[Federal Register Volume 76, Number 91 (Wednesday, May 11, 2011)]
[Proposed Rules]
[Pages 27390-27506]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-9766]
[[Page 27389]]
Vol. 76
Wednesday,
No. 91
May 11, 2011
Part II
Federal Reserve System
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12 CFR Part 226
Regulation Z; Truth in Lending; Proposed Rule
Federal Register / Vol. 76 , No. 91 / Wednesday, May 11, 2011 /
Proposed Rules
[[Page 27390]]
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FEDERAL RESERVE SYSTEM
12 CFR Part 226
[Regulation Z; Docket No. R-1417]
RIN 7100-AD75
Regulation Z; Truth in Lending
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Proposed rule; request for public comment.
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SUMMARY: The Board is publishing for public comment a proposed rule
amending Regulation Z (Truth in Lending) to implement amendments to the
Truth in Lending Act (TILA) made by the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank Act or Act). Regulation Z
currently prohibits a creditor from making a higher-priced mortgage
loan without regard to the consumer's ability to repay the loan. The
proposal would implement statutory changes made by the Dodd-Frank Act
that expand the scope of the ability-to-repay requirement to cover any
consumer credit transaction secured by a dwelling (excluding an open-
end credit plan, timeshare plan, reverse mortgage, or temporary loan).
In addition, the proposal would establish standards for complying with
the ability-to-repay requirement, including by making a ``qualified
mortgage.'' The proposal also implements the Act's limits on prepayment
penalties. Finally, the proposal would require creditors to retain
evidence of compliance with this rule for three years after a loan is
consummated. General rulemaking authority for TILA is scheduled to
transfer to the Consumer Financial Protection Bureau (CFPB) on July 21,
2011. Accordingly, this rulemaking will become a proposal of the CFPB
and will not be finalized by the Board.
DATES: Comments on this proposed rule must be received on or before
July 22, 2011. All comment letters will be transferred to the Consumer
Financial Protection Bureau.
ADDRESSES: You may submit comments, identified by Docket No. R-1417 and
RIN No. 7100-AD75, by any of the following methods:
Agency Web Site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: [email protected]. Include the
docket number in the subject line of the message.
Fax: (202) 452-3819 or (202) 452-3102.
Mail: Address to Jennifer J. Johnson, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and Constitution
Avenue, NW., Washington, DC 20551.
All public comments will be made available on the Board's Web site
at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, comments
will not be edited to remove any identifying or contact information.
Public comments may also be viewed electronically or in paper in Room
MP-500 of the Board's Martin Building (20th and C Streets, NW.) between
9 a.m. and 5 p.m. on weekdays.
FOR FURTHER INFORMATION CONTACT: Jamie Z. Goodson, Catherine Henderson,
or Priscilla Walton-Fein, Attorneys; Paul Mondor, Lorna Neill, Nikita
M. Pastor, or Maureen C. Yap, Senior Attorneys; or Brent Lattin,
Counsel; 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 the Proposed Rule
The Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act or Act) amends the Truth in Lending Act (TILA) to
prohibit creditors from making mortgage loans without regard to the
consumer's repayment ability. Public Law 111-203 Sec. 1411, 124 Stat.
1376, 2142 (to be codified at 15 U.S.C. 1639c). The Act's underwriting
requirements are substantially similar but not identical to the
ability-to-repay requirements adopted by the Board for higher-priced
mortgage loans in July 2008 under the Home Ownership and Equity
Protection Act. 73 FR 44522, Jul. 30, 2008 (``2008 HOEPA Final Rule'').
General rulemaking authority for TILA is scheduled to transfer to the
Consumer Financial Protection Bureau (CFPB) in July 2011. Accordingly,
this rulemaking will become a proposal of the CFPB and will not be
finalized by the Board.
Consistent with the Act, the proposal applies the ability-to-repay
requirements to any consumer credit transaction secured by a dwelling,
except an open-end credit plan, timeshare plan, reverse mortgage, or
temporary loan. Thus, unlike the Board's 2008 HOEPA Final Rule, the
proposal is not limited to higher-priced mortgage loans or loans
secured by the consumer's principal dwelling. The Act prohibits a
creditor from making a mortgage loan unless the creditor makes a
reasonable and good faith determination, based on verified and
documented information, that the consumer will have a reasonable
ability to repay the loan, including any mortgage-related obligations
(such as property taxes).
Consistent with the Act, the proposal provides four options for
complying with the ability-to-repay requirement. First, a creditor can
meet the general ability-to-repay standard by originating a mortgage
loan for which:
The creditor considers and verifies the following eight
underwriting factors in determining repayment ability: (1) Current or
reasonably expected income or assets; (2) current employment status;
(3) the monthly payment on the mortgage; (4) the monthly payment on any
simultaneous loan; (5) the monthly payment for mortgage-related
obligations; (6) current debt obligations; (7) the monthly debt-to-
income ratio, or residual income; and (8) credit history; and
The mortgage payment calculation is based on the fully
indexed rate.
Second, a creditor can refinance a ``non-standard mortgage'' into a
``standard mortgage.'' This is based on a statutory provision that is
meant to provide flexibility for streamlined refinancings, which are
no- or low-documentation transactions designed to quickly refinance a
consumer out of a risky mortgage into a more stable product. Under this
option, the creditor does not have to verify the consumer's income or
assets. The proposal defines a ``standard mortgage'' as a mortgage loan
that, among other things, does not contain negative amortization,
interest-only payments, or balloon payments; and has limited points and
fees.
Third, a creditor can originate a ``qualified mortgage,'' which
provides special protection from liability for creditors who make
``qualified mortgages.'' It is unclear whether that protection is
intended to be a safe harbor or a rebuttable presumption of compliance
with the repayment ability requirement. Therefore, the Board is
proposing two alternative definitions of a ``qualified mortgage.''
