'' is used 
in connection with adjustable-rate mortgages, or with fixed-rate 
mortgages that include low initial payments that will increase. These 
advertisements make clear that the rate or payment is only ``fixed'' 
for a defined period of time, but after that the rate or payment may 
increase. For example, one advertisement reviewed prominently discloses 
that the product is an ``Adjustable-Rate Mortgage'' in large type, and 
clearly discloses in standard type that the rate is ``fixed'' for the 
first three, five, or seven years depending upon the product selected 
and may increase after that time period. Such an advertisement 
demonstrates that there are legitimate and appropriate circumstances 
for using the term ``fixed'' in advertisements for variable-rate 
transactions.
    Section 226.24(i)(2)--Misleading comparisons in advertisements. 
Proposed Sec.  226.24(i)(2) prohibited any advertisement for credit 
secured by a dwelling from making any comparison between actual or 
hypothetical payments or rates and the payment or simple annual rate 
that will be available under the advertised product for less than the 
term of the loan, unless two conditions are satisfied. First, the 
comparison must include with equal prominence and in close proximity to 
the ``teaser'' payment or rate, all applicable payments or rates for 
the advertised product that will apply over the term of the loan and 
the period of time for which each applicable payment or simple annual 
rate will apply.
    Second, the advertisement must include a prominent statement in 
close proximity to the advertised payments that such payments do not 
include amounts for taxes and insurance premiums, if applicable. In the 
case of advertisements for variable-rate transactions where the 
advertised payment or simple annual rate is based on the index and 
margin that will be used to make subsequent rate or payment adjustments 
over the term of the loan, the comparison must include: (a) An equally 
prominent statement in close proximity to the advertised payment or 
rate that the payment or rate is subject to adjustment and the time 
period when the first adjustment will occur; and (b) a prominent 
statement in close proximity to the advertised payment that the payment 
does not include amounts for taxes and insurance premiums, if 
applicable.
    Proposed comment 24(i)-1 clarified that a comparison includes a 
claim about the amount that a consumer may save under the advertised 
product. For example, a statement such as ``save $600 per month on a 
$500,000 loan'' constitutes an implied comparison between the 
advertised product's payment and a consumer's current payment.
    The Board did not propose to prohibit comparisons that take into 
account the consolidation of non-mortgage credit, such as auto loans, 
installment loans, or

[[Page 44588]]

revolving credit card debt, into a single, home-secured loan. However, 
the Board specifically sought comment on whether comparisons based on 
the assumed refinancing of non-mortgage debt into a new home-secured 
loan are associated with abusive lending practices or otherwise not in 
the interest of the borrower and should therefore be prohibited as 
well.
    Creditors and their trade groups, consumer and community advocacy 
groups, federal agencies, and associations of state regulators largely 
supported the proposed requirement that advertisements showing 
comparisons between actual or hypothetical rate or payments and the 
advertised rate or payment disclose information about the rates or 
payments that would apply for the term of the advertised loan and the 
period of time for which such rates or payments would be in effect. One 
mortgage banking trade group suggested that the proposed revisions to 
the trigger term requirements would sufficiently address issues with 
comparison advertisements and that a separate rule was unnecessary. 
Another commenter requested an exception for subordinate lien loans 
from the escrow disclosure component of the rule noting that the 
monthly payments of subordinate liens do not generally include escrows 
for taxes and insurance.
    Commenters were divided on whether comparisons between non-mortgage 
debt and mortgage debt should be allowed. Industry commenters generally 
supported the Board's decision to allow debt consolidation 
advertisements that compare home-secured debt payments to other debt 
payments. They noted that debt consolidation offers consumers concrete 
benefits, such as increased cash flow or reduced interest rates, and 
that advertising communicated these choices to consumers. One bank 
commenter suggested that the Board require additional disclosures to 
alert consumers to the potential consequences of such debt 
consolidation, such as closing costs and loan duration. On the other 
hand, associations of state regulators urged the Board to ban debt 
consolidation comparison advertisements entirely. They argued that 
consumers could be misled about the risks and benefits of consolidating 
short-term unsecured debt into long-term secured debt.
    One large bank, however, pointed out that the interest rates that 
could be disclosed for closed-end home-secured debt would be different 
than the rates for other kinds of secured debt in debt consolidation 
comparison advertisements. The commenter noted that under the proposed 
revisions to Sec.  226.24(c), advertisements for home-secured loans 
would be allowed to use only the APR, which would include finance 
charges, while advertisements for other closed-end loans, such as auto 
loans, would be permitted to promote simple annual rates of interest 
along with APRs, and advertisements from open-end credit would be able 
to disclose APRs that did not have to include any finance charges.
    The Board is adopting the prohibition proposed in Sec.  
226.24(i)(2) on the comparison of actual and hypothetical rates in 
advertisements unless certain conditions are satisfied. The final rule 
is modified to clarify that the information required to be disclosed in 
conjunction with the advertised rate or payment is the information 
required under Sec. Sec.  226.24(f)(2) and (3). By referencing Sec.  
226.24(f), the final rule incorporates, without repeating, the 
requirements of that section. By referencing Sec.  226.24(f)(3), the 
final rule exempts subordinate lien loans from the escrow disclosure 
component of the rule. In addition, the final rule maintains the 
proposed requirement that advertisements making comparisons to a 
variable-rate transaction, where the advertised payment or simple 
annual rate is based on the index and margin that will be used to make 
subsequent rate or payment adjustments over the term of the loan, must 
include an equally prominent statement in close proximity to the 
payment or rate that the payment or rate is subject to adjustment and 
the time period when the first adjustment will occur.
    Some advertisements for home-secured loans make comparisons between 
actual or hypothetical rate or payment obligations and the rates or 
payments that would apply if the consumer obtains the advertised 
product. The advertised rates or payments used in these comparisons 
frequently are low introductory ``teaser'' rates or payments that will 
not apply over the full term of the loan, and do not include amounts 
for taxes or insurance premiums. In addition, the current rate or 
payment obligations used in these comparisons frequently include not 
only the consumer's mortgage payment, but also possible payments for 
short-term, non-home secured, or revolving credit obligations, such as 
auto loans, installment loans, or credit card debts.
    The Board finds these types of comparisons of rates and payments in 
advertisements to be deceptive under the three-part test for deception 
set forth in part V.A above. Making comparisons in advertisements can 
mislead a consumer if the advertisement compares the consumer's current 
payments or rates to payments or rates available for the advertised 
product that will only be in effect for a limited period of time, 
rather than for the term of the loan. Similarly, the Board finds that 
such comparisons can be misleading if the consumer's current payments 
include amounts for taxes and insurance premiums, but the payments for 
the advertised product do not include those amounts. Information about 
the terms of the loan, such as rate and monthly payment, are material 
and likely to affect a consumer's decision about whether to apply for 
the advertised mortgage loan. Consumers may compare current obligations 
and the lower advertised rates or payments and conclude that the 
advertised loan product will offer them a better interest rate and/or 
monthly payment.
    Some industry commenters requested that, consistent with Sec.  
226.24(f), the rule require information about amounts for taxes and 
insurance premiums only for advertisements for first-lien loans. By 
incorporating the requirements of Sec.  226.24(f), the final rule 
excludes advertisements for subordinate lien loans from the requirement 
that the advertisement include a prominent statement in close proximity 
to the advertised payment that the payment does not include amounts for 
taxes and insurance premiums, if applicable. Monthly payments of 
subordinate lien loans do not generally require escrows for taxes and 
insurance and therefore are unable to include such amounts in any 
monthly payment calculation. Moreover, subordinate lien loans are 
generally advertised for the purpose of replacing or consolidating 
other subordinate lien loans or non-home secured obligations rather 
than home-secured first-lien loans.
    The Board also is not banning debt consolidation advertisements or 
requiring additional disclosures about the cost or consequences of 
consolidating short term unsecured debt into longer term secured debt. 
The Board believes that debt consolidation can be beneficial for some 
consumers. Prohibiting the use of comparisons in advertisements that 
are based solely on low introductory ``teaser'' rates or payments 
should address abusive practices in advertisements focused on debt 
consolidation. However, additional disclosures are unlikely to provide 
consumers with meaningful information at the advertising stage or be 
effective against aggressive push marketing tactics inherent in many 
advertisements.
    Last, the Board emphasizes that under the final rule, the interest 
rate stated for a home-secured loan must be the APR.

[[Page 44589]]

The final rule permits, but does not require, an interest rate for any 
secured debt to be advertised also as a simple annual rate of interest. 
The Board notes that Sec.  226.24(b) allows the simple annual interest 
rate that is applied to an unpaid balance to be stated so long as it is 
not advertised more conspicuously than the APR. Revisions to Sec.  
226.24(c) also allow the use of a simple annual rate of interest that 
is applied to an unpaid balance to be stated in an advertisement for a 
home-secured loan so long as it is not advertised more conspicuously 
than the APR. In addition, the Board's review of advertisements shows 
that many of the comparison advertisements compared monthly payments 
rather than interest rates, perhaps because comparison of monthly 
payments resonate more for consumers than comparison of interest rates.
    Section 226.24(i)(3)--Misrepresentations about government 
endorsement. Proposed Sec.  226.24(i)(3) prohibited statements about 
government endorsement unless the advertisement is for an FHA loan, VA 
loan, or similar loan program that is, in fact, endorsed or sponsored 
by a federal, state, or local government entity. Proposed comment 
24(i)-2 illustrated that a misrepresentation about government 
endorsement would include a statement that the federal Community 
Reinvestment Act entitles the consumer to refinance his or her mortgage 
at the new low rate offered in the advertisement because it conveys to 
the consumer a misleading impression that the advertised product is 
endorsed or sponsored by the federal government. No commenters objected 
to this prohibition.
    The Board is adopting the rule as proposed. Some advertisements for 
home-secured loans characterize the products offered as ``government 
loan programs,'' ``government-supported loans,'' or otherwise endorsed 
or sponsored by a federal or state government entity, even though the 
advertised products are not government-supported loans, such as FHA or 
VA loans, or otherwise endorsed or sponsored by any federal, state, or 
local government entity. Such advertisements can mislead consumers into 
believing that the government is guaranteeing, endorsing, or supporting 
the advertised loan product. Government-endorsed loans often offer 
certain benefits or features that may be attractive to many consumers 
and not otherwise available through private lenders. As a result, the 
fact that a loan product is associated with a government loan program 
can be a material factor in the consumer's decision to apply for that 
particular loan product. For these reasons, the Board finds these types 
of advertisements to be deceptive under the three-part test for 
deception set forth in part V.A above.
    Section 226.24(i)(4)--Misleading use of the current mortgage 
lender's name. Proposed Sec.  226.24(i)(4) prohibited any advertisement 
for a home-secured loan, such as a letter, that is not sent by or on 
behalf of the consumer's current lender from using the name of the 
consumer's current lender, unless the advertisement also discloses with 
equal prominence: (a) the name of the person or creditor making the 
advertisement; and (b) a clear and conspicuous statement that the 
person making the advertisement is not associated with, or acting on 
behalf of, the consumer's current lender.
    Many creditors and their trade groups, state regulators, and other 
commenters offered strong support for the proposed prohibition on the 
misleading use of a consumer's current mortgage lender's name. State 
regulators noted that some states have similar requirements already in 
place and have a history of enforcement in this area. A credit union 
association suggested that the Board ban the use of a mortgage lender's 
name without that lender's permission outright, as is currently done in 
some states, rather than requiring a disclosure. A mortgage banking 
trade group and a large creditor suggested that the regulation clarify 
that the envelope or other mailing materials are part of any 
advertisement and that the required disclosure be closely proximate, as 
well as equally prominent, to the statement of the current lender's 
name.
    The Board is adopting the rule as proposed. Some advertisements for 
home-secured loans prominently display the name of the consumer's 
current mortgage lender, while failing to disclose or to disclose 
adequately the fact that the advertisement is by a mortgage lender that 
is not associated with the consumer's current lender. The Board finds 
that such advertisements may mislead consumers into believing that 
their current lender is offering the loan advertised or that the loan 
terms stated in the advertisement constitute a reduction in the 
consumer's payment amount or rate, rather than an offer to refinance 
the current loan with a different creditor. For these reasons, the 
Board finds these types of advertisements to be deceptive under the 
three-part test for deception set forth in part V.A above.
    Section 226.24(i)(5)--Misleading claims of debt elimination. 
Proposed Sec.  226.24(i)(5) prohibited advertisements for credit 
secured by a dwelling that offer to eliminate debt, or waive or forgive 
a consumer's existing loan terms or obligations to another creditor. 
Proposed comment 24(i)-3 provided examples of claims that would be 
prohibited. These include the following claims: ``Wipe Out Personal 
Debts!'', ``New DEBT-FREE Payment'', ``Set yourself free; get out of 
debt today'', ``Refinance today and wipe your debt clean!'', ``Get 
yourself out of debt * * * Forever!'', and, in the context of an 
advertisement referring to a consumer's existing obligations to another 
creditor, ``Pre-payment Penalty Waiver.'' The proposed comment also 
clarified that this provision does not prohibit an advertisement for a 
home-secured loan from claiming that the advertised product may reduce 
debt payments, consolidate debts, or shorten the term of the debt.
    Most commenters supported the Board's proposal to prohibit 
misleading claims of debt elimination. A number of industry commenters 
also expressed support for the proposed commentary provision clarifying 
that advertisements could still claim to consolidate or reduce debt. 
However, one bank suggested that there were examples of non-misleading 
claims of debt elimination, such as ``eliminate high interest credit 
card debt.''
    The Board is modifying the rule to clarify that only misleading 
claims of debt elimination are prohibited. Based on the advertising 
copy reviewed, some advertisements for home-secured loans include 
statements that promise to eliminate, cancel, wipe-out, waive, or 
forgive debt. The Board finds that such advertisements can mislead 
consumers into believing that they are entering into a debt forgiveness 
program rather than merely replacing one debt obligation with another. 
For these reasons, the Board finds these types of advertisements to be 
deceptive under the three-part test for deception set forth in part V.A 
above.
    Section 226.24(i)(6)--Misleading use of the term ``counselor''. 
Proposed Sec.  226.24(i)(6) prohibited advertisements for credit 
secured by a dwelling from using the terms ``counselor'' or ``financial 
advisor'' to refer to a for-profit mortgage broker or creditor, its 
employees, or persons working for the broker or creditor that are 
involved in offering, originating or selling mortgages. Nothing in the 
proposed rule prohibited advertisements for bona fide consumer credit 
counseling services, such as counseling services provided by non-profit 
organizations, or bona fide financial advisory services, such as 
services provided by certified financial planners. The final rule 
retains the

[[Page 44590]]

prohibition on the use of the term ``counselor'' by for-profit brokers 
or creditors in advertisements for home-secured credit, but does not 
adopt the prohibition on the use of the term ``financial advisor'' for 
the reasons stated below.
    A few creditors and financial services and securities industry 
associations argued that the proposed prohibition on the term 
``financial advisor'' was too broad. These commenters noted that 
registered securities broker-dealers and other licensed financial 
professionals, who may also be licensed as mortgage brokers if required 
under applicable state law, may place advertisements for mortgage 
loans, often in conjunction with a range of other financial products. 
One large securities firm noted that its financial advisors routinely 
refer customers to its credit corporation subsidiary and that these 
financial advisors may place advertisements listing themselves as 
contact persons for a range of services and products, including 
residential mortgage loans. These commenters suggested that the Board 
provide a clear exception for registered securities broker-dealers and 
other investment advisors.
    An association of certified mortgage planning specialists suggested 
a safe harbor for the use of the term ``financial advisor'' for those 
advertisers who have earned a title or designation that requires an 
examination or experience, adherence to a code of ethics, and 
continuing education. This commenter suggested that advertisers that 
did not have fiduciary relationships with consumers be required to 
include a disclaimer in their ads so stating.
    The Board is not adopting the prohibition on the use of the term 
``financial advisor'' as proposed in Sec.  226.24(i)(6). The Board 
recognizes that financial advisors play a legitimate role in assisting 
consumers in selecting appropriate home-secured loans. The prohibition 
on the term ``financial advisor'' was intended to prevent creditors and 
brokers from falsely implying to residential mortgage consumers that 
they are acting in a fiduciary capacity when, in fact, they are not. 
However, the Board did not intend to prevent the legitimate business 
use of, or otherwise conflict or intervene with federal and state laws 
that contemplate the use of, the term ``financial advisor.'' \123\
---------------------------------------------------------------------------

    \123\ See, e.g., Investment Advisors Act of 1940, 14 U.S.C. 80b-
1 et seq.; Securities Exchange Act of 1934, 15 U.S.C. 78a et seq.
---------------------------------------------------------------------------

    For example, securities broker-dealers typically are registered by 
the U.S. Securities and Exchange Commission and/or licensed by a state 
regulatory agency to provide a range of financial advice and services 
on securities, insurance, retirement planning and other financial 
products, including residential mortgage loans. These registered 
securities broker-dealers currently use the term ``financial advisor'' 
in advertisements and solicitations. There are also other financial 
professionals who must meet certain federal or state professional 
standards, certifications or other requirements and use the term 
``financial advisor'' because they are in the business of providing 
financial planning and advice. Examples include investment advisors, 
certified public accountants, and certified financial planners. Many of 
these professionals are obligated to act in the client's interest and 
disclose conflicts of interest (i.e., owe a fiduciary obligation) and 
therefore, the use of the term ``financial advisor'' by such 
individuals is not misleading.\124\ Because it is not practical to 
distinguish with sufficient clarity the legitimate uses of the term 
``financial advisor'' in accordance with various federal or state laws, 
from improper use, the Board is withdrawing the prohibition on the term 
``financial advisor.'' However, the Board notes that the use of the 
term ``financial advisor'' in mortgage advertisements must comply with 
all applicable state and federal laws, including the FTC Act.\125\
---------------------------------------------------------------------------

    \124\ 14 U.S.C. 80b-1 et seq.
    \125\ 15 U.S.C. 41 et seq.
---------------------------------------------------------------------------

    The Board is retaining the prohibition on the use of the term 
counselor. The Board believes that the exception to this prohibition 
for not-for-profit entities is sufficient to capture the legitimate use 
of this term. The use of the term counselor outside of this context is 
likely to mislead consumers into believing that the lender or broker 
has a fiduciary relationship with the consumer and is considering only 
the consumer's best interest. For these reasons, the Board finds these 
types of advertisements to be deceptive under the three-part test for 
deception set forth in part V.A above.
    Section 226.24(i)(7)--Misleading foreign-language advertisements. 
Proposed Sec.  226.24(i)(7) prohibited advertisements for home-secured 
loans from providing information about some trigger terms or required 
disclosures, such as an initial rate or payment, only in a foreign 
language, but providing information about other trigger terms or 
required disclosures, such as information about the fully-indexed rate 
or fully amortizing payment, only in English. Advertisements that 
provide all disclosures in both English and a foreign language or 
advertisements that provide disclosures entirely in English or entirely 
in a foreign language would not be affected by this prohibition.
    Most commenters expressed support for the prohibition on 
advertising triggering information in a foreign language and then 
providing information about other trigger terms or required disclosures 
in English.
    The Board is adopting the rule as proposed. Some advertisements for 
home-secured loans are targeted to non-English speaking consumers. In 
general, this is an appropriate means of promoting home ownership or 
offering loans to under-served, immigrant communities. Some of these 
advertisements, however, provide information about some trigger terms 
or required disclosures, such as a low introductory ``teaser'' rate or 
payment, in a foreign language, but provide information about other 
trigger terms or required disclosures, such as the fully-indexed rate 
or fully amortizing payment, only in English. The Board finds that this 
practice can mislead non-English speaking consumers who may not be able 
to comprehend the important English-language disclosures. For these 
reasons, the Board finds these types of advertisements to be deceptive 
under the three-part test for deception set forth in part V.A above.