Alternative 1 operates as a legal safe harbor and defines a
``qualified mortgage'' as a mortgage for which:
(a) The loan does not contain negative amortization, interest-only
payments, or balloon payments, or a loan term exceeding 30 years;
[[Page 27391]]
(b) The total points and fees do not exceed 3% of the total loan
amount;
(c) The borrower's income or assets are verified and documented;
and
(d) The underwriting of the mortgage (1) is based on the maximum
interest rate in the first five years, (2) uses a payment schedule that
fully amortizes the loan over the loan term, and (3) takes into account
any mortgage-related obligations.
Alternative 2 provides a rebuttable presumption of compliance and
defines a ``qualified mortgage'' as including the criteria listed under
Alternative 1 as well as the following additional underwriting
requirements from the ability-to-repay standard: (1) The consumer's
employment status, (2) the monthly payment for any simultaneous loan,
(3) the consumer's current debt obligations, (4) the total debt-to-
income ratio or residual income, and (5) the consumer's credit history.
Finally, a small creditor operating predominantly in rural or
underserved areas can originate a balloon-payment qualified mortgage.
This standard is evidently meant to accommodate community banks that
originate balloon loans to hedge against interest rate risk. Under this
option, a small creditor can make a balloon-payment qualified mortgage
if the loan term is five years or more, and the payment calculation is
based on the scheduled periodic payments, excluding the balloon
payment.
The proposal also implements the Dodd-Frank Act's limits on
prepayment penalties, lengthens the time creditors must retain records
that evidence compliance with the ability-to-repay and prepayment
penalty provisions, and prohibits evasion of the rule by structuring a
closed-end extension of credit as an open-end plan. The Dodd-Frank Act
contains other consumer protections for mortgages, which will be
implemented in subsequent rulemakings.
II. Background
Over the years, concerns have been raised about creditors
originating mortgage loans without regard to the consumer's ability to
repay the loan. Beginning in about 2006, these concerns were heightened
as mortgage delinquencies and foreclosures rates increased
dramatically, caused in part by the loosening of underwriting
standards. See 73 FR 44524, Jul. 30, 2008. Following is background
information, including a brief summary of the legislative and
regulatory responses to this issue, which culminated in the enactment
of the Dodd-Frank Act on July 21, 2010.
A. TILA and Regulation Z
In 1968, Congress enacted TILA, 15 U.S.C. 1601 et seq., based on
findings that economic stability would be enhanced and competition
among consumer credit providers would be strengthened by the informed
use of credit resulting from consumers' awareness of the cost of
credit. One of the purposes of TILA is to promote the informed use of
consumer credit by requiring disclosures about its costs and terms.
TILA requires additional disclosures for loans secured by consumers'
homes and permits consumers to rescind certain transactions that
involve their principal dwelling. TILA directs the Board to prescribe
regulations to carry out the purposes of the law, and specifically
authorizes the Board, among other things, to issue regulations that
contain such additional requirements, classifications,
differentiations, or other provisions, or that provide for such
adjustments and exceptions for all or any class of transactions, that
in the Board's judgment are necessary or proper to effectuate the
purposes of TILA, facilitate compliance with TILA, or prevent
circumvention or evasion. 15 U.S.C. 1604(a). TILA is implemented by the
Board's Regulation Z, 12 CFR part 226. An Official Staff Commentary
interprets the requirements of the regulation and provides guidance to
creditors in applying the rules to specific transactions. See 12 CFR
part 226, Supp. I.
B. The Home Ownership and Equity Protection Act (HOEPA) and HOEPA Rules
In response to evidence of abusive practices in the home-equity
lending market, Congress amended TILA by enacting the Home Ownership
and Equity Protection Act (HOEPA) in 1994. Public Law 103-325, 108
Stat. 2160. HOEPA defines a class of ``high-cost mortgages,'' which are
generally closed-end home-equity loans (excluding home-purchase loans)
with annual percentage rates (APRs) or total points and fees exceeding
prescribed thresholds.\1\ HOEPA created special substantive protections
for high-cost mortgages, including prohibiting a creditor from engaging
in a pattern or practice of extending a high-cost mortgage to a
consumer based on the consumer's collateral without regard to the
consumer's repayment ability, including the consumer's current and
expected income, current obligations, and employment. TILA Section
129(h); 15 U.S.C. 1639(h). In addition to the disclosures and
limitations specified in the statute, TILA Section 129, as added by
HOEPA, expanded the Board's rulemaking authority. TILA Section
129(l)(2)(A) authorizes the Board to prohibit acts or practices the
Board finds to be unfair and deceptive in connection with mortgage
loans. 15 U.S.C. 1639(l)(2)(A). TILA Section 129(l)(2)(B) 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)(B).
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\1\ Mortgages covered by the HOEPA amendments have been referred
to as ``HOEPA loans,'' ``Section 32 loans,'' or ``high-cost
mortgages.'' The Dodd-Frank Act now refers to these loans as ``high-
cost mortgages.'' See the Dodd-Frank Act Sec. 1431; TILA Section
103(aa). For simplicity and consistency, this proposal will use the
term ``high-cost mortgages'' to refer to mortgages covered by the
HOEPA amendments.
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In addition, HOEPA created three special remedies for a violation
of its provisions. First, a consumer who brings a timely action against
a creditor for a violation of rules issued under TILA Section 129 may
be able to recover special statutory damages equal to the sum of all
finance charges and fees paid by the consumer (often referred to as
``HOEPA damages''), unless the creditor demonstrates that the failure
to comply is not material. TILA Section 130(a); 15 U.S.C. 1640(a). This
recovery is in addition to actual damages; statutory damages in an
individual action or class action, up to a prescribed threshold; and
court costs and attorney fees that would be available for violations of
other TILA provisions. Second, if a creditor assigns a high-cost
mortgage to another person, the consumer may be able to obtain from the
assignee all of the foregoing damages. TILA Section 131(d); 15 U.S.C.
1641(d). For all other loans, TILA Section 131(e), 15 U.S.C. 1641(e),
limits the liability of assignees for violations of Regulation Z to
disclosure violations that are apparent on the face of the disclosure
statement required by TILA. Finally, a consumer has a right to rescind
a transaction for up to three years after consummation when the
mortgage contains a provision prohibited by a rule adopted under the
authority of TILA Section 129(l)(2). TILA Section 125 and 129(j); 15
U.S.C. 1635 and 1639(j). Any consumer who has the right to rescind a
transaction may rescind the transaction as against any assignee. TILA
Section 131(c); 15 U.S.C. 1641(c). The right of rescission does not
extend, however, to home purchase loans, construction loans, or certain
refinancings with the same
[[Page 27392]]
creditor. TILA Section 125(e); 15 U.S.C. 1635(e).
In 1995, the Board implemented the HOEPA amendments at Sec.
226.31, 226.32, and 226.33 of Regulation Z. 60 FR 15463, March 24,
1995. In particular, Sec. 226.32(e)(1) implemented TILA Section 129(h)
to prohibit a creditor from extending a high-cost mortgage based on the
consumer's collateral if, considering the consumer's current and
expected income, current obligations, and employment status, the
consumer would be unable to make the scheduled payments. In 2001, the
Board amended these regulations to expand HOEPA's protections to more
loans by revising the APR threshold, and points and fees definition. 66
FR 65604, Dec. 20, 2001. In addition, the ability-to-repay provisions
in the regulation were revised to provide for a presumption of a
violation of the rule if the creditor engages in a pattern or practice
of making high-cost mortgages without verifying and documenting the
consumers' repayment ability.
C. 2006 and 2007 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 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.
Interagency Guidance on Nontraditional Mortgage Product Risks, 71 FR
58609, Oct. 4, 2006 (``2006 Nontraditional Mortgage Guidance'').
The Board and the other Federal banking agencies addressed concerns
about the subprime market in March 2007 with proposed supervisory
guidance addressing the heightened risks to consumers and institutions
of adjustable-rate mortgages with two- or three-year ``teaser'' rates
followed by substantial increases in the rate and payment. The
guidance, finalized in June of 2007, set out the standards institutions
should follow to ensure borrowers in the subprime market obtain loans
they can afford to repay. Among other steps, the guidance advised
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; and (3) provide
that prepayment penalty clauses expire a reasonable period before
reset, typically at least 60 days. Statement on Subprime Mortgage
Lending, 72 FR 37569, Jul. 10, 2007 (``2007 Subprime Mortgage
Statement'').\2\ The Conference of State Bank Supervisors (``CSBS'')
and the American Association of Residential Mortgage Regulators
(``AARMR'') issued parallel statements for state supervisors to use
with state-supervised entities, and many states adopted the statements.
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\2\ The 2006 Nontraditional Mortgage Guidance and the 2007
Subprime Mortgage Statement will hereinafter collectively be
referred to as the ``Interagency Supervisory Guidance.''
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D. 2008 HOEPA Final Rule
In 2006 and 2007, the Board held a series of national hearings on
consumer protection issues in the mortgage market. During those
hearings, consumer advocates and government officials expressed a
number of concerns, and urged the Board to prohibit or restrict certain
underwriting practices, such as ``stated income'' or ``low
documentation'' loans, and certain product features, such as prepayment
penalties. See 73 FR 44527, Jul. 30, 2008. The Board was also urged to
adopt regulations under HOEPA, because, unlike the Interagency
Supervisory Guidance, the regulations would apply to all creditors and
would be enforceable by consumers through civil actions.
In response to these hearings, in July of 2008, the Board adopted
final rules pursuant to the Board's authority in TILA Section
129(l)(2)(A). 73 FR 44522, Jul. 30, 2008 (``2008 HOEPA Final Rule'').
The Board's 2008 HOEPA Final Rule defined a new class of ``higher-
priced mortgage loans,'' . Under the 2008 HOEPA Final Rule, a higher-
priced mortgage loan is a consumer credit transaction secured by the
consumer's principal dwelling with an APR that exceeds the average
prime offer rate (APOR) 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 the dwelling, or by 3.5 or more percentage
points for loans secured by a subordinate lien on the dwelling. Section
226.35(a)(1). The definition of a ``higher-priced mortgage loan''
includes those loans that are defined as ``high-cost mortgages.''
Among other things, the Board's 2008 HOEPA Final Rule revised the
ability-to-repay requirements for high-cost mortgages, and extended
these requirements to higher-priced mortgage loans. Sections
226.34(a)(4), 226.35(b)(1). Specifically, the rule:
Prohibits a creditor from extending a higher-priced
mortgage loan based on the collateral and without regard to the
consumer's repayment ability.
Prohibits a creditor from relying on income or assets to
assess repayment ability unless the creditor verifies such amounts
using third-party documents that provide reasonably reliable evidence
of the consumer's income and assets.
In addition, the Board's 2008 Final Rule provides certain restrictions
on prepayment penalties for high-cost mortgages and higher-priced
mortgage loans. Sections 226.32(d), 226.35(b)(2).
E. The Dodd-Frank Act
In 2007, Congress held hearings focused on rising subprime
foreclosure rates and the extent to which lending practices contributed
to them. See 73 FR 44528, Jul. 30, 2008. Consumer advocates testified
that certain lending terms or practices contributed to the
foreclosures, including a failure to consider the consumer's ability to
repay, low- or no-documentation loans, hybrid adjustable-rate
mortgages, and prepayment penalties. Industry representatives, on the
other hand, testified that adopting substantive restrictions on
subprime loan terms would risk reducing access to credit for some
borrowers. In response to these hearings, the House of Representatives
passed the Mortgage Reform and Anti-Predatory Lending Act in 2007 and
2009. H.R. 3915, 110th Cong. (2007); H.R. 1728, 111th Cong. (2009).
Both bills would have amended TILA to provide consumer protections for
mortgages, including ability-to-repay requirements, but neither bill
was passed by the Senate.
Then, on July 21, 2010, the Dodd-Frank Act was signed into law.