XII. Mortgage Loan Disclosures

A. Early Mortgage Loan Disclosures--Sec.  226.19

    Pursuant to its authority under TILA Section 105(a), 15 U.S.C. 
1604(a), the Board proposed to require creditors to give consumers 
transaction-specific, early mortgage loan disclosures for closed-end 
loans secured by a consumer's principal dwelling, including 
refinancings, home equity loans (other than HELOCs) and reverse 
mortgages. The proposed rule would require that creditors deliver this 
disclosure not later than three business days after application and 
before a consumer pays a fee to any person, other than a fee for 
obtaining the consumer's credit history. The Board also proposed 
corresponding changes to the staff commentary and certain other 
conforming amendments to Regulation Z. Providing the mortgage loan 
disclosure early for all mortgage transactions, and before consumers 
have paid significant fees, would help consumers make informed use of 
credit and better enable them to shop among available credit 
alternatives.
    The Board is adopting Sec.  226.19(a)(1) as proposed, with new 
commentary to

[[Page 44591]]

address concerns about application of the fee restriction to third 
parties, such as mortgage brokers. The early mortgage loan disclosure 
rule is effective for loans for which a creditor has received an 
application on or after October 1, 2009.
Public Comment
    The Board sought comment on whether the benefits of requiring the 
early mortgage loan disclosure would outweigh operational or other 
costs, and whether further guidance was necessary to clarify what fees 
would be deemed in connection with an application.
    Many creditors and their trade associations opposed the proposal, 
arguing that the operational cost and compliance difficulties (for 
example, system reprogramming, testing, procedural changes, and staff 
training) outweigh the benefits of improving consumers' ability to shop 
among alternative loans. They noted that the burden may be significant 
for some creditors, such as community banks. Citing operational 
difficulties, many industry commenters requested a compliance period of 
up to 18 months from the effective date of the final rule. They also 
expressed concern about the scope of the fee restriction and its 
application to third party originators.
    Consumer groups, state regulators and enforcement agencies that 
commented on proposed Sec.  226.19(a)(1) generally supported the 
proposed rule because it would increase the availability of information 
to consumers when they are shopping for loans. Some, however, argued 
for greater enforceability and redisclosure before consummation of the 
loan transaction to enhance the accuracy of the information disclosed.
Discussion
    TILA Section 128(b)(1), 15 U.S.C. 1638(b)(1), provides that the 
closed-end credit disclosure (mortgage loan disclosure), which includes 
the APR and other material disclosures, must be delivered ``before the 
credit is extended.'' Regulation Z currently implements this statutory 
provision by allowing creditors to provide the disclosures at any time 
before consummation. TILA Section 128(b)(2) and Sec.  226.19 of 
Regulation Z apply to ``residential mortgage transactions'' subject to 
RESPA and require that ``good faith estimates'' of the mortgage loan 
disclosure be made before the credit is extended, or delivered not 
later than three business days after the creditor receives the 
consumer's written application, whichever is earlier. 15 U.S.C. 
1638(b)(2). A residential mortgage transaction includes loans to 
finance the acquisition or initial construction of a consumer's 
dwelling but does not include refinance or home-equity loans. The Board 
proposed to amend Regulation Z to implement TILA Section 128(b)(1) in a 
manner that would require the disclosures earlier in the mortgage 
transaction, rather than at any time before consummation, which would 
result in a requirement similar to TILA Section 128(b)(2).
    The final rule is issued pursuant to TILA Section 105(a), which 
mandates that the Board prescribe regulations to carry out TILA's 
purposes. 15 U.S.C. 1604(a). TILA Section 102(a) provides, in pertinent 
part, that TILA's purposes are to assure a meaningful disclosure of 
credit terms so that the consumer is better able to compare various 
credit terms available and avoid the uninformed use of credit. 15 
U.S.C. 1601(a). The final rule is intended to help consumers make 
informed use of credit and shop among available credit alternatives.
    Under current Regulation Z, creditors need not deliver a mortgage 
loan disclosure on non-purchase mortgage transactions until 
consummation. As a practical matter, consumers commonly do not receive 
disclosures until the closing table. By that time consumers may not be 
in a position to make meaningful use of the disclosure. Once consumers 
have reached the settlement table, it is likely too late for them to 
use the disclosure to shop for mortgages or to inform themselves 
adequately of the terms of the loan. Consumers receive at settlement a 
large, often overwhelming, number of documents, and may not reasonably 
be able to focus adequate attention on the mortgage loan disclosure to 
verify that it reflects what they believe to be the loan's terms. 
Moreover, by the time of loan consummation, consumers may feel 
committed to the loan because they are accessing equity for an urgent 
need, may be refinancing a loan to obtain a lower rate (which may only 
be available for a short time), or may have already paid substantial 
application or other fees.
    The early mortgage loan disclosure required by the final rule will 
provide information to consumers about the terms of the loan, such as 
the payment schedule, earlier in the shopping process. For example, 
ARMs may have a low, initial fixed rate period followed by a higher 
variable rate based on an index plus margin. Some fixed rate loans also 
may have a temporary initial rate that is discounted. These loans may 
be marketed to consumers on the basis of the low initial payment or the 
low initial interest rate. The payment schedule will show the increases 
in monthly payments when the rate increases. It will also show an APR 
for the full loan term based on the fully indexed rate instead of the 
initial rate. Providing this information not later than three business 
days after application, and before the consumer has paid a substantial 
fee, will help ensure that consumers have a genuine opportunity to 
review the credit terms offered; that the terms are consistent with 
their understanding of the transaction; and that the credit terms meet 
their needs and are affordable. This information will further enable 
the consumer to decide whether to move forward with the transaction or 
continue to shop among alternative loan products and sources of credit.
    The Board recognizes that the early mortgage loan disclosure rule 
will impose additional costs on creditors, some of which may be passed 
on in part to consumers. Because early disclosures currently are 
required for home purchase loans, some creditors already deliver early 
mortgage loan disclosures on non-purchase mortgages. Not all creditors, 
however, follow this practice, and they will also incur one-time 
implementation costs to modify their systems in addition to ongoing 
costs to originate loans. The Board believes, however, that the 
benefits to consumers of receiving early estimates of loan terms, such 
as enhanced shopping and competition, offset any additional costs.
The Final Rule
    For the reasons discussed below, the Board is adopting the rule as 
proposed with new staff commentary to address, through examples, the 
application of the fee restriction to third parties, such as mortgage 
brokers. The final rule applies to all closed-end loans secured by a 
consumer's principal dwelling (other than HELOCs) and requires 
creditors to deliver the early mortgage loan disclosure to consumers no 
later than three business days after application and before any fee is 
paid, other than a fee for obtaining the consumer's credit history, 
such as a credit report.
    Third party originators. The Board proposed Sec.  226.19(a)(1)(ii) 
to prohibit a creditor or any other person from collecting a fee, other 
than a fee for obtaining the consumer's credit history, until the early 
mortgage loan disclosure is received by the consumer.
    Many creditors and their trade associations argued that the fee 
restriction would be difficult or impossible to apply and monitor in 
the wholesale channel, especially with respect to appraisal fees. These 
commenters noted that third parties, such as mortgage brokers, submit 
consumer applications to multiple

[[Page 44592]]

creditors; they expressed concern that under the proposal lenders might 
have to refuse to accept a new application where the consumer has 
already paid a fee to a prior creditor but then withdrew the first 
application or had it denied.
    Most creditors also expressed concern that the phrase ``any other 
person'' would require them to monitor the timing of fees paid to 
brokers, and stated that they could not track such information 
accurately. Many creditors requested that the Board clarify whether 
creditors would have to refuse applications submitted by a broker that 
already had obtained a fee from the consumer (other than a fee for 
obtaining the consumer's credit history) because it would be too late 
for creditors to comply with the timing requirement of the early 
mortgage loan disclosure. A few commenters urged the Board to limit the 
fee restriction to fees collected only by creditors.
    The Board is adopting the proposed rule without modification but is 
adding comment 19(a)(1)(ii)-3 to clarify the rule's treatment of 
applications submitted by third parties, such as mortgage brokers, and 
to provide examples of compliance with the rule. A broker's submission 
of a consumer's information (registration) to more than one creditor, 
and the layered underwriting and approval process that occurs in the 
wholesale channel, may complicate implementation of the fee 
restriction. Generally a broker submits a consumer's written 
application (the trigger for early TILA disclosures under Sec.  
226.19(a)(1)(i)) to only one creditor based on product offerings, the 
consumer's choice, and other factors. Under the final rule, once the 
creditor receives the consumer's written application, the creditor must 
provide the early mortgage loan disclosure after which the creditor 
and/or the broker may collect fees (other than a fee for obtaining the 
consumer's credit history) from the consumer. However, after the 
collection of fees, the creditor may engage in further underwriting 
that could result in a denial of the consumer's application. The broker 
may then submit the application to a different creditor who must also 
comply with the final rule.
    The Board proposed to regulate the collection of fees by ``any 
other person'' in Sec.  226.19(a)(1)(ii) to avoid circumvention of the 
fee restriction. However, in some circumstances it may not be 
reasonable to expect creditors to know whether the consumer paid a fee 
to a broker before receiving the early mortgage loan disclosure. 
Therefore, the Board is adding new comment 19(a)(1)(ii)-3 to illustrate 
through examples when creditors are in compliance with Sec.  
226.19(a)(1)(ii). The new commentary addresses the situation where a 
mortgage broker submits a consumer's written application to a new 
creditor because a prior creditor denied the consumer's mortgage 
application, or the consumer withdrew the application, but the consumer 
already paid a fee to the prior creditor (aside from a fee for 
obtaining the consumer's credit history). The comment clarifies that in 
this situation, the new creditor or third party complies with Sec.  
226.19(a)(1)(ii) if it does not collect or impose any additional fee 
until after the consumer receives an early mortgage loan disclosure 
from the new creditor.
    Many creditors also stated that the rule would inappropriately 
require them to monitor the actions of third parties. Although the rule 
does not require creditors to take specific action with respect to 
monitoring third parties, creditors must comply with this rule whether 
they deal with consumers directly or indirectly through third parties. 
Creditors that receive applications through a third party may choose to 
require through contractual arrangement that the third party include 
with a consumer's written application a certification, for example, 
that no fee has been collected in violation of Sec.  226.19(a)(1). The 
Board also notes that the federal banking agencies have issued guidance 
that addresses, among other things, systems and controls that should be 
in place for establishing and maintaining relationship with third 
parties.\126\
---------------------------------------------------------------------------

    \126\ See, e.g., Nontraditional Mortgage Guidance.
---------------------------------------------------------------------------

    The Board recognizes that unscrupulous third parties may not comply 
with the fee restriction, regardless of contractual obligations. The 
Board may consider, as part of its overall review of closed-end 
disclosures, whether it should propose rules that would directly 
prohibit third parties from collecting a fee before the consumer 
receives the early mortgage loan disclosure, other than a fee for 
obtaining the consumer's credit history.
    Scope of the fee restriction. Regulation Z currently does not 
prohibit creditors from collecting any fee before giving consumers the 
closed-end credit disclosures required by Sec.  226.19(a)(1). The Board 
proposed in Sec.  226.19(a)(1)(ii) to prohibit the collection of any 
fee, other than a fee for obtaining the consumer's credit history, 
until after the consumer receives the early mortgage loan disclosure. 
Most industry commenters urged the Board to broaden the fee exception 
to include, for example, rate lock, appraisal and flood certification 
fees. They argued that prohibiting these fees could harm consumers in a 
rising interest rate environment, delay consumers' access to credit 
(for example, delay conditional approvals, application processing, 
closing and funding of loans), and reverse the benefits of automated 
and streamlined mortgage loan processing. Some commenters urged 
alternatively that the Board restrict only the imposition of 
nonrefundable fees. In contrast, state regulators urged the Board to 
tighten the fee restriction, noting that allowing the collection of 
credit report fees will conflict with many state laws.
    The Board is adopting the rule regarding the fee restriction as 
proposed. Consumers typically pay fees to apply for a mortgage loan, 
such as fees for a credit report, a property appraisal, or an interest 
rate lock, as well as general ``application'' fees to process the loan. 
If the fees are significant, as they often are for appraisals and for 
extended rate locks, consumers may feel constrained from shopping for 
alternative loans because they feel financially committed to the 
transaction. This risk is particularly high in the subprime market, 
where consumers often are cash-strapped and where limited price 
transparency may obscure the benefits of shopping for mortgage loans, 
as discussed in more detail in part II. The risk also applies to the 
prime market, where many consumers would find a fee of several hundred 
dollars, such as the fee often imposed for an appraisal and other 
services, to be costly enough to deter them from shopping further among 
alternative loans and sources. Limiting the fee restriction to 
nonrefundable fees also would likely undermine the intent of the rule. 
Consumers, especially those in the subprime market, may not have 
sufficient cash to pay ``refundable fees'' to multiple creditors, and 
therefore would be discouraged from shopping or otherwise unable to 
obtain multiple early mortgage loan disclosures to compare credit 
terms.
    In addition, the definition of ``business day'' under Sec.  
226.2(a)(6) is being revised for purposes of the consumer's receipt of 
early mortgage loan disclosures under Sec.  226.19(a)(1)(ii). Existing 
Sec.  226.2(a)(6) contains two definitions of ``business day.'' Under 
the standard definition, a business day means a day on which the 
creditor's offices are open to the public for carrying on substantially 
all of its business functions. However, for purposes of rescission 
under Sec. Sec.  226.15 and 226.23, and for purposes of

[[Page 44593]]

Sec.  226.31, a ``business day'' means all calendar days except Sundays 
and specified legal public holidays. The definition of ``business day'' 
is being revised to apply the second definition of business day to the 
consumer's receipt of early mortgage loan disclosures under Sec.  
226.19(a)(1)(ii). The Board believes that the definition of business 
day that excludes Sundays and legal public holidays is more appropriate 
because consumers should not be presumed to have received disclosures 
in the mail on a day on which there is no mail delivery.
    Under the final rule, creditors may presume that the consumer 
receives the early mortgage loan disclosure three business days after 
mailing. For example, a creditor that puts the early mortgage loan 
disclosure in the mail on a Friday can presume that the consumer 
receives such disclosure the following Tuesday, and impose appraisal, 
rate-lock and other application fees after midnight on Tuesday 
(assuming there are no intervening legal public holidays). The Board 
does not believe that the rule delaying the collection of fees will 
have a significant negative impact on the mortgage loan application and 
approval process. Three business days sets an appropriate timeframe for 
the consumer to receive and review the early mortgage loan disclosure. 
It is not always practical for a creditor to know when a consumer will 
actually receive the early mortgage loan disclosure. Creditors can 
choose among many different methods to deliver the disclosures to 
consumers, such as by overnight delivery service, e-mail or regular 
postal mail. In most instances consumers will receive the early 
mortgage loan disclosure within three business days, and the Board 
notes that it is common industry practice to deliver mortgage 
disclosures by overnight courier.
    The Board contemplated providing a longer timeframe for the 
presumption of receipt of the early mortgage loan disclosure. Some 
originators could delay hiring an appraiser until after the consumer 
pays an appraisal fee, which would delay the appraisal report and the 
processing time for the application. Some creditors may refuse to lock-
in the interest rate until after the consumer pays a rate lock fee, or 
alternatively lock-in the interest rate and bear some market risk or 
cost until it can impose a rate lock fee on the consumer. The Board 
believes the three business day time frame for the fee restriction 
strikes a proper balance between enabling consumers to review their 
credit terms before making a financial commitment and maintaining the 
efficiency of automated and streamlined loan processing.
    Presumption of receipt. Proposed Sec.  226.19(a)(1)(ii) provided 
that a fee may not be imposed until after a consumer has received the 
early mortgage loan disclosure and that the consumer is presumed to 
receive the disclosure three business days after it is mailed. Proposed 
comment 19(a)(1)(ii)-1 clarified further that creditors may charge a 
consumer a fee, in all cases, after midnight of the third business day 
following mailing the disclosure, and for disclosures delivered in 
person, fees may be charged anytime after delivery.
    One commenter addressed the receipt of disclosures sent by mail and 
suggested that the Board consider: (1) A presumption that disclosures 
sent by overnight courier are received by the consumer the next day; 
and (2) a presumption that disclosures delivered by electronic 
communication in compliance with applicable requirements under the 
Electronic Signatures in Global and National Commerce Act (``E-Sign 
Act''), 15 U.S.C. 7001 et seq., are received by the consumer 
immediately.
    The Board considered but is not adopting rules for overnight 
courier and other delivery methods. For example, overnight courier 
companies do not appear to adhere to one generally accepted definition 
for ``overnight delivery''; it may mean next business day or next 
calendar day. Recognized holidays and business hours also affect what 
is considered overnight delivery. In light of these variations the 
Board believes it is not feasible to define with sufficient clarity 
what may be considered acceptable ``overnight delivery'' or to 
delineate a presumption of receipt for all available methods of 
delivery.
    In addition, although the final rule provides a presumption of 
receipt if the early mortgage loan disclosure is delivered by mail, it 
does not prevent creditors from choosing any permissible method 
available to deliver the early mortgage loan disclosure, such as 
overnight courier or e-mail if in compliance with the E-Sign Act. 
Creditors may impose such fees any time after the consumer actually 
receives the early mortgage loan disclosure. Evidence of receipt by the 
consumer, such as documentation that the mortgage loan disclosure was 
delivered by certified mail, overnight delivery, or e-mail (if similar 
documentation is available), is sufficient to establish compliance with 
Sec.  226.19(a)(1)(ii).
    Exception to fee restriction. Proposed Sec.  226.19(a)(1)(iii) 
provided that a fee for obtaining the consumer's credit history may be 
charged before the consumer receives the early mortgage loan 
disclosure, provided the fee is ``bona fide and reasonable in amount.'' 
Many creditors and their trade associations noted that different 
pricing schedules make it difficult to ascertain the exact cost of a 
credit report and urged the Board to allow creditors to charge a flat 
or nominal fee for the credit report.
    The Board is adopting Sec.  226.19(a)(1)(iii) as proposed. The 
final rule recognizes that creditors generally cannot provide accurate 
transaction-specific cost estimates without having considered the 
consumer's credit history. Requiring creditors to bear the cost of 
reviewing credit history with little assurance the consumer will apply 
for a loan would be unduly burdensome. Some creditors might forego 
obtaining the consumer's credit history; disclosures made without any 
credit risk assessment of the consumer are likely to be of little value 
to the consumer.
    The language ``bona fide and reasonable in amount,'' in Sec.  
226.19(a)(1)(iii) does not require the creditor to charge the consumer 
the actual cost incurred by the creditor for that particular credit 
report, but rather contemplates a reasonable and justifiable fee. Many 
creditors enter into arrangements where pricing varies based on volume 
of business or other legitimate business factors, which makes the exact 
charge imposed on a particular consumer difficult to determine. The 
Board believes that a fee that bears a reasonable relationship to the 
actual charge incurred by the creditor is ``bona fide and reasonable in 
amount.''
    Enhanced civil remedies and redisclosure. The Board proposed the 
early mortgage loan disclosure pursuant to its authority under TILA 
Section 105(a), 15 U.S.C. 1604(a). Consumer advocacy groups generally 
support the early mortgage loan disclosure, but urged the Board to 
allow for civil enforcement to ensure compliance. They argued that 
without enhanced remedies, the disclosures could become instruments for 
``bait and switch'' schemes. Specifically, consumer groups urged the 
Board to use its authority under TILA Section 129(l)(2), 15 U.S.C. 
1639(l)(2), in addition to Section 105(a), and declare that failure to 
deliver timely and accurate early disclosures is an unfair and 
deceptive practice subject to enhanced damages under Section 129(l)(2). 
Consumer groups also argued that the early mortgage loan disclosure 
should be considered a material disclosure subject to remedies 
available

[[Page 44594]]

under TILA Section 130(a)(4), 15 U.S.C. 1640(a)(4) and extended 
rescission rights.
    The Board is adopting the final rule as proposed, pursuant to its 
authority under TILA Section 105(a), 15 U.S.C. 1604(a). The early 
mortgage loan disclosure is an early good faith estimate of 
transaction-specific terms, such as the APR and payment schedule. 
Although the Board shares commenters' concerns about bait and switch 
tactics, responsible creditors may not know the precise credit terms to 
disclose, and therefore must provide estimates, because the disclosure 
must be provided before the underwriting process is complete. However, 
through its review of closed-end mortgage disclosures, the Board may 
determine that some requirement for accuracy of the early disclosures 
is feasible.
    Consumer groups and others also suggested that the Board require 
redisclosure of the early mortgage loan disclosure some time period 
(e.g., at least seven days) before consummation if there have been 
material changes. They asserted that an inaccurate or misleading early 
disclosure could cause consumers to stop shopping based on erroneous 
credit terms. Under current Sec.  226.19(a)(2), redisclosure already is 
required no later than consummation and industry practice is to give 
the consumer a final TILA at closing, which does not facilitate 
shopping. The final rule does not revise the requirements for 
redisclosure prior to consummation. The Board may consider the need for 
additional rules as part of its overall review of closed-end mortgage 
disclosures.

B. Plans To Improve Disclosure

    Most creditors and their trade associations, citing the HUD's 
current RESPA proposal and the 1998 Federal Reserve Board and HUD Joint 
Report to the Congress Concerning Reform to TILA and RESPA, urged the 
Board to delay the proposed early mortgage loan disclosure rule and 
make it part of broader disclosure reform, or at least part of the 
comprehensive review of Regulation Z's closed-end rules that the Board 
is conducting currently.
    The Board believes that better information in the mortgage market 
can improve competition and help consumers make better decisions. The 
final rule is designed, in part, to prevent incomplete or misleading 
mortgage loan advertisements and solicitations, and to require 
creditors to provide mortgage disclosures earlier so that consumers can 
get the information they need when it is most useful to them. The Board 
recognizes that the content and format of these required early mortgage 
loan disclosures may need to be updated to reflect the increased 
complexity of mortgage products. The Board is reviewing current TILA 
mortgage disclosures and potential revisions to these disclosures 
through consumer testing. The Board expects that this testing will 
identify potential improvements for the Board to propose for public 
comment in a separate rulemaking. In addition, the Board will continue 
to have discussions with HUD to improve mortgage disclosures.

XIII. Mandatory Compliance Dates

    Under TILA Section 105(d), certain of the Board's disclosure 
regulations are to have an effective date of that October 1 which 
follows by at least six months the date of promulgation. 15 U.S.C. 
1604(d). However, the Board may, at its discretion, lengthen the 
implementation period for creditors to adjust their forms to 
accommodate new requirements, or shorten the period where the Board 
finds that such action is necessary to prevent unfair or deceptive 
disclosure practices. No similar effective date requirement exists for 
non-disclosure regulations.
    The Board requested comment on whether six months would be an 
appropriate implementation period, and on the length of time necessary 
for creditors to implement the proposed rules, as well as whether the 
Board should specify a shorter implementation period for certain 
provisions to prevent unfair or deceptive practices. Three 
organizations of state consumer credit regulators who jointly commented 
suggested that some of the proposed revisions could be enacted quickly 
without any burden to creditors, and requested implementation as soon 
as possible. Many industry commenters and their trade associations 
stated that although six months is an appropriate time period to 
implement some parts of the rule, creditors would need additional time 
to make system enhancements and to implement compliance training for 
other parts of the rule. For example, they stated that extra time is 
needed to establish systems to identify loans at or above the APR 
trigger for higher-priced mortgage loans. Most commenters who addressed 
the effective date specifically requested a compliance period longer 
than six months for the proposed early mortgage loan disclosure 
requirement and the proposed escrow requirement. In light of these 
concerns, the Board believes additional compliance time beyond six 
months is appropriate. Therefore, compliance with the final rule will 
be mandatory as specified below.

Early TILA Disclosures

    Pursuant to Section 105(d), the requirement to provide consumers 
with transaction-specific mortgage loan disclosures under Sec.  226.19 
applies to all applications received on or after October 1, 2009. 
Although state regulators noted that some creditors already have 
systems in place to provide early mortgage loan disclosures to comply 
with state law requirements, creditors and their trade groups generally 
urged the Board to allow more lead time than six months to comply to 
provide sufficient time for system re-programming, testing, procedural 
changes, and staff training.
    The early mortgage disclosure rule is triggered by the date of 
receipt of a consumer's written application, and therefore all written 
applications received by creditors on or after October 1, 2009 must 
comply with Sec.  226.19. Existing comment 19(a)(1)-3 (redesignated as 
comment 19(a)(1)(i)-3) states that a written application is deemed 
received when it reaches the creditor in any of the ways applications 
are normally transmitted, such as mail, hand delivery or through a 
broker.
    For example, a creditor that receives a consumer's written 
application for a mortgage refinancing on September 30, 2009, and which 
is consummated on October 29, 2009, does not need to deliver an early 
mortgage loan disclosure to the consumer and otherwise comply with the 
fee restriction requirements of this rule. A creditor that receives a 
consumer's written application on October 1, 2009 must deliver to the 
consumer an early mortgage loan disclosure within three business days 
and before the consumer pays a fee to any person, other than a fee for 
obtaining the consumer's credit history. The creditor may impose a fee 
on the consumer, such as for an appraisal or underwriting, after the 
consumer receives the disclosure. Under Sec.  226.19(a)(1)(ii) the 
consumer is presumed to have received the early mortgage loan 
disclosure three business days after it is mailed, and therefore, the 
creditor may impose a fee after midnight on the third business day 
following mailing.

Escrow Rules

    As described in part IX.D, although many creditors currently 
provide for escrows, large creditor commenters and their trade 
associations requested that this provision be delayed by 12 to 24 
months to allow creditors that currently have no escrowing capacity or 
infrastructure to implement the necessary systems and processes.

[[Page 44595]]

Manufactured housing industry commenters were particularly concerned 
because, as described in Part IX.D, currently a limited infrastructure 
is in place for escrowing on manufactured housing loans. Accordingly, 
the requirement to establish an escrow account for taxes and insurance 
(Sec.  226.35(b)(3)) for higher-priced mortgage loans is effective for 
such loans for which creditors receive applications on or after April 
1, 2010. For higher-priced mortgage loans secured by manufactured 
housing, however, compliance is mandatory for such loans for which 
creditors receive applications on or after October 1, 2010.