Public Law 111-203, 124 Stat. 1376 (2010). Title XIV of the Dodd-Frank
Act contains the Mortgage Reform and Anti-Predatory Lending Act.\3\
Sections 1411,
[[Page 27393]]
1412, and 1414 of the Dodd-Frank Act create new TILA Section 129C,
which, among other things, establishes new ability-to-repay
requirements and new limits on prepayment penalties. Public Law 111-
203, Sec. 1411, 1412, 1414, 124 Stat. 1376, 2142-53 (to be codified at
15 U.S.C. 1639c). The Dodd-Frank Act states that Congress created new
TILA Section 129C upon a finding that ``economic stabilization would be
enhanced by the protection, limitation, and regulation of the terms of
residential mortgage credit and the practices related to such credit,
while ensuring that responsible, affordable mortgage credit remains
available to consumers.'' Dodd-Frank Act Section 1402; TILA Section
129B(a)(1). The Dodd-Frank Act further states that the purpose of TILA
Section 129C is to ``assure that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loans.'' Dodd-Frank Act Section 1402; TILA Section
129B(a)(2).
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\3\ Although S. Rpt. No. 111-176 generally contains the
legislative history for the Dodd-Frank Act, it does not contain the
legislative history for the Mortgage Reform and Anti-Predatory
Lending Act. Therefore, the Board has relied on the legislative
history for the 2007 and 2009 House bills for guidance in
interpreting the statute. See H. Rpt. No. 110-441 for H.R. 3915
(2007), and H. Rpt. No. 111-194 for H.R. 1728 (2009).
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Specifically, TILA Section 129C:
Expands coverage of the ability-to-repay requirements to
any consumer credit transaction secured by a dwelling, except an open-
end credit plan, timeshare plan, reverse mortgage, or temporary loan.
Prohibits a creditor from making a mortgage loan unless
the creditor makes a reasonable and good faith determination, based on
verified and documented information, that the consumer has a reasonable
ability to repay the loan according to its terms, and all applicable
taxes, insurance, and assessments.
Provides a presumption of compliance with the ability-to-
repay requirements if the mortgage loan is a ``qualified mortgage,''
which does not contain certain risky features and limits points and
fees on the loan.
Prohibits prepayment penalties unless the mortgage is a
prime, fixed-rate qualified mortgage, and the amount of the prepayment
penalty is limited.
The Dodd-Frank Act creates special remedies for violations of TILA
Section 129C. Section 1416 of the Dodd-Frank Act provides that a
consumer who brings a timely action against a creditor for a violation
of TILA Section 129C(a) (the ability-to-repay requirements) may be able
to recover special statutory damages equal to the sum of all finance
charges and fees paid by the consumer (often referred to as ``HOEPA
damages''), unless the creditor demonstrates that the failure to comply
is not material. TILA Section 130(a). This recovery is in addition to
actual damages; statutory damages in an individual action or class
action, up to a prescribed threshold; and court costs and attorney fees
that would be available for violations of other TILA provisions. In
addition, the statute of limitations for an action for a violation of
TILA Section 129C is three years from the date of the occurrence of the
violation (as compared to one year for other TILA violations). TILA
Section 130(e). Moreover, Section 1413 of the Dodd-Frank Act provides
that a consumer may assert a violation of TILA Section 129C(a) as a
defense to foreclosure by recoupment or set off. TILA Section 130(k).
There is no time limit on the use of this defense.
F. Other Recent Board Actions
In addition to the 2008 HOEPA Final Rule, the Board has recently
published several proposed or final rules for mortgages that are
referenced in or relevant to this proposal.
2009 Closed-End Mortgage Proposal. In August 2009, the Board issued
two proposals to amend Regulation Z: One for closed-end mortgages and
one for home equity lines of credit (``HELOCs''). For closed-end
mortgages, the August 2009 proposal would revise the disclosure
requirements to highlight potentially risky features, such as
adjustable rates and negative amortization, and address other issues,
such as the timing of disclosures. See 74 FR 43232, Aug. 26, 2009
(``2009 Closed-End Mortgage Proposal''). For HELOCs, the August 2009
proposal would revise the disclosure requirements and address other
issues, such as account terminations. 74 FR 43428, Aug. 26, 2009
(``2009 HELOC Proposal''). Public comments for both proposals were due
by December 24, 2009.
2010 Mortgage Proposal. In September 2010, the Board issued a
proposal that would revise Regulation Z with respect to rescission,
refinancing, reverse mortgages, and the refund of certain fees. See 75
FR 58539, Sept. 24, 2010 (``2010 Mortgage Proposal''). Public comments
for this proposal were due by December 23, 2010. On February 1, 2011,
the Board issued a press release stating that it does not expect to
finalize the 2009 Closed-End Mortgage Proposal, 2009 HELOC Proposal, or
the 2010 Mortgage Proposal prior to the transfer of authority for such
rulemakings to the Consumer Financial Protection Bureau in July 2011.
2010 Loan Originator Compensation Rule. In September 2010, the
Board adopted a final rule on loan originator compensation to prohibit
compensation to mortgage brokers and loan officers (collectively,
``loan originators'') that is based on a loan's interest rate or other
terms. The final rule also prohibits loan originators from steering
consumers to loans that are not in the consumers' interest to increase
the loan originator's compensation. 75 FR 58509, Sept. 24, 2010 (``2010
Loan Originator Compensation Rule''). This rule became effective April
6, 2011.
2010 MDIA Interim Final Rule. In May 2009, the Board adopted final
rules implementing the amendments to TILA under the Mortgage Disclosure
Improvement Act of 2008 (``MDIA'').\4\ Among other things, the MDIA and
the final rules require early, transaction-specific disclosures for
mortgage loans secured by a dwelling, and requires waiting periods
between the time when disclosures are given and consummation of the
transaction. These rules became effective July 30, 2009, as required by
the statute. See 74 FR 23289, May 19, 2009. The MDIA also requires
disclosure of payment examples if the loan's interest rate or payments
can change, along with a statement that there is no guarantee that the
consumer will be able to refinance the transaction in the future. Under
the statute, these provisions of the MDIA became effective on January
30, 2011. On September 24, 2010, the Board published an interim rule to
implement these requirements. See 75 FR 58470, Sept. 24, 2010. In
particular, the rule provided definitions for a ``balloon payment,''
``adjustable-rate mortgage,'' ``step-rate mortgage,'' ``fixed-rate
mortgage,'' ``interest-only loan,'' ``negative amortization loan,'' and
the ``fully indexed rate.'' See Sec. 226.18(s)(5) and (s)(7).