Advertising Rules and Other Rules Adopted Under TILA Section 129(l)(2)

    The final advertising rules are effective for advertisements 
occurring on or after October 1, 2009. For example, the advertising 
rules would be applicable to radio advertisements broadcast on or after 
October 1, 2009, or for solicitations mailed on or after October 1, 
2009. The servicing rules are effective for any loans serviced on or 
after October 1, 2009, whether the servicer obtained servicing rights 
on the loan before or after that date. The remaining rules are 
effective for loans for which a creditor receives an application on or 
after October 1, 2009.

Application of Mandatory Compliance Dates; Pre-Existing Obligations

    As described above, the final rule is prospective in application. 
Sometimes a change in the terms of an existing obligation constitutes a 
refinancing, which is a new transaction requiring new disclosures. An 
assumption, where the creditor agrees in writing to accept a subsequent 
consumer as a primary obligor, is also treated as a new transaction. 
See 12 CFR 226.20(a) and (b). A refinancing or assumption is covered by 
a provision of the final rule if the transaction occurs on or after 
that provision's effective date. For example, if a creditor receives an 
application for a refinancing on or after October 1, 2009, and the 
refinancing is consummated on October 15, 2009, the provision 
restricting prepayment penalties in Sec.  226.35(b)(2) applies, but the 
escrow requirement in Sec.  226.35(b)(3) would not apply because the 
escrow provision is only effective for new transactions where the 
application is received on or after April 1, 2010 (or October 1, 2010 
for manufactured housing-secured loans). However, if a modification of 
an existing obligation's terms that does not constitute a refinancing 
under Sec.  226.20(a) occurs on October 15, 2009, the restriction on 
prepayment penalties would not apply. Nevertheless, the loan servicing 
rules in Sec.  226.36(c) will apply to loan servicers as of October 1, 
2009, regardless of when the creditor received the application or 
consummated the transaction.

XIV. Paperwork Reduction Act

    In accordance with the Paperwork Reduction Act (PRA) of 1995 (44 
U.S.C. 3506; 5 CFR part 1320 app. A.1), the Board reviewed the final 
rule under the authority delegated to the Board by the Office of 
Management and Budget (OMB). The collection of information that is 
required by this final rulemaking is found in 12 CFR part 226. The 
Board may not conduct or sponsor, and an organization is not required 
to respond to, this information collection unless the information 
collection displays a currently valid OMB control number. The OMB 
control number is 7100-0199.
    This information collection is required to provide benefits for 
consumers and is mandatory (15 U.S.C. 1601 et seq.). The respondents/
recordkeepers are creditors and other entities subject to Regulation Z, 
including for-profit financial institutions and small businesses. Since 
the Board does not collect any information, no issue of confidentiality 
normally arises. However, in the event the Board were to retain records 
during the course of an examination, the information may be protected 
from disclosure under the exemptions (b)(4), (6), and (8) of the 
Freedom of Information Act (5 U.S.C. 522(b)).
    TILA and Regulation Z are intended to ensure effective disclosure 
of the costs and terms of credit to consumers. For open-end credit, 
creditors are required, among other things, to disclose information 
about the initial costs and terms and to provide periodic statements of 
account activity, notices of changes in terms, and statements of rights 
concerning billing error procedures. Regulation Z requires specific 
types of disclosures for credit and charge card accounts and home-
equity plans. For closed-end loans, such as mortgage and installment 
loans, cost disclosures are required to be provided prior to 
consummation. Special disclosures are required in connection with 
certain products, such as reverse mortgages, certain variable-rate 
loans, and certain mortgages with rates and fees above specified 
thresholds. TILA and Regulation Z also contain rules concerning credit 
advertising. Creditors are required to retain evidence of compliance 
for 24 months, 12 CFR 226.25, but Regulation Z does not specify the 
types of records that must be retained.
    Under the PRA, the Board accounts for the paperwork burden 
associated with Regulation Z for the state member banks and other 
creditors supervised by the Board that engage in lending covered by 
Regulation Z and, therefore, are respondents under the PRA. Appendix I 
of Regulation Z defines the Federal Reserve-regulated institutions as: 
State member banks, branches and agencies of foreign banks (other than 
federal branches, federal agencies, and insured state branches of 
foreign banks), commercial lending companies owned or controlled by 
foreign banks, and organizations operating under section 25 or 25A of 
the Federal Reserve Act. Other federal agencies account for the 
paperwork burden on other creditors. Paperwork burden associated with 
entities that are not creditors will be accounted for by other federal 
agencies. To ease the burden and cost of complying with Regulation Z 
(particularly for small entities), the Board provides model forms, 
which are appended to the regulation.
    As mentioned in the Preamble, on January 9, 2008, a notice of 
proposed rulemaking (NPR) was published in the Federal Register (73 FR 
1672). The comment period for this notice expired on April 8, 2008. No 
comments specifically addressing the burden estimate were received; 
therefore, the burden estimates will remain unchanged as published in 
the NPR. The final rule will impose a one-time increase in the total 
annual burden under Regulation Z by 46,880 hours from 552,398 to 
599,278 hours. This burden increase will be imposed on all Federal 
Reserve-regulated institutions that are deemed to be respondents for 
the purposes of the PRA. Note that these burden estimates do not 
include the burden addressing changes to format, timing, and content 
requirements for the five main types of open-end credit disclosures 
governed by Regulation Z as announced in a separate proposed rulemaking 
(Docket No. R-1286).
    The Board has a continuing interest in the public's opinions of our 
collections of information. At any time, comments regarding the burden 
estimate, or any other aspect of this collection of information, 
including suggestions for reducing the burden, may be sent to: 
Secretary, Board of Governors of the Federal Reserve System, 20th and C 
Streets, NW., Washington, DC 20551; and to the Office of Management and 
Budget, Paperwork Reduction Project (7100-0199), Washington, DC 20503.

[[Page 44596]]

XV. Regulatory Flexibility Analysis

    In accordance with section 4 of the Regulatory Flexibility Act 
(RFA), 5 U.S.C. 601-612, the Board is publishing a final regulatory 
flexibility analysis for the proposed amendments to Regulation Z. The 
RFA requires an agency either to provide a final regulatory flexibility 
analysis with a final rule or certify that the final rule will not have 
a significant economic impact on a substantial number of small 
entities. An entity is considered ``small'' if it has $165 million or 
less in assets for banks and other depository institutions; and $6.5 
million or less in revenues for non-bank mortgage lenders, mortgage 
brokers, and loan servicers.\127\
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    \127\ U.S. Small Business Administration, Table of Small 
Business Size Standards Matched to North American Industry 
Classification System Codes, available at http://www.sba.gov/idc/groups/public/documents/sba_homepage/serv_sstd_tablepdf.pdf.
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    The Board received a large number of comments contending that the 
proposed rule would have a significant impact on various businesses. In 
addition, the Board received one comment on its initial regulatory 
flexibility analysis. Based on public comment, the Board's own 
analysis, and for the reasons stated below, the Board believes that 
this final rule will have a significant economic impact on a 
substantial number of small entities.

1. Statement of the Need for, and Objectives of, the Final Rule

    The Board is publishing final rules to establish new regulatory 
protections for consumers in the residential mortgage market through 
amendments to Regulation Z, which implements TILA and HOEPA. As stated 
more fully above, the amendments are intended to protect consumers in 
the mortgage market from unfair, abusive, or deceptive lending and 
servicing acts or practices while preserving responsible lending and 
sustainable homeownership. Some of the restrictions apply to only 
higher-priced mortgage loans, while others apply to all mortgage loans 
secured by a consumer's principal dwelling. For example, for higher-
priced mortgage loans, the amendments prohibit lending based on the 
collateral without regard to consumers' ability to repay their 
obligations from income, or from other sources besides the collateral. 
In addition, the amendments' goals are to ensure that advertisements 
for mortgage credit provide accurate and balanced information and do 
not contain misleading or deceptive representations; and to provide 
consumers transaction-specific disclosures early enough to use while 
shopping for a mortgage.

2. Summary of Issues Raised by Comments in Response to the Initial 
Regulatory Flexibility Analysis

    In accordance with section 3(a) of the RFA, 5 U.S.C 603(a), the 
Board prepared an initial regulatory flexibility analysis (IRFA) in 
connection with the proposed rule, and acknowledged that the projected 
reporting, recordkeeping, and other compliance requirements of the 
proposed rule would have a significant economic impact on a substantial 
number of small entities. In addition, the Board recognized that the 
precise compliance costs would be difficult to ascertain because they 
would depend on a number of unknown factors, including, among other 
things, the specifications of the current systems used by small 
entities to prepare and provide disclosures and/or solicitations and to 
administer and maintain accounts, the complexity of the terms of credit 
products that they offer, and the range of such product offerings. The 
Board sought information and comment on any costs, compliance 
requirements, or changes in operating procedures arising from the 
application of the proposed rule to small entities. The Board 
recognizes that businesses often pass compliance costs on to consumers 
and that a less costly rule could benefit both small business and 
consumers.
    The Board reviewed comments submitted by various entities in order 
to ascertain the economic impact of the proposed rule on small 
entities. A number of financial institutions and mortgage brokers 
expressed concern that the Board had underestimated the costs of 
compliance. In addition, the Office of Advocacy of the U.S. Small 
Business Administration (Advocacy) submitted a comment on the Board's 
IRFA. Executive Order 13272 directs Federal agencies to respond in a 
final rule to written comments submitted by Advocacy on a proposed 
rule, unless the agency certifies that the public interest is not 
served by doing so. The Board's response to Advocacy's comment letter 
is below.
    Response to U.S. Small Business Administration comment. Advocacy 
supported the consumer protection goals in the proposed rule, but 
expressed concern that the Board's IRFA did not adequately assess the 
impact of the proposed rule on small entities as required by the RFA. 
Advocacy urged the Board to issue a new proposal containing a revised 
IRFA. For the reasons stated below, the Board believes that its IRFA 
complied with the requirements of the RFA and the Board is proceeding 
with a final rule.
    Advocacy suggested that the Board failed to provide sufficient 
information about the economic impact of the proposed rule and that the 
Board's request for public comment on the costs to small entities of 
the proposed rule was not appropriate. Section 3(a) of the RFA requires 
agencies to publish for comment an IRFA which shall describe the impact 
of the proposed rule on small entities. 5 U.S.C 603(a). In addition, 
section 3(b) requires the IRFA to contain certain information including 
a description of the projected reporting, recordkeeping and other 
compliance requirements of the proposed rule, including an estimate of 
the classes of small entities which will be subject to the requirement 
and the type of professional skills necessary for preparation of the 
report or record. 5 U.S.C. 603(b).
    The Board's IRFA complied with the requirements of the RFA. First, 
the Board described the impact of the proposed rule on small entities 
by describing the rule's proposed requirements in detail throughout the 
supplementary information for the proposed rule. Second, the Board 
described the projected compliance requirements of the rule in its 
IRFA, noting the need for small entities to update systems, disclosures 
and underwriting practices.\128\ The RFA does not require the Board to 
undertake an exhaustive economic analysis of the proposal's impact on 
small entities in the IRFA. Instead, the IRFA procedure is intended to 
evoke commentary from small businesses about the effect of the rule on 
their activities, and to require agencies to consider the effect of a 
regulation on those entities. Cement Kiln Recycling Coalition v. EPA, 
255 F.3d 855, 868 (D.C. Cir. 2001). The Board described the projected 
impact of the proposed rule and sought comments from small entities 
themselves on the effect the proposed rule would have on their 
activities. The Board also notes that the final rule does not adopt the 
proposed rule on creditor payments to mortgage brokers, reducing the 
final rule's impact on small mortgage broker entities.
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    \128\ 73 FR 1672, 1720 (Jan. 9, 2008).
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    Advocacy also commented that the Board failed to provide sufficient 
information about the number of small mortgage brokers that may be 
impacted by the rule. Section 3(b)(3) of the RFA requires the IRFA to 
contain a description of and, where feasible, an estimate of the number 
of small entities to which the proposed rule will apply. 5 U.S.C. 
603(b)(3) (emphasis added). The Board provided a description of the

[[Page 44597]]

small entities to which the proposed rule would apply and provided an 
estimate of the number of small depository institutions to which the 
proposed rule would apply.\129\ The Board also provided an estimate of 
the total number of mortgage broker entities and estimated that most of 
these were small entities.\130\ The Board stated that it was not aware 
of a reliable source for the total number of small entities likely to 
be affected by the proposal.\131\ Thus, the Board did not find it 
feasible to estimate their number.
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    \129\ Id. at 1719.
    \130\ Id. at 1720. According to the National Association of 
Mortgage Brokers, in 2004 there were 53,000 mortgage brokerage 
companies that employed an estimated 418,700 people. The Board 
believes that most of these companies are small entities. In its 
comment letter, Advocacy noted that the appropriate SBA size 
standard for mortgage brokers is $6.5 million in average annual 
receipts and that, of 15,590 mortgage broker firms in the U.S. 
according to the 2002 Economic Census data, 15,195 would be 
classified as small using the $6.5 million standard.
    \131\ 73 FR 1672, 1719 (Jan. 9, 2008).
---------------------------------------------------------------------------

    Advocacy also suggested that the Board's IRFA did not sufficiently 
address alternatives to the proposed rule. Section 3(c) of the RFA 
requires that an IRFA contain a description of any significant 
alternatives to the proposed rule which accomplish the stated 
objectives of applicable statutes and which minimize any significant 
economic impact of the proposed rule on small entities. 5 U.S.C. 
603(c). The Board's IRFA discusses the alternative of improved 
disclosures and requests comment on other alternatives. Advocacy 
commented that the Board's IRFA does not discuss the economic impact 
that the disclosure alternative would have on small entities. Yet the 
Board's IRFA discussion of the disclosure alternative indicates that 
the Board does not believe that the disclosure alternative would 
accomplish the stated objectives of applicable statutes.\132\ Advocacy 
also suggested that the Board did not discuss other alternatives such 
as a later implementation date. However, the Board specifically 
discussed and requested comment on the effective date in another 
section of the supplementary information to the proposed rule.\133\ 
Section 5(a) of the RFA permits an agency to perform the IRFA analysis 
(among others) in conjunction with or as part of any other analysis 
required by any other law if such other analysis satisfies the 
provisions of the RFA. 5 U.S.C. 605(a). Other alternatives were 
discussed throughout the supplementary information to the Board's 
proposal.
---------------------------------------------------------------------------

    \132\ Id. at 1720.
    \133\ Id. at 1717.
---------------------------------------------------------------------------

    Other comments. In addition to Advocacy's comment letter, a number 
of industry commenters expressed concerns that the rule, as proposed, 
would be costly to implement, would not provide enough flexibility, and 
would not adequately respond to the needs or nature of their business. 
Many commenters argued that improved disclosures could protect 
consumers against unfair acts or practices in connection with closed-
end mortgage loans secured by a consumer's principal dwelling as well 
as the proposed rule. As discussed in part XII, while the Board 
anticipates proposing improvements to mortgage loan disclosures, the 
Board believes that better disclosures alone would not adequately 
address unfair, abusive or deceptive practices in the mortgage market, 
including the subprime market. Since improved disclosures alone would 
fail to accomplish the stated objectives of TILA Section 129(l)(2), 
which authorizes the Board to prohibit unfair or deceptive practices in 
connection with mortgage loans, the Board concluded that improved 
disclosures alone do not represent a significant alternative to the 
proposed rule, as a result of which the IRFA did not discuss the 
economic impact of improved disclosures.
    Many of the issues raised by commenters do not apply uniquely to 
small entities and are addressed above in other parts of the 
SUPPLEMENTARY INFORMATION. The comments that expressed specific 
concerns about the effect of the proposed rule on small entities are 
discussed below.
    Defining loans as higher-priced. The proposed rule defined higher-
priced mortgage loans as loans with an APR that exceeds the comparable 
Treasury security by three or more percentage points for first-lien 
loans, or five or more percentage points for subordinate-lien loans. 
Some small banks, community banks and manufactured housing 
representatives expressed concerns that, based on the proposed 
definition of higher-priced mortgage loans, some prime loans may be 
classified as higher-priced, which could have negative impact on their 
business. Many of these commenters proposed changing the definition of 
higher-priced mortgage loans, and manufactured housing industry 
representatives proposed a separate standard for personal property 
loans on manufactured homes.
    As discussed above, the Board is adopting a definition of ``higher-
priced mortgage loan'' that is similar in concept to the definition 
proposed, but different in the particulars. The final definition, like 
the proposed definition, sets a threshold above a market rate to 
distinguish higher-priced mortgage loans from the rest of the mortgage 
market. Instead of yields on Treasury securities, the definition in the 
final rule uses a survey-based estimate of market rates for the lowest-
risk prime mortgages, referred to as the average prime offer rate. The 
Board believes that the final rule will more effectively meet both 
goals of covering prime loans and excluding prime, though it will cover 
some prime loans under certain market conditions.
    Escrows. The proposed rule would require creditors to establish 
escrow accounts for taxes and insurance and permitted them to allow 
borrowers to opt out of escrows 12 months after loan consummation. 
Several industry commenters noted that the compliance with the escrow 
proposal would be costly and many small banks and community banks 
commented that they do not currently require escrows because of this 
cost. A few small lenders commented that the costs of setting up escrow 
accounts are prohibitively expensive but did not disclose what such 
costs are. Manufactured housing industry commenters were especially 
concerned about the cost of requiring escrows for manufactured homes 
that are taxed as personal property because there is no unified, 
systematic process for the collection of personal property taxes among 
various government entities.
    The final rule is adopted substantially as proposed. As discussed 
above, the Board does not believe that alternatives to the final rule 
would achieve HOEPA's objectives. The Board has, however, chosen 
effective dates for the final rule that give creditors a longer 
implementation period for establishing escrow accounts. Comments on the 
effective dates of the final rule are discussed below.
    Broker disclosures. The Board proposed to prohibit creditors from 
paying a mortgage broker more than the consumer had agreed in advance 
that the broker would receive. A large number of mortgage brokers 
commented that the proposal could lead to brokers being less 
competitive in the marketplace and may result in some small brokers 
exiting the marketplace.
    The Board tested the proposal in several dozen one-on-one 
interviews with a diverse group of consumers. On the basis of this 
testing and other information, the Board is withdrawing its proposal to 
prohibit creditors from paying a mortgage broker more than the

[[Page 44598]]

consumer had agreed in advance that the broker would receive. The Board 
is concerned that the proposed agreement and disclosures would confuse 
consumers and undermine their decision making rather than improve it. 
The Board will continue to explore available options to address 
potentially unfair acts or practices associated with originator 
compensation arrangements such as yield spread premiums.
    Servicing. The proposed rule prohibited mortgage servicers from 
``pyramiding'' late fees, failing to credit payments as of the date of 
receipt, failing to provide loan payoff statements upon request within 
a reasonable time, or failing to deliver a fee schedule to a consumer 
upon request. Several commenters noted that the fee schedule 
disclosures would be very costly for a servicer since fees vary by 
state, county, city, investor and even product. The Board has 
considered the concerns raised by commenters and has concluded that the 
transparency benefit of the schedule does not sufficiently offset the 
burdens of producing such a schedule. Thus, the Board is not adopting 
the proposed fee schedule disclosure.
    Early disclosures. The proposed rule would require creditors to 
give consumers transaction-specific, early mortgage loan disclosures 
for certain closed-end loans secured by a consumer's principal 
dwelling. The proposed rule would require creditors to deliver this 
disclosure within three business days of application and before a 
consumer pays a fee to any person, other than a fee for obtaining the 
consumer's credit report. Many creditors and their trade associations 
opposed the proposal due to operational cost and compliance 
difficulties (for example, system reprogramming, testing, procedural 
changes, and staff training). They noted that the burden may be 
significant for some small entity creditors, such as community banks.
    The Board is adopting Sec.  226.19(a)(1)(iii) substantially as 
proposed. The Board believes that alternatives to the final rule would 
not achieve TILA's objectives. However, as discussed below, the Board 
has chosen an implementation period for the final rule that responds to 
creditors' concerns about the time required to comply with the rule.
    Effective date. The Board requested comment on whether six months 
would be an appropriate implementation period, and on the length of 
time necessary for creditors to implement the proposed rules, as well 
as whether the Board should specify a shorter implementation period for 
certain provisions in order to prevent unfair or deceptive practices.
    Many industry commenters and their trade associations stated that 
six months would be an appropriate implementation period for some parts 
of the rule, but that they would need additional time to implement the 
proposed early mortgage loan disclosure requirement and the proposed 
escrow requirement. Commenters requested additional time to implement 
the early mortgage loan disclosure rule in order to provide sufficient 
time for system re-programming, testing, procedural changes, and staff 
training. And, although many creditors currently provide for escrows, 
other creditors, including many that are small entities, currently have 
no escrowing capacity or infrastructure. These commenters requested a 
period of 12 to 24 months to implement the necessary systems and 
processes. Manufactured housing industry commenters were particularly 
concerned because a limited infrastructure is in place for escrowing on 
manufactured housing loans.
    In light of these concerns, the Board believes additional 
compliance time beyond six months is appropriate. With two exceptions, 
the final rule is effective for loans consummated on or after October 
1, 2009. The requirement to establish an escrow account for taxes and 
insurance for higher-priced mortgage loans is effective for loans 
consummated on or after April 1, 2010, or, for loans secured by 
manufactured housing, consummated on or after October 1, 2010.

3. Description and Estimate of Small Entities To Which the Proposed 
Rule Would Apply

    The final rule applies to all institutions and entities that engage 
in closed-end home-secured lending and servicing. The Board 
acknowledged in its IRFA the lack of a reliable source for the total 
number of small entities likely to be affected by the proposal, since 
the credit provisions of TILA and Regulation Z have broad applicability 
to individuals and businesses that originate, extend and service even 
small numbers of home-secured credit.
    Through data from Reports of Condition and Income (``call 
reports''), the Board identified approximate numbers of small 
depository institutions that would be subject to the proposed rules. 
Based on March 2008 call report data, approximately 8,393 small 
institutions would be subject to the final rule. Approximately 17,101 
depository institutions in the United States filed call report data, 
approximately 12,237 of which had total domestic assets of $165 million 
or less and thus were considered small entities for purposes of the 
RFA. Of 4,554 banks, 401 thrifts and 7,318 credit unions that filed 
call report data and were considered small entities, 4,259 banks, 377 
thrifts, and 3,757 credit unions, totaling 8,393 institutions, extended 
mortgage credit. For purposes of this analysis, thrifts include savings 
banks, savings and loan entities, co-operative banks and industrial 
banks.
    In its IRFA, the Board recognized that it could not identify with 
certainty the number of small nondepository institutions that would be 
subject to the proposed rule. Home Mortgage Disclosure Act (HMDA) data 
indicate that 2,004 non-depository institutions filed HMDA reports in 
2006. Based on the small volume of lending activity reported by these 
institutions, most are likely to be small.
    Certain parts of the final rule would apply to mortgage brokers. 
The Board provided an estimate of the number of mortgage brokers in its 
IRFA, citing data from the National Association of Mortgage Brokers 
indicating that in 2004 there were 53,000 mortgage brokerage 
companies.\134\ The Board estimated in the IRFA that most of these 
companies are small entities. A comment letter received by the U.S. 
Small Business Administration, citing the 2002 Economic Census, stated 
that there were 15,195 small mortgage broker entities.
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    \134\ http://www.namb.org/namb/Industry_Facts.asp?SnID=719224934.
---------------------------------------------------------------------------

    Certain parts of the final rule would also apply to mortgage 
servicers. As noted in IRFA, the Board is not aware, however, of a 
source of data for the number of small mortgage servicers. The 
available data are not sufficient for the Board to realistically 
estimate the number of mortgage servicers that would be subject to the 
final rule and that are small as defined by the U.S. Small Business 
Administration.