Subsequently, the Board issued an interim rule to make certain
clarifying changes. See 75 FR 81836, Dec. 29, 2010. The term ``2010
MDIA Interim Final Rule'' is used to refer to the September 2010 final
rule as revised by the December 2010 final rule.
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\4\ The MDIA is contained in Sections 2501 through 2503 of the
Housing and Economic Recovery Act of 2008, Public Law 110-289,
enacted on July 30, 2008. The MDIA was later amended by the
Emergency Economic Stabilization Act of 2008, Public Law 110-343,
enacted on October 3, 2008.
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2011 Escrow Proposal and Final Rule. In March 2011, the Board
issued a proposal to implement Sections 1461 and 1462 of the Dodd-Frank
Act, which create new TILA Section 129D and provide certain escrow
requirements for higher-priced mortgage loans. See 76 FR 11599, March
2, 2011 (``2011 Escrow Proposal''). In particular, the proposal would
revise the definition of a ``higher-priced mortgage loan,'' and create
an exemption from the escrow requirement for any loan extended by a
creditor that makes most of its first-lien higher-priced mortgage loans
in counties designated by the Board as ``rural or underserved,'' has
annual originations of 100 or fewer
[[Page 27394]]
first-lien mortgage loans, and does not escrow for any mortgage
transaction it services.
In March 2011, the Board also issued a final rule that implements a
provision of the Dodd-Frank Act that increases the APR threshold used
to determine whether a mortgage lender is required to establish an
escrow account for property taxes and insurance for first-lien,
``jumbo'' mortgage loans. See 76 FR 11319, March 2, 2011 (``2011 Jumbo
Loan Escrow Final Rule''). Jumbo loans are loans exceeding the
conforming loan-size limit for purchase by Freddie Mac, as specified by
the legislation.
2011 Risk Retention Proposal. On March 31, 2011, the Board, the
Office of the Comptroller of the Currency, the Federal Deposit
Insurance Corporation, the Securities and Exchange Commission, the U.S.
Department of Housing and Urban Development, and the Federal Housing
Finance Agency (``Agencies'') issued a proposal to implement Section
941 of the Dodd-Frank Act, which adds a new Section 15G to the
Securities Exchange Act of 1934. 15 U.S.C. 78o-11. As required by the
Act, the proposal generally requires the sponsor of an asset-backed
security to retain not less than five percent of the credit risk of the
assets collateralizing the security. The Act and the proposal include a
variety of exemptions, including an exemption for an asset-backed
security that is collateralized exclusively by ``qualified residential
mortgages.'' The Act requires the Agencies to define the term
``qualified residential mortgage'' taking into consideration
underwriting and product features that historical loan performance data
indicate result in a lower risk of default. The Act further provides
that the definition of a ``qualified residential mortgage'' can be ``no
broader than'' the definition of a ``qualified mortgage'' under TILA
Section 129C(b)(2). The 2011 Risk Retention Proposal implements these
provisions of the Act. Public comments for this proposal are due by
June 10, 2011.
G. Development of This Proposal
In developing this proposal, the Board reviewed the laws,
regulations, proposals, and legislative history described above as well
as state ability-to-repay laws. The Board also conducted extensive
outreach with consumer advocates, industry representatives, and Federal
and state regulators, and examined underwriting rules and guidelines
for the Federal Housing Administration, the U.S. Department of
Veterans' Affairs, Fannie Mae, Freddie Mac, the Home Affordable
Modification Program, and private creditors. Finally, the Board
conducted independent analyses regarding the effect of various
underwriting procedures and loan features on loan performance.
III. Legal Authority
TILA Section 105(a) mandates that the Board prescribe regulations
to carry out the purposes of the Act. 15 U.S.C. 1604(a). In addition,
TILA, as amended by the Dodd-Frank Act, specifically authorizes the
Board to:
Issue regulations that contain such additional
requirements, classifications, differentiations, or other provisions,
or that provide for such adjustments and exceptions for all or any
class of transactions, that in the Board's judgment are necessary or
proper to effectuate the purposes of TILA, facilitate compliance with
the Act, or prevent circumvention or evasion. TILA Section 105(a); 15
U.S.C. 1604(a).
By regulation, prohibit or condition terms, acts or
practices relating to residential mortgage loans that the Board finds
to be abusive, unfair, deceptive, or predatory; necessary or proper to
ensure that responsible, affordable mortgage credit remains available
to consumers in a manner consistent with the purposes of the ability-
to-repay requirements; necessary or proper to effectuate the purposes
of the ability-to-repay requirements, to prevent circumvention or
evasion thereof, or to facilitate compliance; or are not in the
interest of the borrower. TILA Section 129B(e); 15 U.S.C. 1639b(e).
Prescribe regulations that revise, add to, or subtract
from the criteria that define a qualified mortgage upon a finding that
such regulations are necessary or proper to ensure that responsible,
affordable mortgage credit remains available to consumers in a manner
consistent with the purposes of the ability-to-repay requirements; or
necessary and appropriate to effectuate the purposes of the ability-to-
repay requirements, to prevent circumvention or evasion thereof, or to
facilitate compliance. TILA Section 129C(b)(3)(B)(i); 15 U.S.C.
1639c(b)(3)(B)(i).
TILA, as amended by the Dodd-Frank Act, states that it is the purpose
of the ability-to-repay requirements to assure that consumers are
offered and receive residential mortgage loans on terms that reasonably
reflect their ability to repay the loans. TILA Section 129B(a)(2); 15
U.S.C. 1639b(a)(2).
IV. Discussion of the Proposed Rule
A. Scope of Coverage
Consistent with the Dodd-Frank Act, the proposal applies to any
dwelling-secured consumer credit transaction, including vacation homes
and home equity loans. The proposal does not apply to open-end credit
plans, timeshare plans, reverse mortgages, or temporary loans with
terms of 12 months or less. The Act essentially codifies the ability-
to-repay requirements of the Board's 2008 HOEPA Final Rule and expands
the scope to the covered transactions described above.
B. Ability-to-Repay Requirements
Consistent with the Dodd-Frank Act, the proposal provides that a
creditor may not make a covered mortgage loan unless the creditor makes
a reasonable and good faith determination, based on verified and
documented information, that the consumer will have a reasonable
ability to repay the loan, including any mortgage-related obligations
(such as property taxes). TILA Section 129C; 15 U.S.C. 1639C. The Act
and the proposal provide four options for complying with the ability-
to-repay requirement. Specifically, a creditor can:
Originate a covered transaction under the general ability-
to-repay standard;
Refinance a ``non-standard mortgage'' into a ``standard
mortgage'';
Originate a ``qualified mortgage,'' which provides a
presumption of compliance with the rule; or
Originate a balloon-payment qualified mortgage, which
provides a presumption of compliance with the rule.
Each of these methods is discussed below, with a description of:
(1) Limits on the loan features or term, (2) limits on points and fees,
(3) underwriting requirements, and (4) payment calculations.
General Ability-to-Repay Standard
Limits on loan features, term, and points and fees. Under the
general ability-to-repay standards, there are no limits on the loan's
features, term, or points and fees, but the creditor must follow
certain underwriting requirements and payment calculations.
Underwriting requirements. Consistent with the Dodd-Frank Act, the
proposal requires the creditor to consider and verify the following
eight underwriting factors:
Current or reasonably expected income or assets;
Current employment status;
[[Page 27395]]
The monthly payment on the covered transaction;
The monthly payment on any simultaneous loan;
The monthly payment for mortgage-related obligations;
Current debt obligations;
The monthly debt-to-income ratio, or residual income; and
Credit history.
The proposal permits the creditor to consider and verify these
underwriting factors based on widely accepted underwriting standards.
The proposal is generally consistent with the Act except in one
respect. The Act does not require the creditor to consider simultaneous
loans that are home equity lines of credit (``HELOCs''), but the Board
is using its adjustment and exception authority and discretionary
regulatory authority to include HELOCs within the definition of
simultaneous loans. The Board believes that such inclusion would help
ensure the consumer's ability to repay the loan. Data and outreach
indicated that the origination of a simultaneous HELOC markedly
increases the rate of default. In addition, this approach is consistent
with the Board's 2008 HOEPA Final Rule.
Payment calculations. Under the general ability-to-repay standard,
the Dodd-Frank Act does not ban mortgage features, but instead requires
the creditor to underwrite the mortgage payment according to certain
assumptions and calculations. Specifically, consistent with the Act,
the proposal requires creditors to calculate the mortgage payment
using: (1) The fully indexed rate; and (2) monthly, substantially equal
payments that amortize the loan amount over the loan term. In addition,
the Board is using its adjustment and exception authority and
discretionary regulatory authority to require the creditor to
underwrite the payment based on the introductory interest rate if it is
greater than the fully indexed rate. Some transactions use a premium
initial rate that is higher than the fully indexed rate. The Board
believes this approach would help ensure the consumer's ability to
repay the loan and prevent circumvention or evasion.
The Act and proposal also provide special payment calculations for
interest-only loans, negative amortization loans, and balloon loans. In
particular, the requirements for balloon loans depend on whether the
loan is ``higher-priced'' \5\ or not. Consistent with the Act, the
proposal requires a creditor to underwrite a higher-priced loan with a
balloon payment by considering the consumer's ability to make the
balloon payment (without refinancing). As a practical matter, this
would mean that a creditor would not be able to make a higher-priced
balloon loan unless the consumer had substantial documented assets or
income.
---------------------------------------------------------------------------
\5\ The Act provides separate underwriting requirements for
balloon loans depending on whether the loan's APR exceeds the APOR
by 1.5 percent for a first-lien loan or by 3.5 percent for a
subordinate-lien loan.
---------------------------------------------------------------------------
The Act permits a creditor to underwrite a balloon loan that is not
higher-priced in accordance with regulations prescribed by the Board.
The proposal requires creditors to underwrite a balloon loan using the
maximum payment scheduled during the first five years after
consummation. This approach would not capture the balloon payment for a
balloon loan with a term of five years or more. The Board believes five
years is the appropriate time horizon in order to ensure consumers have
a reasonable ability to repay the loan, and to preserve credit choice
and availability. Moreover, the five year time horizon is consistent
with other provisions in the Act and the proposal, which require
underwriting based on the first five years after consummation (for
qualified mortgages and the refinancing of a non-standard mortgage) or
which require a minimum term of five years (for balloon-payment
qualified mortgages made by certain creditors).
Refinancing of a Non-Standard Mortgage
The Dodd-Frank Act provides an exception to the ability-to-repay
standard's underwriting requirements if: (1) The same creditor is
refinancing a ``hybrid mortgage'' into a ``standard mortgage,'' (2) the
consumer's monthly payment is reduced through the refinancing, and (3)
the consumer has not been delinquent on any payment on the existing
hybrid mortgage. This provision appears to be intended to provide
flexibility for streamlined refinancings, which are no- or low-
documentation loans designed to quickly refinance a consumer in a risky
mortgage into a more stable product. Streamlined refinancings have
substantially increased in recent years to accommodate consumers at
risk of default.
Definitions--loan features, term, and points and fees. Although the
Act uses the term ``hybrid mortgage,'' the proposal uses the term
``non-standard mortgage,'' defined as (1) an adjustable-rate mortgage
with an introductory fixed interest rate for a period of years, (2) an
interest-only loan, and (3) a negative amortization loan. The Board
believes that this definition is consistent with the legislative
history, which indicates that Congress was generally concerned with
loans that provide for ``payment shock'' through significantly higher
payments over the life of the loan.
The proposal defines the term ``standard mortgage'' as a covered
transaction which, among other things, does not contain negative
amortization, interest-only payments, or balloon payments; and limits
the points and fees.