4. Reporting, Recordkeeping, and Other Compliance Requirements

    The compliance requirements of the final rule are described in the 
SUPPLEMENTARY INFORMATION. Some small entities will be required, among 
other things, to modify their underwriting practices and home-secured 
credit disclosures to comply with the revised rules. The precise costs 
to small entities of updating their systems, disclosures, and 
underwriting practices are difficult to predict. These costs will 
depend on a number of unknown factors, including, among other things, 
the specifications of the

[[Page 44599]]

current systems used by such entities to prepare and provide 
disclosures and/or solicitations and to administer and maintain 
accounts, the complexity of the terms of credit products that they 
offer, and the range of such product offerings. For some small 
entities, certain parts of the rule may require the type of 
professional skills already necessary to meet other legal requirements. 
For example, the Board believes that final rule's requirements with 
regard to advertising will require the same types of professional 
skills and recordkeeping procedures that are needed to comply with 
existing TILA and Regulation Z advertising rules. Other parts of the 
rule may require new professional skills and recordkeeping procedures 
for some small entities. For example, creditors that do not currently 
offer escrow accounts will need to implement that capability. The Board 
believes that costs of the final rule as a whole will have a 
significant economic effect on small entities.

5. Steps Taken To Minimize the Economic Impact On Small Entities

    The steps the Board has taken to minimize the economic impact and 
compliance burden on small entities, including the factual, policy, and 
legal reasons for selecting the alternatives adopted and why each one 
of the other significant alternatives was not accepted, are described 
above in the SUPPLEMENTARY INFORMATION and in the summary of issues 
raised by the public comments in response to the proposal's IRFA. The 
final rule's modifications from the proposed rule that minimize 
economic impact on small entities are summarized below.
    First, the Board has provided a different standard for defining 
higher-priced mortgage loans to more accurately correspond to mortgage 
market conditions and exclude from the definition some prime loans that 
might have been classified as higher-priced under the proposed rule. 
The Board believes that this will decrease the economic impact of the 
final rule on small entities by limiting their compliance costs for 
prime loans the Board does not intend to cover under the higher-priced 
mortgage loan rules.
    Second, the Board is providing an implementation period that 
responds to commenters' concerns about the time needed to comply with 
the final rule. The Board is also providing later effective dates for 
the escrow requirement than for the other parts of the final rule. As 
discussed above, the Board believes that these effective dates will 
decrease costs for small entities by providing them with sufficient 
time to come into compliance with the final rule's requirements.
    The Board also notes that it is withdrawing two proposed rules for 
which small entity commenters expressed concern about the costs of 
compliance. The Board is withdrawing its proposal to prohibit creditors 
from paying a mortgage broker more than the consumer had agreed in 
advance that the broker would receive, and its proposal to require a 
servicer to provide to a consumer upon request a schedule of all 
specific fees and charges that may be imposed in connection with the 
servicing of the consumer's account.
    The Board believes that these changes minimize the significant 
economic impact on small entities while still meeting the stated 
objectives of HOEPA and TILA.

List of Subjects in 12 CFR Part 226

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

Authority and Issuance

0
For the reasons set forth in the preamble, the Board amends Regulation 
Z, 12 CFR part 226, as set forth below:

PART 226--TRUTH IN LENDING (REGULATION Z)

0
1. The authority citation for part 226 is amended to read as follows:

    Authority: 12 U.S.C. 3806; 15 U.S.C. 1604, 1637(c)(5), and 
1639(l).

Subpart A--General

0
2. Section 226.1 is amended by revising paragraph (d)(5) to read as 
follows:


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

* * * * *
    (d) * * *
* * * * *
    (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 specified amounts. 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 that are 
subject to Sec.  226.32. Section 226.35 prohibits specific acts and 
practices in connection with higher-priced mortgage loans, as defined 
in Sec.  226.35(a). Section 226.36 prohibits specific acts and 
practices in connection with credit secured by a consumer's principal 
dwelling.
* * * * *

0
3. Section 226.2 is amended by revising paragraph (a)(6) to read as 
follows:


Sec.  226.2  Definitions and Rules of Construction.

    (a) * * *
    (6) ``Business Day'' means a day on which the creditor's offices 
are open to the public for carrying on substantially all of its 
business functions. However, for purposes of rescission under 
Sec. Sec.  226.15 and 226.23, and for purposes of Sec.  
226.19(a)(1)(ii) and Sec.  226.31, the term means all calendar days 
except Sundays and the legal public holidays specified in 5 U.S.C. 
6103(a), such as New Year's Day, the Birthday of Martin Luther King, 
Jr., Washington's Birthday, Memorial Day, Independence Day, Labor Day, 
Columbus Day, Veterans Day, Thanksgiving Day, and Christmas Day.

Subpart B--Open-End Credit

0
4. Section 226.16 is amended by revising paragraphs (d)(2) through 
(d)(4), and adding new paragraphs (d)(6) and (e) to read as follows:


Sec.  226.16  Advertising.

* * * * *
    (d) Additional requirements for home-equity plans
* * * * *
    (2) Discounted and premium rates. If an advertisement states an 
initial annual percentage rate that is not based on the index and 
margin used to make later rate adjustments in a variable-rate plan, the 
advertisement also shall state with equal prominence and in close 
proximity to the initial rate:
    (i) The period of time such initial rate will be in effect; and
    (ii) A reasonably current annual percentage rate that would have 
been in effect using the index and margin.
    (3) Balloon payment. If an advertisement contains a statement of 
any minimum periodic payment and a balloon payment may result if only 
the minimum periodic payments are made, even if such a payment is 
uncertain or unlikely, the advertisement also shall state with equal 
prominence and in close proximity to the minimum periodic payment 
statement that a balloon payment may result, if applicable.\36e\ A 
balloon payment results if paying the minimum periodic payments does 
not fully amortize the outstanding balance by a specified date

[[Page 44600]]

or time, and the consumer is required to repay the entire outstanding 
balance at such time. If a balloon payment will occur when the consumer 
makes only the minimum payments required under the plan, an 
advertisement for such a program which contains any statement of any 
minimum periodic payment shall also state with equal prominence and in 
close proximity to the minimum periodic payment statement:
---------------------------------------------------------------------------

    \36e\ [Reserved.]
---------------------------------------------------------------------------

    (i) That a balloon payment will result; and
    (ii) The amount and timing of the balloon payment that will result 
if the consumer makes only the minimum payments for the maximum period 
of time that the consumer is permitted to make such payments.
    (4) Tax implications. An advertisement that states that any 
interest expense incurred under the home-equity plan is or may be tax 
deductible may not be misleading in this regard. If an advertisement 
distributed in paper form or through the Internet (rather than by radio 
or television) is for a home-equity plan secured by the consumer's 
principal dwelling, and the advertisement states that the advertised 
extension of credit may exceed the fair market value of the dwelling, 
the advertisement shall clearly and conspicuously state that:
    (i) The interest on the portion of the credit extension that is 
greater than the fair market value of the dwelling is not tax 
deductible for Federal income tax purposes; and
    (ii) The consumer should consult a tax adviser for further 
information regarding the deductibility of interest and charges.
* * * * *
    (6) Promotional rates and payments--(i) Definitions. The following 
definitions apply for purposes of paragraph (d)(6) of this section:
    (A) Promotional rate. The term ``promotional rate'' means, in a 
variable-rate plan, any annual percentage rate that is not based on the 
index and margin that will be used to make rate adjustments under the 
plan, if that rate is less than a reasonably current annual percentage 
rate that would be in effect under the index and margin that will be 
used to make rate adjustments under the plan.
    (B) Promotional payment. The term ``promotional payment'' means--
    (1) For a variable-rate plan, any minimum payment applicable for a 
promotional period that:
    (i) Is not derived by applying the index and margin to the 
outstanding balance when such index and margin will be used to 
determine other minimum payments under the plan; and
    (ii) Is less than other minimum payments under the plan derived by 
applying a reasonably current index and margin that will be used to 
determine the amount of such payments, given an assumed balance.
    (2) For a plan other than a variable-rate plan, any minimum payment 
applicable for a promotional period if that payment is less than other 
payments required under the plan given an assumed balance.
    (C) Promotional period. A ``promotional period'' means a period of 
time, less than the full term of the loan, that the promotional rate or 
promotional payment may be applicable.
    (ii) Stating the promotional period and post-promotional rate or 
payments. If any annual percentage rate that may be applied to a plan 
is a promotional rate, or if any payment applicable to a plan is a 
promotional payment, the following must be disclosed in any 
advertisement, other than television or radio advertisements, in a 
clear and conspicuous manner with equal prominence and in close 
proximity to each listing of the promotional rate or payment:
    (A) The period of time during which the promotional rate or 
promotional payment will apply;
    (B) In the case of a promotional rate, any annual percentage rate 
that will apply under the plan. If such rate is variable, the annual 
percentage rate must be disclosed in accordance with the accuracy 
standards in Sec. Sec.  226.5b, or 226.16(b)(1)(ii) as applicable; and
    (C) In the case of a promotional payment, the amounts and time 
periods of any payments that will apply under the plan. In variable-
rate transactions, payments that will be determined based on 
application of an index and margin shall be disclosed based on a 
reasonably current index and margin.
    (iii) Envelope excluded. The requirements in paragraph (d)(6)(ii) 
of this section do not apply to an envelope in which an application or 
solicitation is mailed, or to a banner advertisement or pop-up 
advertisement linked to an application or solicitation provided 
electronically.
    (e) Alternative disclosures--television or radio advertisements. An 
advertisement for a home-equity plan subject to the requirements of 
Sec.  226.5b made through television or radio stating any of the terms 
requiring additional disclosures under paragraph (b) or (d)(1) of this 
section may alternatively comply with paragraph (b) or (d)(1) of this 
section by stating the information required by paragraph (b)(2) of this 
section or paragraph (d)(1)(ii) of this section, as applicable, and 
listing a toll-free telephone number, or any telephone number that 
allows a consumer to reverse the phone charges when calling for 
information, along with a reference that such number may be used by 
consumers to obtain additional cost information.

Subpart C--Closed-End Credit

0
5. Section 226.17 is amended by revising paragraphs (b) and (f) to read 
as follows:


Sec.  226.17  General disclosure requirements.

* * * * *
    (b) Time of disclosures. The creditor shall make disclosures before 
consummation of the transaction. In certain mortgage transactions, 
special timing requirements are set forth in Sec.  226.19(a). In 
certain variable-rate transactions, special timing requirements for 
variable-rate disclosures are set forth in Sec.  226.19(b) and Sec.  
226.20(c). In certain transactions involving mail or telephone orders 
or a series of sales, the timing of the disclosures may be delayed in 
accordance with paragraphs (g) and (h) of this section.
* * * * *
    (f) Early disclosures. If disclosures required by this subpart are 
given before the date of consummation of a transaction and a subsequent 
event makes them inaccurate, the creditor shall disclose before 
consummation (except that, for certain mortgage transactions, Sec.  
226.19(a)(2) permits redisclosure no later than consummation or 
settlement, whichever is later).\39\
---------------------------------------------------------------------------

    \39\ [Reserved.]
---------------------------------------------------------------------------

* * * * *

0
6. Section 226.19 is amended by revising the heading and paragraph 
(a)(1) to read as follows:


Sec.  226.19  Certain mortgage and variable-rate transactions.

    (a) Mortgage transactions subject to RESPA--(1)(i) Time of 
disclosures. In a mortgage transaction subject to the Real Estate 
Settlement Procedures Act (12 U.S.C. 2601 et seq.) that is secured by 
the consumer's principal dwelling, other than a home equity line of 
credit subject to Sec.  226.5b, the creditor shall make good faith 
estimates of the disclosures required by Sec.  226.18 before 
consummation, or shall deliver or place them in the mail not later than 
three business days after the creditor receives the consumer's written 
application, whichever is earlier.
    (ii) Imposition of fees. Except as provided in paragraph 
(a)(1)(iii) of this

[[Page 44601]]

section, neither a creditor nor any other person may impose a fee on 
the consumer in connection with the consumer's application for a 
mortgage transaction subject to paragraph (a)(1)(i) of this section 
before the consumer has received the disclosures required by paragraph 
(a)(1)(i) of this section. If the disclosures are mailed to the 
consumer, the consumer is considered to have received them three 
business days after they are mailed.
    (iii) Exception to fee restriction. A creditor or other person may 
impose a fee for obtaining the consumer's credit history before the 
consumer has received the disclosures required by paragraph (a)(1)(i) 
of this section, provided the fee is bona fide and reasonable in 
amount.
* * * * *

0
7. Section 226.23 is amended by revising footnote 48 to paragraph 
(a)(3) to read ``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. Sec.  226.32(c) and (d) 
and 226.35(b)(2).''

0
8. Section 226.24 is amended by redesignating paragraphs (b) through 
(d) as paragraphs (c) through (e), respectively, adding new paragraph 
(b), revising newly designated paragraphs (c) through (e), removing and 
reserving footnote 49, and adding new paragraphs (f) through (i), to 
read as follows:


Sec.  226.24  Advertising.

* * * * *
    (b) Clear and conspicuous standard. Disclosures required by this 
section shall be made clearly and conspicuously.
    (c) Advertisement of rate of finance charge. If an advertisement 
states a rate of finance charge, it shall state the rate as an ``annual 
percentage rate,'' using that term. If the annual percentage rate may 
be increased after consummation, the advertisement shall state that 
fact. If an advertisement is for credit not secured by a dwelling, the 
advertisement shall not state any other rate, except that a simple 
annual rate or periodic rate that is applied to an unpaid balance may 
be stated in conjunction with, but not more conspicuously than, the 
annual percentage rate. If an advertisement is for credit secured by a 
dwelling, the advertisement shall not state any other rate, except that 
a simple annual rate that is applied to an unpaid balance may be stated 
in conjunction with, but not more conspicuously than, the annual 
percentage rate.
    (d) Advertisement of terms that require additional disclosures--(1) 
Triggering terms. If any of the following terms is set forth in an 
advertisement, the advertisement shall meet the requirements of 
paragraph (d)(2) of this section:
    (i) The amount or percentage of any downpayment.
    (ii) The number of payments or period of repayment.
    (iii) The amount of any payment.
    (iv) The amount of any finance charge.
    (2) Additional terms. An advertisement stating any of the terms in 
paragraph (d)(1) of this section shall state the following terms,\49\ 
as applicable (an example of one or more typical extensions of credit 
with a statement of all the terms applicable to each may be used):
---------------------------------------------------------------------------

    \49\ [Reserved.]
---------------------------------------------------------------------------

    (i) The amount or percentage of the downpayment.
    (ii) The terms of repayment, which reflect the repayment 
obligations over the full term of the loan, including any balloon 
payment.
    (iii) The ``annual percentage rate,'' using that term, and, if the 
rate may be increased after consummation, that fact.
    (e) Catalogs or other multiple-page advertisements; electronic 
advertisements--(1) If a catalog or other multiple-page advertisement, 
or an electronic advertisement (such as an advertisement appearing on 
an Internet Web site), gives information in a table or schedule in 
sufficient detail to permit determination of the disclosures required 
by paragraph (d)(2) of this section, it shall be considered a single 
advertisement if--
    (i) The table or schedule is clearly and conspicuously set forth; 
and
    (ii) Any statement of the credit terms in paragraph (d)(1) of this 
section appearing anywhere else in the catalog or advertisement clearly 
refers to the page or location where the table or schedule begins.
    (2) A catalog or other multiple-page advertisement or an electronic 
advertisement (such as an advertisement appearing on an Internet Web 
site) complies with paragraph (d)(2) of this section if the table or 
schedule of terms includes all appropriate disclosures for a 
representative scale of amounts up to the level of the more commonly 
sold higher-priced property or services offered.
    (f) Disclosure of Rates and Payments in Advertisements for Credit 
Secured by a Dwelling.
    (1) Scope. The requirements of this paragraph apply to any 
advertisement for credit secured by a dwelling, other than television 
or radio advertisements, including promotional materials accompanying 
applications.
    (2) Disclosure of rates--(i) In general. If an advertisement for 
credit secured by a dwelling states a simple annual rate of interest 
and more than one simple annual rate of interest will apply over the 
term of the advertised loan, the advertisement shall disclose in a 
clear and conspicuous manner:
    (A) Each simple annual rate of interest that will apply. In 
variable-rate transactions, a rate determined by adding an index and 
margin shall be disclosed based on a reasonably current index and 
margin;
    (B) The period of time during which each simple annual rate of 
interest will apply; and
    (C) The annual percentage rate for the loan. If such rate is 
variable, the annual percentage rate shall comply with the accuracy 
standards in Sec. Sec.  226.17(c) and 226.22.
    (ii) Clear and conspicuous requirement. For purposes of paragraph 
(f)(2)(i) of this section, clearly and conspicuously disclosed means 
that the required information in paragraphs (f)(2)(i)(A) through (C) 
shall be disclosed with equal prominence and in close proximity to any 
advertised rate that triggered the required disclosures. The required 
information in paragraph (f)(2)(i)(C) may be disclosed with greater 
prominence than the other information.
    (3) Disclosure of payments--(i) In general. In addition to the 
requirements of paragraph (c) of this section, if an advertisement for 
credit secured by a dwelling states the amount of any payment, the 
advertisement shall disclose in a clear and conspicuous manner:
    (A) The amount of each payment that will apply over the term of the 
loan, including any balloon payment. In variable-rate transactions, 
payments that will be determined based on the application of the sum of 
an index and margin shall be disclosed based on a reasonably current 
index and margin;
    (B) The period of time during which each payment will apply; and
    (C) In an advertisement for credit secured by a first lien on a 
dwelling, the fact that the payments do not include amounts for taxes 
and insurance premiums, if applicable, and that the actual payment 
obligation will be greater.
    (ii) Clear and conspicuous requirement. For purposes of paragraph 
(f)(3)(i) of this section, a clear and conspicuous disclosure means 
that the

[[Page 44602]]

required information in paragraphs (f)(3)(i)(A) and (B) shall be 
disclosed with equal prominence and in close proximity to any 
advertised payment that triggered the required disclosures, and that 
the required information in paragraph (f)(3)(i)(C) shall be disclosed 
with prominence and in close proximity to the advertised payments.
    (4) Envelope excluded. The requirements in paragraphs (f)(2) and 
(f)(3) of this section do not apply to an envelope in which an 
application or solicitation is mailed, or to a banner advertisement or 
pop-up advertisement linked to an application or solicitation provided 
electronically.
    (g) Alternative disclosures--television or radio advertisements. An 
advertisement made through television or radio stating any of the terms 
requiring additional disclosures under paragraph (d)(2) of this section 
may comply with paragraph (d)(2) of this section either by:
    (1) Stating clearly and conspicuously each of the additional 
disclosures required under paragraph (d)(2) of this section; or
    (2) Stating clearly and conspicuously the information required by 
paragraph (d)(2)(iii) of this section and listing a toll-free telephone 
number, or any telephone number that allows a consumer to reverse the 
phone charges when calling for information, along with a reference that 
such number may be used by consumers to obtain additional cost 
information.
    (h) Tax implications. If an advertisement distributed in paper form 
or through the Internet (rather than by radio or television) is for a 
loan secured by the consumer's principal dwelling, and the 
advertisement states that the advertised extension of credit may exceed 
the fair market value of the dwelling, the advertisement shall clearly 
and conspicuously state that:
    (1) The interest on the portion of the credit extension that is 
greater than the fair market value of the dwelling is not tax 
deductible for Federal income tax purposes; and
    (2) The consumer should consult a tax adviser for further 
information regarding the deductibility of interest and charges.
    (i) Prohibited acts or practices in advertisements for credit 
secured by a dwelling. The following acts or practices are prohibited 
in advertisements for credit secured by a dwelling:
    (1) Misleading advertising of ``fixed'' rates and payments. Using 
the word ``fixed'' to refer to rates, payments, or the credit 
transaction in an advertisement for variable-rate transactions or other 
transactions where the payment will increase, unless:
    (i) In the case of an advertisement solely for one or more 
variable-rate transactions,
    (A) The phrase ``Adjustable-Rate Mortgage,'' ``Variable-Rate 
Mortgage,'' or ``ARM'' appears in the advertisement before the first 
use of the word ``fixed'' and is at least as conspicuous as any use of 
the word ``fixed'' in the advertisement; and
    (B) Each use of the word ``fixed'' to refer to a rate or payment is 
accompanied by an equally prominent and closely proximate statement of 
the time period for which the rate or payment is fixed, and the fact 
that the rate may vary or the payment may increase after that period;
    (ii) In the case of an advertisement solely for non-variable-rate 
transactions where the payment will increase (e.g., a stepped-rate 
mortgage transaction with an initial lower payment), each use of the 
word ``fixed'' to refer to the payment is accompanied by an equally 
prominent and closely proximate statement of the time period for which 
the payment is fixed, and the fact that the payment will increase after 
that period; or
    (iii) In the case of an advertisement for both variable-rate 
transactions and non-variable-rate transactions,
    (A) The phrase ``Adjustable-Rate Mortgage,'' ``Variable-Rate 
Mortgage,'' or ``ARM'' appears in the advertisement with equal 
prominence as any use of the term ``fixed,'' ``Fixed-Rate Mortgage,'' 
or similar terms; and
    (B) Each use of the word ``fixed'' to refer to a rate, payment, or 
the credit transaction either refers solely to the transactions for 
which rates are fixed and complies with paragraph (i)(1)(ii) of this 
section, if applicable, or, if it refers to the variable-rate 
transactions, is accompanied by an equally prominent and closely 
proximate statement of the time period for which the rate or payment is 
fixed, and the fact that the rate may vary or the payment may increase 
after that period.
    (2) Misleading comparisons in advertisements. Making any comparison 
in an advertisement between actual or hypothetical credit payments or 
rates and any payment or simple annual rate that will be available 
under the advertised product for a period less than the full term of 
the loan, unless:
    (i) In general. The advertisement includes a clear and conspicuous 
comparison to the information required to be disclosed under sections 
226.24(f)(2) and (3); and
    (ii) Application to variable-rate transactions. If the 
advertisement is for a variable-rate transaction, and the advertised 
payment or simple annual rate is based on the index and margin that 
will be used to make subsequent rate or payment adjustments over the 
term of the loan, the advertisement includes an equally prominent 
statement in close proximity to the payment or rate that the payment or 
rate is subject to adjustment and the time period when the first 
adjustment will occur.
    (3) Misrepresentations about government endorsement. Making any 
statement in an advertisement that the product offered is a 
``government loan program'', ``government-supported loan'', or is 
otherwise endorsed or sponsored by any federal, state, or local 
government entity, unless the advertisement is for an FHA loan, VA 
loan, or similar loan program that is, in fact, endorsed or sponsored 
by a federal, state, or local government entity.
    (4) Misleading use of the current lender's name. Using the name of 
the consumer's current lender in an advertisement that is not sent by 
or on behalf of the consumer's current lender, unless the 
advertisement:
    (i) Discloses with equal prominence the name of the person or 
creditor making the advertisement; and
    (ii) Includes a clear and conspicuous statement that the person 
making the advertisement is not associated with, or acting on behalf 
of, the consumer's current lender.
    (5) Misleading claims of debt elimination. Making any misleading 
claim in an advertisement that the mortgage product offered will 
eliminate debt or result in a waiver or forgiveness of a consumer's 
existing loan terms with, or obligations to, another creditor.
    (6) Misleading use of the term ``counselor''. Using the term 
``counselor'' in an advertisement to refer to a for-profit mortgage 
broker or mortgage creditor, its employees, or persons working for the 
broker or creditor that are involved in offering, originating or 
selling mortgages.
    (7) Misleading foreign-language advertisements. Providing 
information about some trigger terms or required disclosures, such as 
an initial rate or payment, only in a foreign language in an 
advertisement, but providing information about other trigger terms or 
required disclosures, such as information about the fully-indexed rate 
or fully amortizing payment, only in English in the same advertisement.

Subpart E--Special Rules for Certain Home Mortgage Transactions

0
9. Section 226.32 is amended by revising paragraphs (d)(6) and (d)(7) 
to read as follows:

[[Page 44603]]

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

* * * * *
    (d) * * *
    (6) Prepayment penalties. Except as allowed under paragraph (d)(7) 
of this section, a penalty for paying all or part of the principal 
before the date on which the principal is due. A prepayment penalty 
includes computing a refund of unearned interest by a method that is 
less favorable to the consumer than the actuarial method, as defined by 
section 933(d) of the Housing and Community Development Act of 1992, 15 
U.S.C. 1615(d).
    (7) Prepayment penalty exception. A mortgage transaction subject to 
this section may provide for a prepayment penalty (including a refund 
calculated according to the rule of 78s) otherwise permitted by law if, 
under the terms of the loan:
    (i) The penalty will not apply after the two-year period following 
consummation;
    (ii) The penalty will not apply if the source of the prepayment 
funds is a refinancing by the creditor or an affiliate of the creditor;
    (iii) At consummation, the consumer's total monthly debt payments 
(including amounts owed under the mortgage) do not exceed 50 percent of 
the consumer's monthly gross income, as verified in accordance with 
Sec.  226.34(a)(4)(ii); and
    (iv) The amount of the periodic payment of principal or interest or 
both may not change during the four-year period following consummation.
* * * * *

0
10. Section 226.34 is amended by revising the heading and paragraph 
(a)(4) to read as follows:


Sec.  226.34  Prohibited acts or practices in connection with credit 
subject to Sec.  226.32.

    (a) * * *
    (4) Repayment ability. Extend credit subject to Sec.  226.32 to a 
consumer based on the value of the consumer's collateral without regard 
to the consumer's repayment ability as of consummation, including the 
consumer's current and reasonably expected income, employment, assets 
other than the collateral, current obligations, and mortgage-related 
obligations.
    (i) Mortgage-related obligations. For purposes of this paragraph 
(a)(4), mortgage-related obligations are expected property taxes, 
premiums for mortgage-related insurance required by the creditor as set 
forth in Sec.  226.35(b)(3)(i), and similar expenses.
    (ii) Verification of repayment ability. Under this paragraph (a)(4) 
a creditor must verify the consumer's repayment ability as follows:
    (A) A creditor must verify amounts of income or assets that it 
relies on to determine repayment ability, including expected income or 
assets, by the consumer's Internal Revenue Service Form W-2, tax 
returns, payroll receipts, financial institution records, or other 
third-party documents that provide reasonably reliable evidence of the 
consumer's income or assets.
    (B) Notwithstanding paragraph (a)(4)(ii)(A), a creditor has not 
violated paragraph (a)(4)(ii) if the amounts of income and assets that 
the creditor relied upon in determining repayment ability are not 
materially greater than the amounts of the consumer's income or assets 
that the creditor could have verified pursuant to paragraph 
(a)(4)(ii)(A) at the time the loan was consummated.
    (C) A creditor must verify the consumer's current obligations.
    (iii) Presumption of compliance. A creditor is presumed to have 
complied with this paragraph (a)(4) with respect to a transaction if 
the creditor:
    (A) Verifies the consumer's repayment ability as provided in 
paragraph (a)(4)(ii);
    (B) Determines the consumer's repayment ability using the largest 
payment of principal and interest scheduled in the first seven years 
following consummation and taking into account current obligations and 
mortgage-related obligations as defined in paragraph (a)(4)(i); and
    (C) Assesses the consumer's repayment ability taking into account 
at least one of the following: The ratio of total debt obligations to 
income, or the income the consumer will have after paying debt 
obligations.
    (iv) Exclusions from presumption of compliance. Notwithstanding the 
previous paragraph, no presumption of compliance is available for a 
transaction for which:
    (A) The regular periodic payments for the first seven years would 
cause the principal balance to increase; or
    (B) The term of the loan is less than seven years and the regular 
periodic payments when aggregated do not fully amortize the outstanding 
principal balance.
    (v) Exemption. This paragraph (a)(4) does not apply to temporary or 
``bridge'' loans with terms of twelve months or less, such as a loan to 
purchase a new dwelling where the consumer plans to sell a current 
dwelling within twelve months.
* * * * *

0
11. New Sec.  226.35 is added to read as follows:


Sec.  226.35  Prohibited acts or practices in connection with higher-
priced mortgage loans.

    (a) Higher-priced mortgage loans--(1) For purposes of this section, 
a higher-priced mortgage loan is a consumer credit transaction secured 
by the consumer's principal dwelling with an annual percentage rate 
that exceeds the average prime offer rate for a comparable transaction 
as of the date the interest rate is set by 1.5 or more percentage 
points for loans secured by a first lien on a dwelling, or by 3.5 or 
more percentage points for loans secured by a subordinate lien on a 
dwelling.
    (2) ``Average prime offer rate'' means an annual percentage rate 
that is derived from average interest rates, points, and other loan 
pricing terms currently offered to consumers by a representative sample 
of creditors for mortgage transactions that have low-risk pricing 
characteristics. The Board publishes average prime offer rates for a 
broad range of types of transactions in a table updated at least weekly 
as well as the methodology the Board uses to derive these rates.
    (3) Notwithstanding paragraph (a)(1) of this section, the term 
``higher-priced mortgage loan'' does not include a transaction to 
finance the initial construction of a dwelling, a temporary or 
``bridge'' loan with a term of twelve months or less, such as a loan to 
purchase a new dwelling where the consumer plans to sell a current 
dwelling within twelve months, a reverse-mortgage transaction subject 
to Sec.  226.33, or a home equity line of credit subject to Sec.  
226.5b.
    (b) Rules for higher-priced mortgage loans. Higher-priced mortgage 
loans are subject to the following restrictions:
    (1) Repayment ability. A creditor shall not extend credit based on 
the value of the consumer's collateral without regard to the consumer's 
repayment ability as of consummation as provided in Sec.  226.34(a)(4).
    (2) Prepayment penalties. A loan may not include a penalty 
described by Sec.  226.32(d)(6) unless:
    (i) The penalty is otherwise permitted by law, including Sec.  
226.32(d)(7) if the loan is a mortgage transaction described in Sec.  
226.32(a); and
    (ii) Under the terms of the loan--
    (A) The penalty will not apply after the two-year period following 
consummation;
    (B) The penalty will not apply if the source of the prepayment 
funds is a refinancing by the creditor or an affiliate of the creditor; 
and
    (C) The amount of the periodic payment of principal or interest or 
both

[[Page 44604]]

may not change during the four-year period following consummation.
    (3) Escrows--(i) Failure to escrow for property taxes and 
insurance. Except as provided in paragraph (b)(3)(ii) of this section, 
a creditor may not extend a loan secured by a first lien on a principal 
dwelling unless an escrow account is established before consummation 
for payment of property taxes and premiums for mortgage-related 
insurance required by the creditor, such as insurance against loss of 
or damage to property, or against liability arising out of the 
ownership or use of the property, or insurance protecting the creditor 
against the consumer's default or other credit loss.
    (ii) Exemptions for loans secured by shares in a cooperative and 
for certain condominium units--(A) Escrow accounts need not be 
established for loans secured by shares in a cooperative; and
    (B) Insurance premiums described in paragraph (b)(3)(i) of this 
section need not be included in escrow accounts for loans secured by 
condominium units, where the condominium association has an obligation 
to the condominium unit owners to maintain a master policy insuring 
condominium units.
    (iii) Cancellation. A creditor or servicer may permit a consumer to 
cancel the escrow account required in paragraph (b)(3)(i) of this 
section only in response to a consumer's dated written request to 
cancel the escrow account that is received no earlier than 365 days 
after consummation.
    (iv) Definition of escrow account. For purposes of this section, 
``escrow account'' shall have the same meaning as in 24 CFR 3500.17(b) 
as amended.
    (4) Evasion; open-end credit. In connection with credit secured by 
a consumer's principal dwelling that does not meet the definition of 
open-end credit in Sec.  226.2(a)(20), a creditor shall not structure a 
home-secured loan as an open-end plan to evade the requirements of this 
section.

0
12. New Sec.  226.36 is added to read as follows:


Sec.  226.36  Prohibited acts or practices in connection with credit 
secured by a consumer's principal dwelling.

    (a) Mortgage broker defined. For purposes of this section, the term 
``mortgage broker'' means a person, other than an employee of a 
creditor, who for compensation or other monetary gain, or in 
expectation of compensation or other monetary gain, arranges, 
negotiates, or otherwise obtains an extension of consumer credit for 
another person. The term includes a person meeting this definition, 
even if the consumer credit obligation is initially payable to such 
person, unless the person provides the funds for the transaction at 
consummation out of the person's own resources, out of deposits held by 
the person, or by drawing on a bona fide warehouse line of credit.
    (b) Misrepresentation of value of consumer's dwelling--(1) Coercion 
of appraiser. In connection with a consumer credit transaction secured 
by a consumer's principal dwelling, no creditor or mortgage broker, and 
no affiliate of a creditor or mortgage broker shall directly or 
indirectly coerce, influence, or otherwise encourage an appraiser to 
misstate or misrepresent the value of such dwelling.
    (i) Examples of actions that violate this paragraph (b)(1) include:
    (A) Implying to an appraiser that current or future retention of 
the appraiser depends on the amount at which the appraiser values a 
consumer's principal dwelling;
    (B) Excluding an appraiser from consideration for future engagement 
because the appraiser reports a value of a consumer's principal 
dwelling that does not meet or exceed a minimum threshold;
    (C) Telling an appraiser a minimum reported value of a consumer's 
principal dwelling that is needed to approve the loan;
    (D) Failing to compensate an appraiser because the appraiser does 
not value a consumer's principal dwelling at or above a certain amount; 
and
    (E) Conditioning an appraiser's compensation on loan consummation.
    (ii) Examples of actions that do not violate this paragraph (b)(1) 
include:
    (A) Asking an appraiser to consider additional information about a 
consumer's principal dwelling or about comparable properties;
    (B) Requesting that an appraiser provide additional information 
about the basis for a valuation;
    (C) Requesting that an appraiser correct factual errors in a 
valuation;
    (D) Obtaining multiple appraisals of a consumer's principal 
dwelling, so long as the creditor adheres to a policy of selecting the 
most reliable appraisal, rather than the appraisal that states the 
highest value;
    (E) Withholding compensation from an appraiser for breach of 
contract or substandard performance of services as provided by 
contract; and
    (F) Taking action permitted or required by applicable federal or 
state statute, regulation, or agency guidance.
    (2) When extension of credit prohibited. In connection with a 
consumer credit transaction secured by a consumer's principal dwelling, 
a creditor who knows, at or before loan consummation, of a violation of 
paragraph (b)(1) of this section in connection with an appraisal shall 
not extend credit based on such appraisal unless the creditor documents 
that it has acted with reasonable diligence to determine that the 
appraisal does not materially misstate or misrepresent the value of 
such dwelling.
    (3) Appraiser defined. As used in this paragraph (b), an appraiser 
is a person who engages in the business of providing assessments of the 
value of dwellings. The term ``appraiser'' includes persons that 
employ, refer, or manage appraisers and affiliates of such persons.
    (c) Servicing practices. (1) In connection with a consumer credit 
transaction secured by a consumer's principal dwelling, no servicer 
shall--
    (i) Fail to credit a payment to the consumer's loan account as of 
the date of receipt, except when a delay in crediting does not result 
in any charge to the consumer or in the reporting of negative 
information to a consumer reporting agency, or except as provided in 
paragraph (c)(2) of this section;
    (ii) Impose on the consumer any late fee or delinquency charge in 
connection with a payment, when the only delinquency is attributable to 
late fees or delinquency charges assessed on an earlier payment, and 
the payment is otherwise a full payment for the applicable period and 
is paid on its due date or within any applicable grace period; or
    (iii) Fail to provide, within a reasonable time after receiving a 
request from the consumer or any person acting on behalf of the 
consumer, an accurate statement of the total outstanding balance that 
would be required to satisfy the consumer's obligation in full as of a 
specified date.
    (2) If a servicer specifies in writing requirements for the 
consumer to follow in making payments, but accepts a payment that does 
not conform to the requirements, the servicer shall credit the payment 
as of 5 days after receipt.
    (3) For purposes of this paragraph (c), the terms ``servicer'' and 
``servicing'' have the same meanings as provided in 24 CFR 3500.2(b), 
as amended.
    (d) This section does not apply to a home equity line of credit 
subject to Sec.  226.5b.

Supplement I to Part 226--Official Staff Interpretations

Subpart A--General

0
13. In Supplement I to Part 226, under Section 226.1--Authority, 
Purpose, Coverage, Organization, Enforcement

[[Page 44605]]

and Liability, new headings 1(d) Organization and Paragraph 1(d)(5), 
and new paragraph 1(d)(5)-1 are added to read as follows:

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

* * * * *
    1(d) Organization.
    Paragraph 1(d)(5).
    1. Effective dates. The Board's revisions to Regulation Z 
published on July 30, 2008 (the ``final rules''), apply to covered 
loans (including refinance loans and assumptions considered new 
transactions under 226.20), for which the creditor receives an 
application on or after October 1, 2009, except for the final rules 
on advertising, escrows, and loan servicing. The final rules on 
escrows in Sec.  226.35(b)(3) are effective for covered loans, 
(including refinancings and assumptions in 226.20) for which the 
creditor receives an application on or after April 1, 2010; but for 
such loans secured by manufactured housing on or after October 1, 
2010. The final rules applicable to servicers in Sec.  226.36(c) 
apply to all covered loans serviced on or after October 1, 2009. The 
final rules on advertising apply to advertisements occurring on or 
after October 1, 2009. For example, a radio ad occurs on the date it 
is first broadcast; a solicitation occurs on the date it is mailed 
to the consumer. The following examples illustrate the application 
of the effective dates for the final rules.
    i. General. A refinancing or assumption as defined in 226.20(a) 
or (b) is a new transaction and is covered by a provision of the 
final rule if the creditor receives an application for the 
transaction on or after that provision's effective date. For 
example, if a creditor receives an application for a refinance loan 
covered by 226.35(a) on or after October 1, 2009, and the refinance 
loan is consummated on October 15, 2009, the provision restricting 
prepayment penalties in Sec.  226.35(b)(2) applies. However, If the 
transaction were a modification of an existing obligation's terms 
that does not constitute a refinance loan under Sec.  226.20(a), the 
final rules, including for example the restriction on prepayment 
penalties would not apply.
    ii. Escrows. Assume a consumer applies for a refinance loan to 
be secured by a dwelling (that is not a manufactured home) on March 
15, 2010, and the loan is consummated on April 2, 2010, the escrow 
rule in 226.35(b)(3) does not apply.
    iii. Servicing. Assume that a consumer applies for a new loan on 
August 1, 2009. The loan is consummated on September 1, 2009. The 
servicing rules in 226.36(c) apply to the servicing of that loan as 
of October 1, 2009.


0
14. In Supplement I to Part 226, under Section 226.2--Definitions and 
Rules of Construction, 2(a) Definitions, 2(a)(6) Business day, 
paragraph 2(a)(6)-2 is revised, and under 2(a)(24) Residential mortgage 
transaction, paragraphs 2(a)(24)-1 and 2(a)(24)-5.ii are revised, to 
read as follows:

Section 226.2--Definitions and Rules of Construction

    2(a) Definitions.
* * * * *
    2(a)(6) Business day.
* * * * *
    2. Recission rule. A more precise rule for what is a business 
day (all calendar days except Sundays and the federal legal holidays 
listed in 5 U.S.C. 6103(a)) applies when the right of rescission, 
the receipt of disclosures for certain mortgage transactions under 
section 226.19(a)(1)(ii), or mortgages subject to section 226.32 are 
involved. (See also comment 31(c)(1)-1.) Four federal legal holidays 
are identified in 5 U.S.C. 6103(a) by a specific date: New Year's 
Day, January 1; Independence Day, July 4; Veterans Day, November 11; 
and Christmas Day, December 25. When one of these holidays (July 4, 
for example) falls on a Saturday, federal offices and other entities 
might observe the holiday on the preceding Friday (July 3). The 
observed holiday (in the example, July 3) is a business day for 
purposes of rescission, the receipt of disclosures for certain 
mortgage transactions under section 226.19(a)(1)(ii), or the 
delivery of disclosures for certain high-cost mortgages covered by 
section 226.32.
* * * * *
    2(a)(24) Residential mortgage transaction.
    1. Relation to other sections. This term is important in five 
provisions in the regulation:
    i. Sec.  226.4(c)(7)--exclusions from the finance charge.
    ii. Sec.  226.15(f)--exemption from the right of rescission.
    iii. Sec.  226.18(q)--whether or not the obligation is 
assumable.
    iv. Sec.  226.20(b)--disclosure requirements for assumptions.
    v. Sec.  226.23(f)--exemption from the right of rescission.
* * * * *
    5. Acquisition. * * *
* * * * *
    ii. Examples of new transactions involving a previously acquired 
dwelling include the financing of a balloon payment due under a land 
sale contract and an extension of credit made to a joint owner of 
property to buy out the other joint owner's interest. In these 
instances, disclosures are not required under Sec.  226.18(q) 
(assumability policies). However, the rescission rules of Sec. Sec.  
226.15 and 226.23 do apply to these new transactions.
* * * * *

Subpart B--Open-End Credit

0
 15. In Supplement I to Part 226, under Section 226.16--Advertising, 
paragraph 16-1 is revised, paragraph 16-2 is redesignated as paragraph 
16-6, and new paragraphs 16-2 through 16-5 and 16-7 are added; under 
16(d) Additional requirements for home-equity plans, paragraph 16(d)-3 
is revised, paragraphs 16(d)-5, 16(d)-6, and 16(d)-7 are redesignated 
as paragraphs 16(d)-7, 16(d)-8, and 16(d)-9, respectively, new 
paragraphs 16(d)-5 and 16(d)-6 are added, and newly designated 
paragraphs 16(d)-7 and 16(d)-9 are revised; and new heading 16(e) 
Alternative disclosures--television or radio advertisements is added, 
and new paragraphs 16(e)-1 and 16(e)-2 are added, to read as follows:

Section 226.16--Advertising

    1. Clear and conspicuous standard--general. Section 226.16 is 
subject to the general ``clear and conspicuous'' standard for 
subpart B (see Sec.  226.5(a)(1)) but prescribes no specific rules 
for the format of the necessary disclosures, aside from the format 
requirements related to the disclosure of a promotional rate under 
Sec.  226.16(d)(6). Aside from the terms described in Sec.  
226.16(d)(6), the credit terms need not be printed in a certain type 
size nor need they appear in any particular place in the 
advertisement.
    2. Clear and conspicuous standard--promotional rates or payments 
for home-equity plans. For purposes of Sec.  226.16(d)(6), a clear 
and conspicuous disclosure means that the required information in 
Sec.  226.16(d)(6)(ii)(A)-(C) is disclosed with equal prominence and 
in close proximity to the promotional rate or payment to which it 
applies. If the information in Sec.  226.16(d)(6)(ii)(A)-(C) is the 
same type size and is located immediately next to or directly above 
or below the promotional rate or payment to which it applies, 
without any intervening text or graphical displays, the disclosures 
would be deemed to be equally prominent and in close proximity. 
Notwithstanding the above, for electronic advertisements that 
disclose promotional rates or payments, compliance with the 
requirements of Sec.  226.16(c) is deemed to satisfy the clear and 
conspicuous standard.
    3. Clear and conspicuous standard--Internet advertisements for 
home-equity plans. For purposes of this section, a clear and 
conspicuous disclosure for visual text advertisements on the 
Internet for home-equity plans subject to the requirements of Sec.  
226.5b means that the required disclosures are not obscured by 
techniques such as graphical displays, shading, coloration, or other 
devices and comply with all other requirements for clear and 
conspicuous disclosures under Sec.  226.16(d). See also comment 
16(c)(1)-2.
    4. Clear and conspicuous standard--televised advertisements for 
home-equity plans. For purposes of this section, including 
alternative disclosures as provided for by Sec.  226.16(e), a clear 
and conspicuous disclosure in the context of visual text 
advertisements on television for home-equity plans subject to the 
requirements of Sec.  226.5b means that the required disclosures are 
not obscured by techniques such as graphical displays, shading, 
coloration, or other devices, are displayed in a manner that allows 
for a consumer to read the information required to be disclosed, and 
comply with all other requirements for clear and conspicuous 
disclosures under Sec.  226.16(d). For example, very fine print in a 
television advertisement would not meet the clear and conspicuous 
standard if consumers cannot see and read the information required 
to be disclosed.