Underwriting requirements. If the conditions described above are
met, the Act states that the creditor may give concerns about
preventing a likely default a ``higher priority as an acceptable
underwriting practice.'' The Board interprets this provision to provide
an exception from the general ability-to-repay requirements for income
and asset verification. The Board believes that this approach is
consistent with the statute and would preserve access to streamlined
refinancings.
Payment calculations. The proposal provides specific payment
calculations for purposes of determining whether the refinancing
reduces the consumer's monthly mortgage payment, and for determining
whether the consumer has the ability to repay the standard mortgage.
The calculation for the non-standard mortgage would reflect the highest
payment that would occur as of the date of the expiration of the period
during which introductory-rate payments, interest-only payments, or
negatively amortizing payments are permitted. For a standard mortgage,
the calculation would be based on: (1) The maximum interest rate that
may apply during the first five years after consummation, and (2)
monthly, substantially equal payments that amortize the loan amount
over the loan term.
Safe Harbor or Presumption of Compliance for a Qualified Mortgage
Under the Board's 2008 HOEPA Final Rule, a creditor may obtain a
presumption of compliance with the repayment ability requirement if it
follows the required procedures, such as verifying the consumer's
income or assets, and additional optional procedures, such as assessing
the consumer's debt-to-income ratio. However, the 2008 HOEPA Final Rule
makes clear that even if the creditor follows the required and optional
criteria, the creditor has only obtained a presumption of compliance
with the repayment ability requirement. The consumer can still rebut or
overcome
[[Page 27396]]
that presumption by showing that, despite following the required and
optional procedures, the creditor nonetheless disregarded the
consumer's ability to repay the loan. For example, the consumer could
present evidence that although the creditor assessed the consumer's
debt-to-income ratio, that ratio was very high with little residual
income. This evidence may be sufficient to overcome the presumption of
compliance and demonstrate that the creditor extended credit without
regard to the consumer's ability to repay the loan.
The Dodd-Frank Act provides special protection from liability for
creditors who make ``qualified mortgages,'' but it is unclear whether
that protection is intended to be a safe harbor or a rebuttable
presumption of compliance with the repayment ability requirement. The
Act states that a creditor or assignee ``may presume'' that a loan has
met the repayment ability requirement if the loan is a ``qualified
mortgage.'' This might suggest that originating a qualified mortgage
only provides a presumption of compliance, which the consumer can rebut
by providing evidence that the creditor did not, in fact, make a good
faith and reasonable determination of the consumer's ability to repay
the loan.
However, the Act does not state that a creditor that makes a
``qualified mortgage'' must comply with all of the underwriting
criteria of the general ability-to-repay standard. Specifically, the
Act defines a ``qualified mortgage'' as a covered transaction for
which:
The loan does not contain negative amortization, interest-
only payments, or balloon payments;
The term does not exceed 30 years;
The points and fees generally do not exceed three percent
of the total loan amount;
The income or assets are considered and verified;
The total debt-to-income ratio or residual income complies
with any guideline or regulation prescribed by the Board; and
The underwriting: (1) Is based on the maximum rate during
the first five years, (2) uses a payment schedule that fully amortizes
the loan over the loan term, and (3) takes into account all mortgage-
related obligations.
The definition of a ``qualified mortgage'' does not require the
creditor to consider and verify the following underwriting requirements
that are part of the general ability-to-repay standard: (1) The
consumer's employment status, (2) the payment of any simultaneous loans
of which the creditor knows or has reason to know, (3) the consumer's
current obligations, and (4) the consumer's credit history. Thus, if
the ``qualified mortgage'' definition is deemed to be a safe harbor,
the consumer could not allege the creditor violated the repayment
ability requirement by failing to consider and verify employment
status, simultaneous loans, current obligations, or credit history.
Under this approach, originating a ``qualified mortgage'' would be an
alternative to complying with the general ability-to-repay standard and
would operate as a safe harbor. Thus, if a creditor satisfied the
qualified mortgage criteria, the consumer could not assert that the
creditor had violated the ability-to-repay provisions. The consumer
could only show that the creditor did not comply with one of the
qualified mortgage safe harbor criteria.
There are sound policy reasons for interpreting a ``qualified
mortgage'' as providing either a safe harbor or a presumption of
compliance. Interpreting a ``qualified mortgage'' as a safe harbor
would provide creditors with an incentive to make qualified mortgages.
That is, in exchange for limiting loan fees and features, the
creditor's regulatory burden and exposure to liability would be
reduced. Consumers may benefit by being provided with mortgage loans
that do not have certain risky features or high costs. However, the
drawback to this approach is that a creditor could not be challenged
for failing to underwrite a loan based on the consumer's employment
status, simultaneous loans, current debt obligations, or credit
history, or for generally not making a reasonable and good faith
determination of the consumer's ability to repay the loan.
Interpreting a ``qualified mortgage'' as providing a rebuttable
presumption of compliance would better ensure that creditors consider a
consumer's ability to repay the loan. Creditors would have to make
individualized determinations that the consumer had the ability to
repay the loan based on all of the underwriting factors listed in the
general ability-to-repay standard. This approach would require the
creditor to comply with all of the ability-to-repay standards, and
preserve the consumer's ability to use these standards in a defense to
foreclosure or other legal action. In addition, a consumer could assert
that, despite complying with the criteria for a qualified mortgage and
the ability-to-repay standard, the creditor did not make a reasonable
and good faith determination of the consumer's ability to repay the
loan. However, the drawback of this approach is that it provides little
legal certainty for the creditor, and thus, little incentive to make a
``qualified mortgage,'' which limits loan fees and features.
Because of the statutory ambiguity and these competing concerns,
the Board is proposing two alternative definitions of a ``qualified
mortgage.'' Alternative 1 defines a ``qualified mortgage'' based on the
criteria listed in the Act, and the definition operates as a legal safe
harbor and alternative to complying with the general ability-to-repay
standard. Alternative 1 does not define a ``qualified mortgage'' to
include a requirement to consider the consumer's debt-to-income ratio
or residual income. Because of the discretion inherent in making these
calculations, such a requirement would not provide certainty that the
loan is a qualified mortgage.