[[Page 44606]]

    5. Clear and conspicuous standard--oral advertisements for home-
equity plans. For purposes of this section, including alternative 
disclosures as provided for by Sec.  226.16(e), a clear and 
conspicuous disclosure in the context of an oral advertisement for 
home-equity plans subject to the requirements of Sec.  226.5b, 
whether by radio, television, the Internet, or other medium, means 
that the required disclosures are given at a speed and volume 
sufficient for a consumer to hear and comprehend them. For example, 
information stated very rapidly at a low volume in a radio or 
television advertisement would not meet the clear and conspicuous 
standard if consumers cannot hear and comprehend the information 
required to be disclosed.
    6. Expressing the annual percentage rate in abbreviated form. * 
* *
    7. Effective date. For guidance on the applicability of the 
Board's revisions to Sec.  226.16 published on July 30, 2008, see 
comment 1(d)(5)-1.
* * * * *
    16(d) Additional requirements for home-equity plans.
* * * * *
    3. Statements of tax deductibility. An advertisement that refers 
to deductibility for tax purposes is not misleading if it includes a 
statement such as ``consult a tax advisor regarding the 
deductibility of interest.'' An advertisement distributed in paper 
form or through the Internet (rather than by radio or television) 
that states that the advertised extension of credit may exceed the 
fair market value of the consumer's dwelling is not misleading if it 
clearly and conspicuously states the required information in 
Sec. Sec.  226.16(d)(4)(i) and (ii).
* * * * *
    5. Promotional rates and payments in advertisements for home-
equity plans. Section 226.16(d)(6) requires additional disclosures 
for promotional rates or payments.
    i. Variable-rate plans. In advertisements for variable-rate 
plans, if the advertised annual percentage rate is based on (or the 
advertised payment is derived from) the index and margin that will 
be used to make rate (or payment) adjustments over the term of the 
loan, then there is no promotional rate or promotional payment. If, 
however, the advertised annual percentage rate is not based on (or 
the advertised payment is not derived from) the index and margin 
that will be used to make rate (or payment) adjustments, and a 
reasonably current application of the index and margin would result 
in a higher annual percentage rate (or, given an assumed balance, a 
higher payment) then there is a promotional rate or promotional 
payment.
    ii. Equal prominence, close proximity. Information required to 
be disclosed in Sec.  226.16(d)(6)(ii) that is immediately next to 
or directly above or below the promotional rate or payment (but not 
in a footnote) is deemed to be closely proximate to the listing. 
Information required to be disclosed in Sec.  226.16(d)(6)(ii) that 
is in the same type size as the promotional rate or payment is 
deemed to be equally prominent.
    iii. Amounts and time periods of payments. Section 
226.16(d)(6)(ii)(C) requires disclosure of the amount and time 
periods of any payments that will apply under the plan. This section 
may require disclosure of several payment amounts, including any 
balloon payment. For example, if an advertisement for a home-equity 
plan offers a $100,000 five-year line of credit and assumes that the 
entire line is drawn resulting in a minimum payment of $800 per 
month for the first six months, increasing to $1,000 per month after 
month six, followed by a $50,000 balloon payment after five years, 
the advertisement must disclose the amount and time period of each 
of the two monthly payment streams, as well as the amount and timing 
of the balloon payment, with equal prominence and in close proximity 
to the promotional payment. However, if the final payment could not 
be more than twice the amount of other minimum payments, the final 
payment need not be disclosed.
    iv. Plans other than variable-rate plans. For a plan other than 
a variable-rate plan, if an advertised payment is calculated in the 
same way as other payments based on an assumed balance, the fact 
that the minimum payment could increase solely if the consumer made 
an additional draw does not make the payment a promotional payment. 
For example, if a payment of $500 results from an assumed $10,000 
draw, and the payment would increase to $1,000 if the consumer made 
an additional $10,000 draw, the payment is not a promotional 
payment.
    v. Conversion option. Some home-equity plans permit the consumer 
to repay all or part of the balance during the draw period at a 
fixed rate (rather than a variable rate) and over a specified time 
period. The fixed-rate conversion option does not, by itself, make 
the rate or payment that would apply if the consumer exercised the 
fixed-rate conversion option a promotional rate or payment.
    vi. Preferred-rate provisions. Some home-equity plans contain a 
preferred-rate provision, where the rate will increase upon the 
occurrence of some event, such as the consumer-employee leaving the 
creditor's employ, the consumer closing an existing deposit account 
with the creditor, or the consumer revoking an election to make 
automated payments. A preferred-rate provision does not, by itself, 
make the rate or payment under the preferred-rate provision a 
promotional rate or payment.
    6. Reasonably current index and margin. For the purposes of this 
section, an index and margin is considered reasonably current if:
    i. For direct mail advertisements, it was in effect within 60 
days before mailing;
    ii. For advertisements in electronic form it was in effect 
within 30 days before the advertisement is sent to a consumer's e-
mail address, or in the case of an advertisement made on an Internet 
Web site, when viewed by the public; or
    iii. For printed advertisements made available to the general 
public, including ones contained in a catalog, magazine, or other 
generally available publication, it was in effect within 30 days 
before printing.
    7. Relation to other sections. Advertisements for home-equity 
plans must comply with all provisions in Sec.  226.16 not solely the 
rules in Sec.  226.16(d). If an advertisement contains information 
(such as the payment terms) that triggers the duty under Sec.  
226.16(d) to state the annual percentage rate, the additional 
disclosures in Sec.  226.16(b) must be provided in the 
advertisement. While Sec.  226.16(d) does not require a statement of 
fees to use or maintain the plan (such as membership fees and 
transaction charges), such fees must be disclosed under Sec.  
226.16(b)(1) and (3).
* * * * *
    9. Balloon payment. See comment 5b(d)(5)(ii)-3 for information 
not required to be stated in advertisements, and on situations in 
which the balloon payment requirement does not apply.
    16(e) Alternative disclosures--television or radio 
advertisements.
    1. Multi-purpose telephone number. When an advertised telephone 
number provides a recording, disclosures should be provided early in 
the sequence to ensure that the consumer receives the required 
disclosures. For example, in providing several options--such as 
providing directions to the advertiser's place of business--the 
option allowing the consumer to request disclosures should be 
provided early in the telephone message to ensure that the option to 
request disclosures is not obscured by other information.
    2. Statement accompanying telephone number. Language must 
accompany a telephone number indicating that disclosures are 
available by calling the telephone number, such as ``call 1-800-000-
0000 for details about credit costs and terms.''

Subpart C--Closed-End Credit

0
16. In Supplement I to Part 226, under Section 226.17--General 
Disclosure Requirements, 17(c) Basis of disclosures and use of 
estimates, Paragraph 17(c)(1), paragraph 17(c)(1)-8 is revised, and 
under 17(f) Early disclosures, paragraph 17(f)-4 is revised, to read as 
follows:

Section 226.17--General Disclosure Requirements

* * * * *
    17(c) Basis of disclosures and use of estimates.
* * * * *
    Paragraph 17(c)(1).
* * * * *
    8. Basis of disclosures in variable-rate transactions. The 
disclosures for a variable-rate transaction must be given for the 
full term of the transaction and must be based on the terms in 
effect at the time of consummation. Creditors should base the 
disclosures only on the initial rate and should not assume that this 
rate will increase. For example, in a loan with an initial rate of 
10 percent and a 5 percentage points rate cap, creditors should base 
the disclosures on the initial rate and should not assume that this 
rate will increase 5 percentage points. However, in a variable-rate 
transaction with a seller buydown that is reflected in the credit 
contract, a consumer

[[Page 44607]]

buydown, or a discounted or premium rate, disclosures should not be 
based solely on the initial terms. In those transactions, the 
disclosed annual percentage rate should be a composite rate based on 
the rate in effect during the initial period and the rate that is 
the basis of the variable-rate feature for the remainder of the 
term. (See the commentary to Sec.  226.17(c) for a discussion of 
buydown, discounted, and premium transactions and the commentary to 
Sec.  226.19(a)(2) for a discussion of the redisclosure in certain 
mortgage transactions with a variable-rate feature.)
* * * * *
    17(f) Early disclosures.
* * * * *
    4. Special rules. In mortgage transactions subject to Sec.  
226.19, the creditor must redisclose if, between the delivery of the 
required early disclosures and consummation, the annual percentage 
rate changes by more than a stated tolerance. When subsequent events 
occur after consummation, new disclosures are required only if there 
is a refinancing or an assumption within the meaning of Sec.  
226.20.
* * * * *
0
17. In Supplement I to Part 226, under Section 226.19--Certain 
Residential Mortgage and Variable-Rate Transactions, the heading is 
revised, heading 19(a)(1) Time of disclosure is redesignated as heading 
19(a)(1)(i) Time of disclosure, paragraphs 19(a)(1)(i)-1 and 
19(a)(1)(i)-5 are revised, new heading 19(a)(1)(ii) Imposition of fees 
and new paragraphs 19(a)(1)(ii)-1 through 19(a)(1)(ii)-3 are added , 
and new heading 19(a)(1)(iii) Exception to fee restriction and new 
paragraph 19(a)(1)(iii)-1 are added, to read as follows:

Section 226.19--Certain Mortgage and Variable-Rate Transactions

    19(a)(1)(i) Time of disclosure.
    1. Coverage. This section requires early disclosure of credit 
terms in mortgage transactions that are secured by a consumer's 
principal dwelling and also subject to the Real Estate Settlement 
Procedures Act (RESPA) and its implementing Regulation X, 
administered by the Department of Housing and Urban Development 
(HUD). To be covered by Sec.  226.19, a transaction must be a 
federally related mortgage loan under RESPA. ``Federally related 
mortgage loan'' is defined under RESPA (12 U.S.C. 2602) and 
Regulation X (24 CFR 3500.2), and is subject to any interpretations 
by HUD. RESPA coverage includes such transactions as loans to 
purchase dwellings, refinancings of loans secured by dwellings, and 
subordinate-lien home-equity loans, among others. Although RESPA 
coverage relates to any dwelling, Sec.  226.19(a) applies to such 
transactions only if they are secured by a consumer's principal 
dwelling. Also, home equity lines of credit subject to Sec.  226.5b 
are not covered by Sec.  226.19(a). For guidance on the 
applicability of the Board's revisions to Sec.  226.19(a) published 
on July 30, 2008, see comment 1(d)(5)-1
* * * * *
    5. Itemization of amount financed. In many mortgage 
transactions, the itemization of the amount financed required by 
Sec.  226.18(c) will contain items, such as origination fees or 
points, that also must be disclosed as part of the good faith 
estimates of settlement costs required under RESPA. Creditors 
furnishing the RESPA good faith estimates need not give consumers 
any itemization of the amount financed, either with the disclosures 
provided within three days after application or with the disclosures 
given at consummation or settlement.
    19(a)(1)(ii) Imposition of fees.
    1. Timing of fees. The consumer must receive the disclosures 
required by this section before paying or incurring any fee imposed 
by a creditor or other person in connection with the consumer's 
application for a mortgage transaction that is subject to Sec.  
226.19(a)(1)(i), except as provided in Sec.  226.19(a)(1)(iii). If 
the creditor delivers the disclosures to the consumer in person, a 
fee may be imposed anytime after delivery. If the creditor places 
the disclosures in the mail, the creditor may impose a fee after the 
consumer receives the disclosures or, in all cases, after midnight 
on the third business day following mailing of the disclosures. For 
purposes of Sec.  226.19(a)(1)(ii), the term ``business day'' means 
all calendar days except Sundays and legal public holidays referred 
to in Sec.  226.2(a)(6). See Comment 2(a)(6)-2. For example, 
assuming that there are no intervening legal public holidays, a 
creditor that receives the consumer's written application on Monday 
and mails the early mortgage loan disclosure on Tuesday may impose a 
fee on the consumer after midnight on Friday.
    2. Fees restricted. A creditor or other person may not impose 
any fee, such as for an appraisal, underwriting, or broker services, 
until the consumer has received the disclosures required by Sec.  
226.19(a)(1)(i). The only exception to the fee restriction allows 
the creditor or other person to impose a bona fide and reasonable 
fee for obtaining a consumer's credit history, such as for a credit 
report(s).
    3. Collection of fees. A creditor complies with Sec.  
226.19(a)(1)(ii) if--
    i. The creditor receives a consumer's written application 
directly from the consumer and does not collect any fee, other than 
a fee for obtaining a consumer's credit history, until the consumer 
receives the early mortgage loan disclosure.
    ii. A third party submits a consumer's written application to a 
creditor and both the creditor and third party do not collect any 
fee, other than a fee for obtaining a consumer's credit history, 
until the consumer receives the early mortgage loan disclosure from 
the creditor.
    iii. A third party submits a consumer's written application to a 
second creditor following a prior creditor's denial of an 
application made by the same consumer (or following the consumer's 
withdrawal), and, if a fee already has been assessed, the new 
creditor or third party does not collect or impose any additional 
fee until the consumer receives an early mortgage loan disclosure 
from the new creditor.
    19(a)(1)(iii) Exception to fee restriction.
    1. Requirements. A creditor or other person may impose a fee 
before the consumer receives the required disclosures if it is for 
obtaining the consumer's credit history, such as by purchasing a 
credit report(s) on the consumer. The fee also must be bona fide and 
reasonable in amount. For example, a creditor may collect a fee for 
obtaining a credit report(s) if it is in the creditor's ordinary 
course of business to obtain a credit report(s). If the criteria in 
Sec.  226.19(a)(1)(iii) are met, the creditor may describe or refer 
to this fee, for example, as an ``application fee.''
* * * * *

0
18. In Supplement I to Part 226, under Section 226.24--Advertising, 
paragraph 24-1 is revised; heading 24(d) Catalogs or other multiple-
page advertisements; electronic advertisements and paragraphs 24(d)-1 
through 24(d)-4 are redesignated as heading 24(e) Catalogs or other 
multiple-page advertisements; electronic advertisements and paragraphs 
24(e)-1 through 24(e)-4, respectively; headings 24(c) Advertisements of 
terms that require additional disclosures, Paragraph 24(c)(1), and 
Paragraph 24(c)(2) and paragraphs 24(c)-1, 24(c)(1)-1 through 24(c)(1)-
4, and 24(c)(2)-1 through 24(c)(2)-4 are redesignated as headings 24(d) 
Advertisements of terms that require additional disclosures, Paragraph 
24(d)(1), and Paragraph 24(d)(2) and paragraphs 24(d)-1, 24(d)(1)-1 
through 24(d)(1)-4, and 24(d)(2)-1 through 24(d)(2)-4, respectively; 
heading 24(b) Advertisement of rate of finance charge and paragraphs 
24(b)-1 through 24(b)-5 are redesignated as heading 24(c) Advertisement 
of rate of finance charge and paragraphs 24(c)-1 through 24(c)-5, 
respectively; new heading 24(b) Clear and conspicuous standard and new 
paragraphs 24(b)-1 through 24(b)-5 are added; newly designated 
paragraphs 24(c)-2 and 24(c)-3 are revised, newly designated paragraph 
24(c)-4 is removed, and newly designated paragraph 24(c)-5 is further 
redesignated as 24(c)-4 and revised; newly designated paragraphs 24(d)-
1, 24(d)(1)-3, and 24(d)(2)-2 are revised, newly designated paragraphs 
24(d)(2)-3 and 24(d)(2)-4 are further redesignated as 24(d)(2)-4 and 
24(d)(2)-5, respectively, new paragraph 24(d)(2)-3 is added, and newly 
designated paragraph 24(d)(2)-5 is revised; newly designated paragraph 
24(e)-1, 24(e)-2, and 24(e)-4 are revised; and new headings 24(f) 
Disclosure of rates and payments in advertisements for credit secured 
by a dwelling, 24(f)(3) Disclosure of payments, 24(g) Alternative 
disclosures--television or

[[Page 44608]]

radio advertisements, and 24(i) Prohibited acts or practices in 
advertisements for credit secured by a dwelling and new paragraphs 
24(f)-1 through 24(f)-6, 24(f)(3)-1, 24(f)(3)-2, 24(g)-1, 24(g)-2, and 
24(i)-1 through 24(i)-3 are added, to read as follows:

Section 226.24--Advertising

    1. Effective date. For guidance on the applicability of the 
Board's changes to Sec.  226.24 published on July 30, 2008, see 
comment 1(d)(5)-1.
* * * * *
    24(b) Clear and conspicuous standard.
    1. Clear and conspicuous standard--general. This section is 
subject to the general ``clear and conspicuous'' standard for this 
subpart, see Sec.  226.17(a)(1), but prescribes no specific rules 
for the format of the necessary disclosures, other than the format 
requirements related to the advertisement of rates and payments as 
described in comment 24(b)-2 below. The credit terms need not be 
printed in a certain type size nor need they appear in any 
particular place in the advertisement. For example, a merchandise 
tag that is an advertisement under the regulation complies with this 
section if the necessary credit terms are on both sides of the tag, 
so long as each side is accessible.
    2. Clear and conspicuous standard--rates and payments in 
advertisements for credit secured by a dwelling. For purposes of 
Sec.  226.24(f), a clear and conspicuous disclosure means that the 
required information in Sec. Sec.  226.24(f)(2)(i) and 
226.24(f)(3)(i)(A) and (B) is disclosed with equal prominence and in 
close proximity to the advertised rates or payments triggering the 
required disclosures, and that the required information in Sec.  
226.24(f)(3)(i)(C) is disclosed prominently and in close proximity 
to the advertised rates or payments triggering the required 
disclosures. If the required information in Sec. Sec.  
226.24(f)(2)(i) and 226.24(f)(3)(i)(A) and (B) is the same type size 
as the advertised rates or payments triggering the required 
disclosures, the disclosures are deemed to be equally prominent. The 
information in Sec.  226.24(f)(3)(i)(C) must be disclosed 
prominently, but need not be disclosed with equal prominence or be 
the same type size as the payments triggering the required 
disclosures. If the required information in Sec. Sec.  
226.24(f)(2)(i) and 226.24(f)(3)(i) is located immediately next to 
or directly above or below the advertised rates or payments 
triggering the required disclosures, without any intervening text or 
graphical displays, the disclosures are deemed to be in close 
proximity. Notwithstanding the above, for electronic advertisements 
that disclose rates or payments, compliance with the requirements of 
Sec.  226.24(e) is deemed to satisfy the clear and conspicuous 
standard.
    3. Clear and conspicuous standard--Internet advertisements for 
credit secured by a dwelling. For purposes of this section, a clear 
and conspicuous disclosure for visual text advertisements on the 
Internet for credit secured by a dwelling means that the required 
disclosures are not obscured by techniques such as graphical 
displays, shading, coloration, or other devices and comply with all 
other requirements for clear and conspicuous disclosures under Sec.  
226.24. See also comment 24(e)-4.
    4. Clear and conspicuous standard--televised advertisements for 
credit secured by a dwelling. For purposes of this section, 
including alternative disclosures as provided for by Sec.  
226.24(g), a clear and conspicuous disclosure in the context of 
visual text advertisements on television for credit secured by a 
dwelling means that the required disclosures are not obscured by 
techniques such as graphical displays, shading, coloration, or other 
devices, are displayed in a manner that allows a consumer to read 
the information required to be disclosed, and comply with all other 
requirements for clear and conspicuous disclosures under Sec.  
226.24. For example, very fine print in a television advertisement 
would not meet the clear and conspicuous standard if consumers 
cannot see and read the information required to be disclosed.
    5. Clear and conspicuous standard--oral advertisements for 
credit secured by a dwelling. For purposes of this section, 
including alternative disclosures as provided for by Sec.  
226.24(g), a clear and conspicuous disclosure in the context of an 
oral advertisement for credit secured by a dwelling, whether by 
radio, television, or other medium, means that the required 
disclosures are given at a speed and volume sufficient for a 
consumer to hear and comprehend them. For example, information 
stated very rapidly at a low volume in a radio or television 
advertisement would not meet the clear and conspicuous standard if 
consumers cannot hear and comprehend the information required to be 
disclosed.
    24(c) Advertisement of rate of finance charge.
* * * * *
    2. Simple or periodic rates. The advertisement may not 
simultaneously state any other rate, except that a simple annual 
rate or periodic rate applicable to an unpaid balance may appear 
along with (but not more conspicuously than) the annual percentage 
rate. An advertisement for credit secured by a dwelling may not 
state a periodic rate, other than a simple annual rate, that is 
applied to an unpaid balance. For example, in an advertisement for 
credit secured by a dwelling, a simple annual interest rate may be 
shown in the same type size as the annual percentage rate for the 
advertised credit, subject to the requirements of section 226.24(f). 
A simple annual rate or periodic rate that is applied to an unpaid 
balance is the rate at which interest is accruing; those terms do 
not include a rate lower than the rate at which interest is 
accruing, such as an effective rate, payment rate, or qualifying 
rate.
    3. Buydowns. When a third party (such as a seller) or a creditor 
wishes to promote the availability of reduced interest rates 
(consumer or seller buydowns), the advertised annual percentage rate 
must be determined in accordance with the commentary to Sec.  
226.17(c) regarding the basis of transactional disclosures for 
buydowns. The seller or creditor may advertise the reduced simple 
interest rate, provided the advertisement shows the limited term to 
which the reduced rate applies and states the simple interest rate 
applicable to the balance of the term. The advertisement may also 
show the effect of the buydown agreement on the payment schedule for 
the buydown period, but this will trigger the additional disclosures 
under Sec.  226.24(d)(2).
    4. Discounted variable-rate transactions. The advertised annual 
percentage rate for discounted variable-rate transactions must be 
determined in accordance with comment 17(c)(1)-10 regarding the 
basis of transactional disclosures for such financing.
    i. A creditor or seller may promote the availability of the 
initial rate reduction in such transactions by advertising the 
reduced simple annual rate, provided the advertisement shows with 
equal prominence and in close proximity the limited term to which 
the reduced rate applies and the annual percentage rate that will 
apply after the term of the initial rate reduction expires. See 
Sec.  226.24(f).
    ii. Limits or caps on periodic rate or payment adjustments need 
not be stated. To illustrate using the second example in comment 
17(c)(1)-10, the fact that the rate is presumed to be 11 percent in 
the second year and 12 percent for the remaining 28 years need not 
be included in the advertisement.
    iii. The advertisement may also show the effect of the discount 
on the payment schedule for the discount period, but this will 
trigger the additional disclosures under Sec.  226.24(d).
    24(d) Advertisement of terms that require additional 
disclosures.
    1. General rule. Under Sec.  226.24(d)(1), whenever certain 
triggering terms appear in credit advertisements, the additional 
credit terms enumerated in Sec.  226.24(d)(2) must also appear. 
These provisions apply even if the triggering term is not stated 
explicitly but may be readily determined from the advertisement. For 
example, an advertisement may state ``80 percent financing 
available,'' which is in fact indicating that a 20 percent 
downpayment is required.
    Paragraph 24(d)(1).
* * * * *
    3. Payment amount. The dollar amount of any payment includes 
statements such as:
     ``Payable in installments of $103''.
     ``$25 weekly''.
     ``$500,000 loan for just $1,650 per month''.
     ``$1,200 balance payable in 10 equal installments''.

In the last example, the amount of each payment is readily 
determinable, even though not explicitly stated. But statements such 
as ``monthly payments to suit your needs'' or ``regular monthly 
payments'' are not deemed to be statements of the amount of any 
payment.
* * * * *
    Paragraph 24(d)(2).
* * * * *
    2. Disclosure of repayment terms. The phrase ``terms of 
repayment'' generally has the same meaning as the ``payment 
schedule'' required to be disclosed under Sec.  226.18(g). Section 
226.24(d)(2)(ii) provides flexibility to

[[Page 44609]]

creditors in making this disclosure for advertising purposes. 
Repayment terms may be expressed in a variety of ways in addition to 
an exact repayment schedule; this is particularly true for 
advertisements that do not contemplate a single specific 
transaction. Repayment terms, however, must reflect the consumer's 
repayment obligations over the full term of the loan, including any 
balloon payment, see comment 24(d)(2)-3, not just the repayment 
terms that will apply for a limited period of time. For example:
    i. A creditor may use a unit-cost approach in making the 
required disclosure, such as ``48 monthly payments of $27.83 per 
$1,000 borrowed.''
    ii. In an advertisement for credit secured by a dwelling, when 
any series of payments varies because of the inclusion of mortgage 
insurance premiums, a creditor may state the number and timing of 
payments, the fact that payments do not include amounts for mortgage 
insurance premiums, and that the actual payment obligation will be 
higher.
    iii. In an advertisement for credit secured by a dwelling, when 
one series of monthly payments will apply for a limited period of 
time followed by a series of higher monthly payments for the 
remaining term of the loan, the advertisement must state the number 
and time period of each series of payments, and the amounts of each 
of those payments. For this purpose, the creditor must assume that 
the consumer makes the lower series of payments for the maximum 
allowable period of time.
    3. Balloon payment; disclosure of repayment terms. In some 
transactions, a balloon payment will occur when the consumer only 
makes the minimum payments specified in an advertisement. A balloon 
payment results if paying the minimum payments does not fully 
amortize the outstanding balance by a specified date or time, 
usually the end of the term of the loan, and the consumer must repay 
the entire outstanding balance at such time. If a balloon payment 
will occur when the consumer only makes the minimum payments 
specified in an advertisement, the advertisement must state with 
equal prominence and in close proximity to the minimum payment 
statement the amount and timing of the balloon payment that will 
result if the consumer makes only the minimum payments for the 
maximum period of time that the consumer is permitted to make such 
payments.
    4. Annual percentage rate. * * *
    5. Use of examples. A creditor may use illustrative credit 
transactions to make the necessary disclosures under Sec.  
226.24(d)(2). That is, where a range of possible combinations of 
credit terms is offered, the advertisement may use examples of 
typical transactions, so long as each example contains all of the 
applicable terms required by Sec.  226.24(d). The examples must be 
labeled as such and must reflect representative credit terms made 
available by the creditor to present and prospective customers.
    24(e) Catalogs or other multiple-page advertisements; electronic 
advertisements.
    1. Definition. The multiple-page advertisements to which this 
section refers are advertisements consisting of a series of 
sequentially numbered pages--for example, a supplement to a 
newspaper. A mailing consisting of several separate flyers or pieces 
of promotional material in a single envelope does not constitute a 
single multiple-page advertisement for purposes of Sec.  226.24(e).
    2. General. Section 226.24(e) permits creditors to put credit 
information together in one place in a catalog or other multiple-
page advertisement or in an electronic advertisement (such as an 
advertisement appearing on an Internet Web site). The rule applies 
only if the advertisement contains one or more of the triggering 
terms from Sec.  226.24(d)(1). A list of different annual percentage 
rates applicable to different balances, for example, does not 
trigger further disclosures under Sec.  226.24(d)(2) and so is not 
covered by Sec.  226.24(e).
* * * * *
    4. Electronic advertisement. If an electronic advertisement 
(such as an advertisement appearing on an Internet Web site) 
contains the table or schedule permitted under Sec.  226.24(e)(1), 
any statement of terms set forth in Sec.  226.24(d)(1) appearing 
anywhere else in the advertisement must clearly direct the consumer 
to the location where the table or schedule begins. For example, a 
term triggering additional disclosures may be accompanied by a link 
that directly takes the consumer to the additional information.
    24(f) Disclosure of rates and payments in advertisements for 
credit secured by a dwelling.
    1. Applicability. The requirements of Sec.  226.24(f)(2) apply 
to advertisements for loans where more than one simple annual rate 
of interest will apply. The requirements of Sec.  226.24(f)(3)(i)(A) 
require a clear and conspicuous disclosure of each payment that will 
apply over the term of the loan. In determining whether a payment 
will apply when the consumer may choose to make a series of lower 
monthly payments that will apply for a limited period of time, the 
creditor must assume that the consumer makes the series of lower 
payments for the maximum allowable period of time. See comment 
24(d)(2)-2.iii. However, for purposes of Sec.  226.24(f), the 
creditor may, but need not, assume that specific events which 
trigger changes to the simple annual rate of interest or to the 
applicable payments will occur. For example:
    i. Fixed-rate conversion loans. If a loan program permits 
consumers to convert their variable-rate loans to fixed rate loans, 
the creditor need not assume that the fixed-rate conversion option, 
by itself, means that more than one simple annual rate of interest 
will apply to the loan under Sec.  226.24(f)(2) and need not 
disclose as a separate payment under Sec.  226.24(f)(3)(i)(A) the 
payment that would apply if the consumer exercised the fixed-rate 
conversion option.
    ii. Preferred-rate loans. Some loans contain a preferred-rate 
provision, where the rate will increase upon the occurrence of some 
event, such as the consumer-employee leaving the creditor's employ 
or the consumer closing an existing deposit account with the 
creditor or the consumer revoking an election to make automated 
payments. A creditor need not assume that the preferred-rate 
provision, by itself, means that more than one simple annual rate of 
interest will apply to the loan under Sec.  226.24(f)(2) and the 
payments that would apply upon occurrence of the event that triggers 
the rate increase need not be disclosed as a separate payments under 
Sec.  226.24(f)(3)(i)(A).
    iii. Rate reductions. Some loans contain a provision where the 
rate will decrease upon the occurrence of some event, such as if the 
consumer makes a series of payments on time. A creditor need not 
assume that the rate reduction provision, by itself, means that more 
than one simple annual rate of interest will apply to the loan under 
Sec.  226.24(f)(2) and need not disclose the payments that would 
apply upon occurrence of the event that triggers the rate reduction 
as a separate payments under Sec.  226.24(f)(3)(i)(A).
    2. Equal prominence, close proximity. Information required to be 
disclosed under Sec. Sec.  226.24(f)(2)(i) and 226.24(f)(3)(i) that 
is immediately next to or directly above or below the simple annual 
rate or payment amount (but not in a footnote) is deemed to be 
closely proximate to the listing. Information required to be 
disclosed under Sec. Sec.  226.24(f)(2)(i) and 226.24(f)(3)(i)(A) 
and (B) that is in the same type size as the simple annual rate or 
payment amount is deemed to be equally prominent.
    3. Clear and conspicuous standard. For more information about 
the applicable clear and conspicuous standard, see comment 24(b)-2.
    4. Comparisons in advertisements. When making any comparison in 
an advertisement between actual or hypothetical credit payments or 
rates and the payments or rates available under the advertised 
product, the advertisement must state all applicable payments or 
rates for the advertised product and the time periods for which 
those payments or rates will apply, as required by this section.
    5. Application to variable-rate transactions--disclosure of 
rates. In advertisements for variable-rate transactions, if a simple 
annual rate that applies at consummation is not based on the index 
and margin that will be used to make subsequent rate adjustments 
over the term of the loan, the requirements of Sec.  226.24(f)(2)(i) 
apply.
    6. Reasonably current index and margin. For the purposes of this 
section, an index and margin is considered reasonably current if:
    i. For direct mail advertisements, it was in effect within 60 
days before mailing;
    ii. For advertisements in electronic form it was in effect 
within 30 days before the advertisement is sent to a consumer's e-
mail address, or in the case of an advertisement made on an Internet 
Web site, when viewed by the public; or
    iii. For printed advertisements made available to the general 
public, including ones contained in a catalog, magazine, or other 
generally available publication, it was in effect within 30 days 
before printing.
    24(f)(3) Disclosure of payments.
    1. Amounts and time periods of payments. Section 226.24(f)(3)(i) 
requires disclosure of the amounts and time periods of all payments 
that will apply over the term of the loan. This section may require 
disclosure of several payment amounts, including any balloon 
payment. For example, if an

[[Page 44610]]

advertisement for credit secured by a dwelling offers $300,000 of 
credit with a 30-year loan term for a payment of $600 per month for 
the first six months, increasing to $1,500 per month after month 
six, followed by a balloon payment of $30,000 at the end of the loan 
term, the advertisement must disclose the amount and time periods of 
each of the two monthly payment streams, as well as the amount and 
timing of the balloon payment, with equal prominence and in close 
proximity to each other. However, if the final scheduled payment of 
a fully amortizing loan is not greater than two times the amount of 
any other regularly scheduled payment, the final payment need not be 
disclosed.
    2. Application to variable-rate transactions--disclosure of 
payments. In advertisements for variable-rate transactions, if the 
payment that applies at consummation is not based on the index and 
margin that will be used to make subsequent payment adjustments over 
the term of the loan, the requirements of Sec.  226.24(f)(3)(i) 
apply.
    24(g) Alternative disclosures--television or radio 
advertisements.
    1. Multi-purpose telephone number. When an advertised telephone 
number provides a recording, disclosures should be provided early in 
the sequence to ensure that the consumer receives the required 
disclosures. For example, in providing several options--such as 
providing directions to the advertiser's place of business--the 
option allowing the consumer to request disclosures should be 
provided early in the telephone message to ensure that the option to 
request disclosures is not obscured by other information.
    2. Statement accompanying telephone number. Language must 
accompany a telephone number indicating that disclosures are 
available by calling the telephone number, such as ``call 1-800-000-
0000 for details about credit costs and terms.''
    24(i) Prohibited acts or practices in advertisements for credit 
secured by a dwelling.
    1. Comparisons in advertisements. The requirements of Sec.  
226.24(i)(2) apply to all advertisements for credit secured by a 
dwelling, including radio and television advertisements. A 
comparison includes a claim about the amount a consumer may save 
under the advertised product. For example, a statement such as 
``save $300 per month on a $300,000 loan'' constitutes an implied 
comparison between the advertised product's payment and a consumer's 
current payment.
    2. Misrepresentations about government endorsement. A statement 
that the federal Community Reinvestment Act entitles the consumer to 
refinance his or her mortgage at the low rate offered in the 
advertisement is prohibited because it conveys a misleading 
impression that the advertised product is endorsed or sponsored by 
the federal government.
    3. Misleading claims of debt elimination. The prohibition 
against misleading claims of debt elimination or waiver or 
forgiveness does not apply to legitimate statements that the 
advertised product may reduce debt payments, consolidate debts, or 
shorten the term of the debt. Examples of misleading claims of debt 
elimination or waiver or forgiveness of loan terms with, or 
obligations to, another creditor of debt include: ``Wipe-Out 
Personal Debts!'', ``New DEBT-FREE Payment'', ``Set yourself free; 
get out of debt today'', ``Refinance today and wipe your debt 
clean!'', ``Get yourself out of debt * * * Forever!'', and ``Pre-
payment Penalty Waiver.''

Subpart E--Special Rules for Certain Home Mortgage Transactions

0
19. In Supplement I to Part 226, under Section 226.32-Requirements for 
Certain Closed-End Home Mortgages, 32(a) Coverage, new heading 
Paragraph 32(a)(2) and new paragraph 32(a)(2)-1 are added, under 32(d) 
Limitations, new paragraphs 32(d)-1 and 32(d)-2 are added, and under 
32(d)(7) Prepayment penalty exception, Paragraph 32(d)(7)(iii), 
paragraphs 32(d)(7)(iii)-1 and 32(d)(7)(iii)-2 are removed and new 
paragraphs 32(d)(7)(iii)-1 through 32(d)(7)(iii)-3 are added, and new 
heading Paragraph 32(d)(7)(iv) and new paragraphs 32(d)(7)(iv)-1 and 
32(d)(7)(iv)-2 are added, to read as follows:

Section 226.32--Requirements for Certain Closed-End Home Mortgages 
32(a) Coverage.

* * * * *
    Paragraph 32(a)(2).
    1. Exemption limited. Section 226.32(a)(2) lists certain 
transactions exempt from the provisions of Sec.  226.32. 
Nevertheless, those transactions may be subject to the provisions of 
Sec.  226.35, including any provisions of Sec.  226.32 to which 
Sec.  226.35 refers. See 12 CFR 226.35(a).
* * * * *
    32(d) Limitations.
    1. Additional prohibitions applicable under other sections. 
Section 226.34 sets forth certain prohibitions in connection with 
mortgage credit subject to Sec.  226.32, in addition to the 
limitations in Sec.  226.32(d). Further, Sec.  226.35(b) prohibits 
certain practices in connection with transactions that meet the 
coverage test in Sec.  226.35(a). Because the coverage test in Sec.  
226.35(a) is generally broader than the coverage test in Sec.  
226.32(a), most Sec.  226.32 mortgage loans are also subject to the 
prohibitions set forth in Sec.  226.35(b) (such as escrows), in 
addition to the limitations in Sec.  226.32(d).
    2. Effective date. For guidance on the application of the 
Board's revisions published on July 30, 2008 to Sec.  226.32, see 
comment 1(d)(5)-1.
* * * * *
    32(d)(7) Prepayment penalty exception.
    Paragraph 32(d)(7)(iii).
    1. Calculating debt-to-income ratio. ``Debt'' does not include 
amounts paid by the borrower in cash at closing or amounts from the 
loan proceeds that directly repay an existing debt. Creditors may 
consider combined debt-to-income ratios for transactions involving 
joint applicants. For more information about obligations and inflows 
that may constitute ``debt'' or ``income'' for purposes of Sec.  
226.32(d)(7)(iii), see comment 34(a)(4)-6 and comment 
34(a)(4)(iii)(C)-1.
    2. Verification. Creditors shall verify income in the manner 
described in Sec.  226.34(a)(4)(ii) and the related comments. 
Creditors may verify debt with a credit report. However, a credit 
report may not reflect certain obligations undertaken just before or 
at consummation of the transaction and secured by the same dwelling 
that secures the transaction. Section 226.34(a)(4) may require 
creditors to consider such obligations; see comment 34(a)(4)-3 and 
comment 34(a)(4)(ii)(C)-1.
    3. Interaction with Regulation B. Section 226.32(d)(7)(iii) does 
not require or permit the creditor to make inquiries or 
verifications that would be prohibited by Regulation B, 12 CFR part 
202.
    Paragraph 32(d)(7)(iv).
    1. Payment change. Section 226.32(d)(7) sets forth the 
conditions under which a mortgage transaction subject to this 
section may have a prepayment penalty. Section 226.32(d)(7)(iv) 
lists as a condition that the amount of the periodic payment of 
principal or interest or both may not change during the four-year 
period following consummation. The following examples show whether 
prepayment penalties are permitted or prohibited under Sec.  
226.32(d)(7)(iv) in particular circumstances.
    i. Initial payments for a variable-rate transaction consummated 
on January 1, 2010 are $1,000 per month. Under the loan agreement, 
the first possible date that a payment in a different amount may be 
due is January 1, 2014. A prepayment penalty is permitted with this 
mortgage transaction provided that the other Sec.  226.32(d)(7) 
conditions are met, that is: provided that the prepayment penalty is 
permitted by other applicable law, the penalty expires on or before 
Dec. 31, 2011, the penalty will not apply if the source of the 
prepayment funds is a refinancing by the creditor or its affiliate, 
and at consummation the consumer's total monthly debts do not exceed 
50 percent of the consumer's monthly gross income, as verified.
    ii. Initial payments for a variable-rate transaction consummated 
on January 1, 2010 are $1,000 per month. Under the loan agreement, 
the first possible date that a payment in a different amount may be 
due is December 31, 2013. A prepayment penalty is prohibited with 
this mortgage transaction because the payment may change within the 
four-year period following consummation.
    iii. Initial payments for a graduated-payment transaction 
consummated on January 1, 2010 are $1,000 per month. Under the loan 
agreement, the first possible date that a payment in a different 
amount may be due is January 1, 2014. A prepayment penalty is 
permitted with this mortgage transaction provided that the other 
Sec.  226.32(d)(7) conditions are met, that is: provided that the 
prepayment penalty is permitted by other applicable law, the penalty 
expires on or before December 31, 2011, the penalty will not apply 
if the source of the prepayment funds is a refinancing by the 
creditor or its affiliate, and at consummation the consumer's total 
monthly debts do not exceed 50 percent of the consumer's monthly 
gross income, as verified.

[[Page 44611]]

    iv. Initial payments for a step-rate transaction consummated on 
January 1, 2010 are $1,000 per month. Under the loan agreement, the 
first possible date that a payment in a different amount may be due 
is December 31, 2013. A prepayment penalty is prohibited with this 
mortgage transaction because the payment may change within the four-
year period following consummation.
    2. Payment changes excluded. Payment changes due to the 
following circumstances are not considered payment changes for 
purposes of this section:
    i. A change in the amount of a periodic payment that is 
allocated to principal or interest that does not change the total 
amount of the periodic payment.
    ii. The borrower's actual unanticipated late payment, 
delinquency, or default; and
    iii. The borrower's voluntary payment of additional amounts (for 
example when a consumer chooses to make a payment of interest and 
principal on a loan that only requires the consumer to pay 
interest).
* * * * *

0
20. In Supplement I to Part 226, under Section 226.34--Prohibited Acts 
or Practices in Connection with Credit Secured by a Consumer's 
Dwelling; Open-end Credit, the heading is revised, and under 34(a) 
Prohibited acts or practices for loans subject to Sec.  226.32, 
34(a)(4) Repayment ability, paragraphs 34(a)(4)-1 through 34(a)(4)-4 
are removed, and new paragraphs 34(a)(4)-1 through 34(a)(4)-7, new 
heading 34(a)(4)(i) Mortgage-related obligations and new paragraph 
34(a)(4)(i)-1, new heading 34(a)(4)(ii) Verification of repayment 
ability and new paragraphs 34(a)(4)(ii)-1 through 34(a)(4)(ii)-3, new 
heading Paragraph 34(a)(4)(ii)(A) and new paragraphs 34(a)(4)(ii)(A)-1 
through 34(a)(4)(ii)(A)-5, new heading Paragraph 34(a)(4)(ii)(B) and 
new paragraphs 34(a)(4)(ii)(B)-1 and 34(a)(4)(ii)(B)-2, new heading 
Paragraph 34(a)(4)(ii)(C) and new paragraph 34(a)(4)(ii)(C)-1, new 
heading 34(a)(4)(iii) Presumption of compliance and new paragraph 
34(a)(4)(iii)-1, new heading Paragraph 34(a)(4)(iii)(B) and new 
paragraph 34(a)(4)(iii)(B)-1, new heading Paragraph 34(a)(4)(iii)(C) 
and new paragraph 34(a)(4)(iii)(C)-1, and new heading 34(a)(4)(iv) 
Exclusions from the presumption of compliance and new paragraphs 
34(a)(4)(iv)-1 and 34(a)(4)(iv)-2, are added to read as follows:

Section 226.34--Prohibited Acts or Practices in Connection with 
Credit Subject to Sec.  226.32

    34(a) Prohibited acts or practices for loans subject to Sec.  
226.32.
* * * * *
    34(a)(4) Repayment ability.
    1. Application of repayment ability rule. The Sec.  226.34(a)(4) 
prohibition against making loans without regard to consumers' 
repayment ability applies to mortgage loans described in Sec.  
226.32(a). In addition, the Sec.  226.34(a)(4) prohibition applies 
to higher-priced mortgage loans described in Sec.  226.35(a). See 12 
CFR 226.35(b)(1). For guidance on the application of the Board's 
revisions to Sec.  226.34(a)(4) published on July 30, 2008, see 
comment 1(d)(5)-1.
    2. General prohibition. Section 226.34(a)(4) prohibits a 
creditor from extending credit subject to Sec.  226.32 to a consumer 
based on the value of the consumer's collateral without regard to 
the consumer's repayment ability as of consummation, including the 
consumer's current and reasonably expected income, employment, 
assets other than the collateral, current obligations, and property 
tax and insurance obligations. A creditor may base its determination 
of repayment ability on current or reasonably expected income from 
employment or other sources, on assets other than the collateral, or 
both.
    3. Other dwelling-secured obligations. For purposes of Sec.  
226.34(a)(4), current obligations include another credit obligation 
of which the creditor has knowledge undertaken prior to or at 
consummation of the transaction and secured by the same dwelling 
that secures the transaction subject to Sec.  226.32 or Sec.  
226.35. For example, where a transaction subject to Sec.  226.35 is 
a first-lien transaction for the purchase of a home, a creditor must 
consider a ``piggyback'' second-lien transaction of which it has 
knowledge that is used to finance part of the down payment on the 
house.
    4. Discounted introductory rates and non-amortizing or 
negatively-amortizing payments. A credit agreement may determine a 
consumer's initial payments using a temporarily discounted interest 
rate or permit the consumer to make initial payments that are non-
amortizing or negatively amortizing. (Negative amortization is 
permissible for loans covered by Sec.  226.35(a), but not Sec.  
226.32). In such cases the creditor may determine repayment ability 
using the assumptions provided in Sec.  226.34(a)(4)(iv).
    5. Repayment ability as of consummation. Section 226.34(a)(4) 
prohibits a creditor from disregarding repayment ability based on 
the facts and circumstances known to the creditor as of 
consummation. In general, a creditor does not violate this provision 
if a consumer defaults because of a significant reduction in income 
(for example, a job loss) or a significant obligation (for example, 
an obligation arising from a major medical expense) that occurs 
after consummation. However, if a creditor has knowledge as of 
consummation of reductions in income, for example, if a consumer's 
written application states that the consumer plans to retire within 
twelve months without obtaining new employment, or states that the 
consumer will transition from full-time to part-time employment, the 
creditor must consider that information.
    6. Income, assets, and employment. Any current or reasonably 
expected assets or income may be considered by the creditor, except 
the collateral itself. For example, a creditor may use information 
about current or expected salary, wages, bonus pay, tips, and 
commissions. Employment may be full-time, part-time, seasonal, 
irregular, military, or self-employment. Other sources of income 
could include interest or dividends; retirement benefits; public 
assistance; and alimony, child support, or separate maintenance 
payments. A creditor may also take into account assets such as 
savings accounts or investments that the consumer can or will be 
able to use.
    7. Interaction with Regulation B. Section 226.34(a)(4) does not 
require or permit the creditor to make inquiries or verifications 
that would be prohibited by Regulation B, 12 CFR part 202.
    34(a)(4)(i) Mortgage-related obligations.
    1. Mortgage-related obligations. A creditor must include in its 
repayment ability analysis the expected property taxes and premiums 
for mortgage-related insurance required by the creditor as set forth 
in Sec.  226.35(b)(3)(i), as well as similar mortgage-related 
expenses. Similar mortgage-related expenses include homeowners' 
association dues and condominium or cooperative fees.
    34(a)(4)(ii) Verification of repayment ability.
    1. Income and assets relied on. A creditor must verify the 
income and assets the creditor relies on to evaluate the consumer's 
repayment ability. For example, if a consumer earns a salary and 
also states that he or she is paid an annual bonus, but the creditor 
only relies on the applicant's salary to evaluate repayment ability, 
the creditor need only verify the salary.
    2. Income and assets--co-applicant. If two persons jointly apply 
for credit and both list income or assets on the application, the 
creditor must verify repayment ability with respect to both 
applicants unless the creditor relies only on the income or assets 
of one of the applicants in determining repayment ability.
    3. Expected income. If a creditor relies on expected income, the 
expectation must be reasonable and it must be verified with third-
party documents that provide reasonably reliable evidence of the 
consumer's expected income. For example, if the creditor relies on 
an expectation that a consumer will receive an annual bonus, the 
creditor may verify the basis for that expectation with documents 
that show the consumer's past annual bonuses and the expected bonus 
must bear a reasonable relationship to past bonuses. Similarly, if 
the creditor relies on a consumer's expected salary following the 
consumer's receipt of an educational degree, the creditor may verify 
that expectation with a written statement from an employer 
indicating that the consumer will be employed upon graduation at a 
specified salary.
    Paragraph 34(a)(4)(ii)(A).
    1. Internal Revenue Service (IRS) Form W-2. A creditor may 
verify a consumer's income using a consumer's IRS Form W-2 (or any 
subsequent revisions or similar IRS Forms used for reporting wages 
and tax withholding). The creditor may also use an electronic 
retrieval service for obtaining the consumer's W-2 information.
    2. Tax returns. A creditor may verify a consumer's income or 
assets using the consumer's tax return. A creditor may also use IRS 
Form 4506 ``Request for Copy of Tax Return,'' Form 4506-T ``Request 
for Transcript of Tax Return,'' or Form 8821

[[Page 44612]]

``Tax Information Authorization'' (or any subsequent revisions or 
similar IRS Forms appropriate for obtaining tax return information 
directly from the IRS) to verify the consumer's income or assets. 
The creditor may also use an electronic retrieval service for 
obtaining tax return information.
    3. Other third-party documents that provide reasonably reliable 
evidence of consumer's income or assets. Creditors may verify income 
and assets using documents produced by third parties. Creditors may 
not rely on information provided orally by third parties, but may 
rely on correspondence from the third party, such as by letter or e-
mail. The creditor may rely on any third-party document that 
provides reasonably reliable evidence of the consumer's income or 
assets. For example, creditors may verify the consumer's income 
using receipts from a check-cashing or remittance service, or by 
obtaining a written statement from the consumer's employer that 
states the consumer's income.
    4. Information specific to the consumer. Creditors must verify a 
consumer's income or assets using information that is specific to 
the individual consumer. Creditors may use third-party databases 
that contain individual-specific data about a consumer's income or 
assets, such as a third-party database service used by the 
consumer's employer for the purpose of centralizing income 
verification requests, so long as the information is reasonably 
current and accurate. Information about average incomes for the 
consumer's occupation in the consumer's geographic location or 
information about average incomes paid by the consumer's employer, 
however, would not be specific to the individual consumer.
    5. Duplicative collection of documentation. A creditor that has 
made a loan to a consumer and is refinancing or extending new credit 
to the same consumer need not collect from the consumer a document 
the creditor previously obtained if the creditor has no information 
that would reasonably lead the creditor to believe that document has 
changed since it was initially collected. For example, if the 
creditor has obtained the consumer's 2006 tax return to make a home 
purchase loan in May 2007, the creditor may rely on the 2006 tax 
return if the creditor makes a home equity loan to the same consumer 
in August 2007. Similarly, if the creditor has obtained the 
consumer's bank statement for May 2007 in making the first loan, the 
creditor may rely on that bank statement for that month in making 
the subsequent loan in August 2007.
    Paragraph 34(a)(4)(ii)(B).
    1. No violation if income or assets relied on not materially 
greater than verifiable amounts. A creditor that does not verify 
income or assets used to determine repayment ability with reasonably 
reliable third-party documents does not violate Sec.  
226.34(a)(4)(ii) if the creditor demonstrates that the income or 
assets it relied upon were not materially greater than the amounts 
that the creditor would have been able to verify pursuant to Sec.  
226.34(a)(4)(ii). For example, if a creditor determines a consumer's 
repayment ability by relying on the consumer's annual income of 
$40,000 but fails to obtain documentation of that amount before 
extending the credit, the creditor will not have violated this 
section if the creditor later obtains evidence that would satisfy 
Sec.  226.34(a)(4)(ii)(A), such as tax return information, showing 
that the creditor could have documented, at the time the loan was 
consummated, that the consumer had an annual income not materially 
less than $40,000.
    2. Materially greater than. Amounts of income or assets relied 
on are not materially greater than amounts that could have been 
verified at consummation if relying on the verifiable amounts would 
not have altered a reasonable creditor's decision to extend credit 
or the terms of the credit.
    Paragraph 34(a)(4)(ii)(C).
    1. In general. A credit report may be used to verify current 
obligations. A credit report, however, might not reflect an 
obligation that a consumer has listed on an application. The 
creditor is responsible for considering such an obligation, but the 
creditor is not required to independently verify the obligation. 
Similarly, a creditor is responsible for considering certain 
obligations undertaken just before or at consummation of the 
transaction and secured by the same dwelling that secures the 
transaction (for example, a ``piggy back'' loan), of which the 
creditor knows, even if not reflected on a credit report. See 
comment 34(a)(4)-3.
    34(a)(4)(iii) Presumption of compliance.
    1. In general. A creditor is presumed to have complied with 
Sec.  226.34(a)(4) if the creditor follows the three underwriting 
procedures specified in paragraph 34(a)(4)(iii) for verifying 
repayment ability, determining the payment obligation, and measuring 
the relationship of obligations to income. The procedures for 
verifying repayment ability are required under paragraph 
34(a)(4)(ii); the other procedures are not required but, if followed 
along with the required procedures, create a presumption that the 
creditor has complied with Sec.  226.34(a)(4). The consumer may 
rebut the presumption with evidence that the creditor nonetheless 
disregarded repayment ability despite following these procedures. 
For example, evidence of a very high debt-to-income ratio and a very 
limited residual income could be sufficient to rebut the 
presumption, depending on all of the facts and circumstances. If a 
creditor fails to follow one of the non-required procedures set 
forth in paragraph 34(a)(4)(iii), then the creditor's compliance is 
determined based on all of the facts and circumstances without there 
being a presumption of either compliance or violation.
    Paragraph 34(a)(4)(iii)(B).
    1. Determination of payment schedule. To retain a presumption of 
compliance under Sec.  226.34(a)(4)(iii), a creditor must determine 
the consumer's ability to pay the principal and interest obligation 
based on the maximum scheduled payment in the first seven years 
following consummation. In general, a creditor should determine a 
payment schedule for purposes of Sec.  226.34(a)(4)(iii)(B) based on 
the guidance in the staff commentary to Sec.  226.17(c)(1). Examples 
of how to determine the maximum scheduled payment in the first seven 
years are provided as follows (all payment amounts are rounded):
    i. Balloon-payment loan; fixed interest rate. A loan in an 
amount of $100,000 with a fixed interest rate of 8.0 percent (no 
points) has a 7-year term but is amortized over 30 years. The 
monthly payment scheduled for 7 years is $733 with a balloon payment 
of remaining principal due at the end of 7 years. The creditor will 
retain the presumption of compliance if it assesses repayment 
ability based on the payment of $733.
    ii. Fixed-rate loan with interest-only payment for five years. A 
loan in an amount of $100,000 with a fixed interest rate of 8.0 
percent (no points) has a 30-year term. The monthly payment of $667 
scheduled for the first 5 years would cover only the interest due. 
After the fifth year, the scheduled payment would increase to $772, 
an amount that fully amortizes the principal balance over the 
remaining 25 years. The creditor will retain the presumption of 
compliance if it assesses repayment ability based on the payment of 
$772.
    iii. Fixed-rate loan with interest-only payment for seven years. 
A loan in an amount of $100,000 with a fixed interest rate of 8.0 
percent (no points) has a 30-year term. The monthly payment of $667 
scheduled for the first 7 years would cover only the interest due. 
After the seventh year, the scheduled payment would increase to 
$793, an amount that fully amortizes the principal balance over the 
remaining 23 years. The creditor will retain the presumption of 
compliance if it assesses repayment ability based on the interest-
only payment of $667.
    iv. Variable-rate loan with discount for five years. A loan in 
an amount of $100,000 has a 30-year term. The loan agreement 
provides for a fixed interest rate of 7.0 percent for an initial 
period of 5 years. Accordingly, the payment scheduled for the first 
5 years is $665. The agreement provides that, after 5 years, the 
interest rate will adjust each year based on a specified index and 
margin. As of consummation, the sum of the index value and margin 
(the fully-indexed rate) is 8.0 percent. Accordingly, the payment 
scheduled for the remaining 25 years is $727. The creditor will 
retain the presumption of compliance if it assesses repayment 
ability based on the payment of $727.
    v. Variable-rate loan with discount for seven years. A loan in 
an amount of $100,000 has a 30-year term. The loan agreement 
provides for a fixed interest rate of 7.125 percent for an initial 
period of 7 years. Accordingly, the payment scheduled for the first 
7 years is $674. After 7 years, the agreement provides that the 
interest rate will adjust each year based on a specified index and 
margin. As of consummation, the sum of the index value and margin 
(the fully-indexed rate) is 8.0 percent. Accordingly, the payment 
scheduled for the remaining years is $725. The creditor will retain 
the presumption of compliance if it assesses repayment ability based 
on the payment of $674.
    vi. Step-rate loan. A loan in an amount of $100,000 has a 30-
year term. The agreement provides that the interest rate will be 5 
percent for two years, 6 percent for three years, and 7 percent 
thereafter. Accordingly,

[[Page 44613]]

the payment amounts are $537 for two years, $597 for three years, 
and $654 thereafter. To retain the presumption of compliance, the 
creditor must assess repayment ability based on the payment of $654.
    Paragraph 34(a)(4)(iii)(C).
    1. ``Income'' and ``debt''. To determine whether to classify 
particular inflows or obligations as ``income'' or ``debt,'' 
creditors may look to widely accepted governmental and non-
governmental underwriting standards, including, for example, those 
set forth in the Federal Housing Administration's handbook on 
Mortgage Credit Analysis for Mortgage Insurance on One- to Four-Unit 
Mortgage Loans.
    34(a)(4)(iv) Exclusions from the presumption of compliance.
    1. In general. The exclusions from the presumption of compliance 
should be interpreted consistent with staff comments 32(d)(1)(i)-1 
and 32(d)(2)-1.
    2. Renewable balloon loan. If a creditor is unconditionally 
obligated to renew a balloon-payment loan at the consumer's option 
(or is obligated to renew subject to conditions within the 
consumer's control), the full term resulting from such renewal is 
the relevant term for purposes of the exclusion of certain balloon-
payment loans. See comment 17(c)(1)-11 for a discussion of 
conditions within a consumer's control in connection with renewable 
balloon-payment loans.
* * * * *

0
21. In Supplement I to Part 226, a new Section 226.35--Prohibited Acts 
or Practices in Connection with Higher-priced Mortgage Loans is added 
to read as follows:

Section 226.35--Prohibited Acts or Practices in Connection With 
Higher-priced Mortgage Loans

    35(a) Higher-priced mortgage loans.
    Paragraph 35(a)(2).
    1. Average prime offer rate. Average prime offer rates are 
annual percentage rates derived from average interest rates, points, 
and other loan pricing terms currently offered to consumers by a 
representative sample of creditors for mortgage transactions that 
have low-risk pricing characteristics. Other pricing terms include 
commonly used indices, margins, and initial fixed-rate periods for 
variable-rate transactions. Relevant pricing characteristics include 
a consumer's credit history and transaction characteristics such as 
the loan-to-value ratio, owner-occupant status, and purpose of the 
transaction. To obtain average prime offer rates, the Board uses a 
survey of creditors that both meets the criteria of Sec.  
226.35(a)(2) and provides pricing terms for at least two types of 
variable-rate transactions and at least two types of non-variable-
rate transactions. An example of such a survey is the Freddie Mac 
Primary Mortgage Market Survey[reg].
    2. Comparable transaction. A higher-priced mortgage loan is a 
consumer credit transaction secured by the consumer's principal 
dwelling with an annual percentage rate that exceeds the average 
prime offer rate for a comparable transaction as of the date the 
interest rate is set by the specified margin. The table of average 
prime offer rates published by the Board indicates how to identify 
the comparable transaction.
    3. Rate set. A transaction's annual percentage rate is compared 
to the average prime offer rate as of the date the transaction's 
interest rate is set (or ``locked'') before consummation. Sometimes 
a creditor sets the interest rate initially and then re-sets it at a 
different level before consummation. The creditor should use the 
last date the interest rate is set before consummation.
    4. Board table. The Board publishes on the Internet, in table 
form, average prime offer rates for a wide variety of transaction 
types. The Board calculates an annual percentage rate, consistent 
with Regulation Z (see Sec.  226.22 and appendix J), for each 
transaction type for which pricing terms are available from a 
survey. The Board estimates annual percentage rates for other types 
of transactions for which direct survey data are not available based 
on the loan pricing terms available in the survey and other 
information. The Board publishes on the Internet the methodology it 
uses to arrive at these estimates.
    35(b) Rules for higher-priced mortgage loans.
    1. Effective date. For guidance on the applicability of the 
rules in Sec.  226.35(b), see comment 1(d)(5)-1.
    Paragraph 35(b)(2)(ii)(C).
    1. Payment change. Section 226.35(b)(2) provides that a loan 
subject to this section may not have a penalty described by Sec.  
226.32(d)(6) unless certain conditions are met. Section 
226.35(b)(2)(ii)(C) lists as a condition that the amount of the 
periodic payment of principal or interest or both may not change 
during the four-year period following consummation. For examples 
showing whether a prepayment penalty is permitted or prohibited in 
connection with particular payment changes, see comment 
32(d)(7)(iv)-1. Those examples, however, include a condition that 
Sec.  226.35(b)(2) does not include: the condition that, at 
consummation, the consumer's total monthly debt payments may not 
exceed 50 percent of the consumer's monthly gross income. For 
guidance about circumstances in which payment changes are not 
considered payment changes for purposes of this section, see comment 
32(d)(7)(iv)-2.
    2. Negative amortization. Section 226.32(d)(2) provides that a 
loan described in Sec.  226.32(a) may not have a payment schedule 
with regular periodic payments that cause the principal balance to 
increase. Therefore, the commentary to Sec.  226.32(d)(7)(iv) does 
not include examples of payment changes in connection with negative 
amortization. The following examples show whether, under Sec.  
226.35(b)(2), prepayment penalties are permitted or prohibited in 
connection with particular payment changes, when a loan agreement 
permits negative amortization:
    i. Initial payments for a variable-rate transaction consummated 
on January 1, 2010 are $1,000 per month and the loan agreement 
permits negative amortization to occur. Under the loan agreement, 
the first date that a scheduled payment in a different amount may be 
due is January 1, 2014 and the creditor does not have the right to 
change scheduled payments prior to that date even if negative 
amortization occurs. A prepayment penalty is permitted with this 
mortgage transaction provided that the other Sec.  226.35(b)(2) 
conditions are met, that is: provided that the prepayment penalty is 
permitted by other applicable law, the penalty expires on or before 
December 31, 2011, and the penalty will not apply if the source of 
the prepayment funds is a refinancing by the creditor or its 
affiliate.
    ii. Initial payments for a variable-rate transaction consummated 
on January 1, 2010 are $1,000 per month and the loan agreement 
permits negative amortization to occur. Under the loan agreement, 
the first date that a scheduled payment in a different amount may be 
due is January 1, 2014, but the creditor has the right to change 
scheduled payments prior to that date if negative amortization 
occurs. A prepayment penalty is prohibited with this mortgage 
transaction because the payment may change within the four-year 
period following consummation.
    35(b)(3) Escrows.
    Paragraph 35(b)(3)(i).
    1. Section 226.35(b)(3) applies to principal dwellings, 
including structures that are classified as personal property under 
state law. For example, an escrow account must be established on a 
higher-priced mortgage loan secured by a first-lien on a mobile 
home, boat or a trailer used as the consumer's principal dwelling. 
See the commentary under Sec. Sec.  226.2(a)(19), 226.2(a)(24), 
226.15 and 226.23. Section 226.35(b)(3) also applies to higher-
priced mortgage loans secured by a first lien on a condominium or a 
cooperative unit if it is in fact used as principal residence.
    2. Administration of escrow accounts. Section 226.35(b)(3) 
requires creditors to establish before the consummation of a loan 
secured by a first lien on a principal dwelling an escrow account 
for payment of property taxes and premiums for mortgage-related 
insurance required by creditor. Section 6 of RESPA, 12 U.S.C. 2605, 
and Regulation X address how escrow accounts must be administered.
    3. Optional insurance items. Section 226.35(b)(3) does not 
require that escrow accounts be established for premiums for 
mortgage-related insurance that the creditor does not require in 
connection with the credit transaction, such as an earthquake 
insurance or debt-protection insurance.
    Paragraph 35(b)(3)(ii)(B).
    1. Limited exception. A creditor is required to escrow for 
payment of property taxes for all first lien loans secured by 
condominium units regardless of whether the creditors escrows 
insurance premiums for condominium unit.


0
22. In Supplement I to Part 226, a new Section 226.36--Prohibited Acts 
or Practices in Connection with Credit Secured by a Consumer's 
Principal Dwelling is added to read as follows:

Section 226.36--Prohibited Acts or Practices in Connection With 
Credit Secured by a Consumer's Principal Dwelling

    1. Effective date. For guidance on the applicability of the 
rules in Sec.  226.36, see comment 1(d)(5)-1.

[[Page 44614]]

    36(a) Mortgage broker defined.
    1. Meaning of mortgage broker. Section 226.36(a) provides that a 
mortgage broker is any person who for compensation or other monetary 
gain arranges, negotiates, or otherwise obtains an extension of 
consumer credit for another person, but is not an employee of a 
creditor. In addition, this definition expressly includes any person 
that satisfies this definition but makes use of ``table funding.'' 
Table funding occurs when a transaction is consummated with the debt 
obligation initially payable by its terms to one person, but another 
person provides the funds for the transaction at consummation and 
receives an immediate assignment of the note, loan contract, or 
other evidence of the debt obligation. Although Sec.  
226.2(a)(17)(1)(B) provides that a person to whom a debt obligation 
is initially payable on its face generally is a creditor, Sec.  
226.36(a) provides that, solely for the purposes of Sec.  226.36, 
such a person is considered a mortgage broker. In addition, although 
consumers themselves often arrange, negotiate, or otherwise obtain 
extensions of consumer credit on their own behalf, they do not do so 
for compensation or other monetary gain or for another person and, 
therefore, are not mortgage brokers under this section.
    36(b) Misrepresentation of value of consumer's principal 
dwelling.
    36(b)(2) When extension of credit prohibited.
    1. Reasonable diligence. A creditor will be deemed to have acted 
with reasonable diligence under Sec.  226.36(b)(2) if the creditor 
extends credit based on an appraisal other than the one subject to 
the restriction in Sec.  226.36(b)(2).
    2. Material misstatement or misrepresentation. Section 
226.36(b)(2) prohibits a creditor who knows of a violation of Sec.  
226.36(b)(1) in connection with an appraisal from extending credit 
based on such appraisal, unless the creditor documents that it has 
acted with reasonable diligence to determine that the appraisal does 
not materially misstate or misrepresent the value of such dwelling. 
A misstatement or misrepresentation of such dwelling's value is not 
material if it does not affect the credit decision or the terms on 
which credit is extended.
    36(c) Servicing practices.
    Paragraph 36(c)(1)(i).
    1. Crediting of payments. Under Sec.  226.36(c)(1)(i), a 
mortgage servicer must credit a payment to a consumer's loan account 
as of the date of receipt. This does not require that a mortgage 
servicer post the payment to the consumer's loan account on a 
particular date; the servicer is only required to credit the payment 
as of the date of receipt. Accordingly, a servicer that receives a 
payment on or before its due date (or within any grace period), and 
does not enter the payment on its books or in its system until after 
the payment's due date (or expiration of any grace period), does not 
violate this rule as long as the entry does not result in the 
imposition of a late charge, additional interest, or similar penalty 
to the consumer, or in the reporting of negative information to a 
consumer reporting agency.
    2. Payments to be credited. Payments should be credited based on 
the legal obligation between the creditor and consumer. The legal 
obligation is determined by applicable state or other law.
    3. Date of receipt. The ``date of receipt'' is the date that the 
payment instrument or other means of payment reaches the mortgage 
servicer. For example, payment by check is received when the 
mortgage servicer receives it, not when the funds are collected. If 
the consumer elects to have payment made by a third-party payor such 
as a financial institution, through a preauthorized payment or 
telephone bill-payment arrangement, payment is received when the 
mortgage servicer receives the third-party payor's check or other 
transfer medium, such as an electronic fund transfer.
    Paragraph 36(c)(1)(ii).
    1. Pyramiding of late fees. The prohibition on pyramiding of 
late fees in this subsection should be construed consistently with 
the ``credit practices rule'' of Regulation AA, 12 CFR 227.15.
    Paragraph 36(c)(1)(iii).
    1. Reasonable time. The payoff statement must be provided to the 
consumer, or person acting on behalf of the consumer, within a 
reasonable time after the request. For example, it would be 
reasonable under most circumstances to provide the statement within 
five business days of receipt of a consumer's request. This time 
frame might be longer, for example, when the servicer is 
experiencing an unusually high volume of refinancing requests.
    2. Person acting on behalf of the consumer. For purposes of 
Sec.  226.36(c)(1)(iii), a person acting on behalf of the consumer 
may include the consumer's representative, such as an attorney 
representing the individual, a non-profit consumer counseling or 
similar organization, or a creditor with which the consumer is 
refinancing and which requires the payoff statement to complete the 
refinancing. A servicer may take reasonable measures to verify the 
identity of any person acting on behalf of the consumer and to 
obtain the consumer's authorization to release information to any 
such person before the ``reasonable time'' period begins to run.
    3. Payment requirements. The servicer may specify reasonable 
requirements for making payoff requests, such as requiring requests 
to be in writing and directed to a mailing address, e-mail address 
or fax number specified by the servicer or orally to a telephone 
number specified by the servicer, or any other reasonable 
requirement or method. If the consumer does not follow these 
requirements, a longer time frame for responding to the request 
would be reasonable.
    4. Accuracy of payoff statements. Payoff statements must be 
accurate when issued.
    Paragraph 36(c)(2).
    1. Payment requirements. The servicer may specify reasonable 
requirements for making payments in writing, such as requiring that 
payments be accompanied by the account number or payment coupon; 
setting a cut-off hour for payment to be received, or setting 
different hours for payment by mail and payments made in person; 
specifying that only checks or money orders should be sent by mail; 
specifying that payment is to be made in U.S. dollars; or specifying 
one particular address for receiving payments, such as a post office 
box. The servicer may be prohibited, however, from requiring payment 
solely by preauthorized electronic fund transfer. (See section 913 
of the Electronic Fund Transfer Act, 15 U.S.C. 1693k.)
    2. Payment requirements--limitations. Requirements for making 
payments must be reasonable; it should not be difficult for most 
consumers to make conforming payments. For example, it would be 
reasonable to require a cut-off time of 5 p.m. for receipt of a 
mailed check at the location specified by the servicer for receipt 
of such check.
    3. Implied guidelines for payments. In the absence of specified 
requirements for making payments, payments may be made at any 
location where the servicer conducts business; any time during the 
servicer's normal business hours; and by cash, money order, draft, 
or other similar instrument in properly negotiable form, or by 
electronic fund transfer if the servicer and consumer have so 
agreed.

    By order of the Board of Governors of the Federal Reserve 
System, July 15, 2008.
Jennifer J. Johnson,
Secretary of the Board.
 [FR Doc. E8-16500 Filed 7-29-08; 8:45 am]
BILLING CODE 6210-01-P