Alternative 2 defines a ``qualified mortgage'' to include the
requirements listed in the Act as well as the other underwriting
requirements that are in the general ability-to-repay standard (i.e.,
employment status, simultaneous loans, current debt obligations, debt-
to-income ratio, and credit history). The definition provides a
presumption of compliance that could be rebutted by the consumer.
Limits on points and fees. The Dodd-Frank Act defines a ``qualified
mortgage'' as a loan for which, among other things, the total points
and fees do not exceed three percent of the total loan amount. In
addition, the Act requires the Board to prescribe rules adjusting this
threshold for ``smaller loans'' and to ``consider the potential impact
of such rules on rural areas and other areas where home values are
lower.'' If the threshold were not adjusted for smaller loans, then
creditors might not be able to recover their fixed costs for
originating the loan. This could deter some creditors from originating
smaller loans, thus reducing access to credit.
The Board is proposing two alternatives for implementing the limits
on points and fees for qualified mortgages. Alternative A is based on
certain tiers of loan amounts (e.g., a points and fees threshold of 3.5
percent of the total loan amount for a loan amount greater than or
equal to $60,000 but less than $75,000). Alternative A is designed to
be an easier calculation for creditors, but may result in some
anomalies (e.g., a points and fees threshold of $2,250 for a $75,000
loan, but a points and fees threshold of $2,450 for a $70,000 loan).
Alternative B is designed to remedy these anomalies by providing a more
precise sliding scale, but may be cumbersome for some creditors. The
proposal solicits comment on these approaches.
[[Page 27397]]
Definition of ``points and fees.'' Generally, a qualified mortgage
cannot have points and fees that exceed three percent of the total loan
amount. Consistent with the Act, the proposal revises Regulation Z to
define ``points and fees'' to now include: (1) Certain mortgage
insurance premiums in excess of the amount payable under Federal
Housing Administration provisions; (2) all compensation paid directly
or indirectly by a consumer or creditor to a loan originator; and (3)
the prepayment penalty on the covered transaction, or on the existing
loan if it is refinanced by the same creditor. The proposal also
provides exceptions to the calculation of points and fees for: (1) Any
bona fide third party charge not retained by the creditor, loan
originator, or an affiliate of either, and (2) certain bona fide
discount points.
Underwriting requirements. As discussed above, it is not clear
whether the Act intends the definition of a ``qualified mortgage'' to
be a somewhat narrowly-defined safe harbor or a more broadly-defined
presumption of compliance. For this reason, the Board is proposing two
alternative definitions with respect to the underwriting requirements.
Under Alternative 1, the underwriting requirements for a qualified
mortgage are limited to requiring a creditor to consider and verify the
consumer's current or reasonably expected income or assets. Under
Alternative 2, the definition of a qualified mortgage requires a
creditor to consider and verify all of the underwriting factors
required under the general ability-to-repay standard, namely: (1) The
currently or reasonably expected income, (2) the employment status, (3)
the monthly payment on any simultaneous loan, (4) the current debt
obligations, (5) the monthly debt-to-income ratio or residual income,
and (6) the credit history.
Payment calculations. Consistent with the Dodd-Frank Act, the
proposal defines a qualified mortgage to require the creditor to
calculate the mortgage payment using the periodic payment of principal
and interest based on the maximum interest rate that may apply during
the first five years after consummation.
Balloon-Payment Qualified Mortgages Made by Certain Creditors
The Board is exercising the authority provided under the Dodd-Frank
Act to provide an exception to the definition of a ``qualified
mortgage'' for a balloon-payment loan made by a creditor that meets the
criteria set forth in the Act. Based on outreach, it appears that some
community banks make short-term balloon loans as a means of hedging
against interest rate risk, and that the community banks typically hold
these loans in portfolio. The Board believes Congress enacted this
exception to ensure access to credit in rural and underserved areas
where consumers may be able to obtain credit only from such community
banks offering these balloon-payment loans. This exception is similar
to the exemption from the escrow requirements provided in another
section of the Dodd-Frank Act.
The proposal provides an exception for a creditor that meets the
following four criteria, with some alternatives:
(1) Operates in predominantly rural or underserved areas. The
creditor, during the preceding calendar year, must have extended more
than 50% of its total covered transactions that provide for balloon
payments in one or more counties designated by the Board as ``rural''
or ``underserved.''
(2) Total annual covered transactions. Under Alternative 1, the
creditor, together with all affiliates, extended covered transactions
of some dollar amount or less during the preceding calendar year. Under
Alternative 2, the creditor, together with all affiliates, extended
some number of covered transactions or fewer during the preceding
calendar year. The proposal solicits comment on an appropriate dollar
amount or number of transactions.
(3) Balloon loans in portfolio. Under Alternative 1, the creditor
must not sell any balloon-payment loans on or after the effective date
of the final rule. Under Alternative 2, the creditor must not have sold
any balloon-payment loans during the preceding and current calendar
year.
(4) Asset size. The creditor must meet an asset size threshold set
annually by the Board, which for calendar year 2011 would be $2
billion.
Limits on loan features. The Dodd-Frank Act generally provides that
a balloon-payment qualified mortgage contains the same limits on loan
features and the loan term as a qualified mortgage, except for allowing
the balloon payment. In addition, the Board is using its adjustment and
exception authority and discretionary regulatory authority to add a
requirement that the loan term be five years or longer. The Board
believes that this requirement would help ensure the consumer's ability
to repay the loan by providing more time for the consumer to build
equity.
Points and fees and underwriting requirements. Consistent with the
Dodd-Frank Act, the proposal requires that a balloon-payment qualified
mortgage provide for the same limits on points and fees and
underwriting requirements as a qualified mortgage.
Payment calculations. Consistent with the Dodd-Frank Act, the
proposal provides that a creditor may underwrite a balloon-payment
qualified mortgage using all of the scheduled payments, except the
balloon payment.
Other Protections
Limits on prepayment penalties. Consistent with the Dodd-Frank Act,
the proposal provides that a covered transaction may not include a
prepayment penalty unless the transaction: (1) Has an APR that cannot
increase after consummation (i.e., a fixed-rate or step-rate mortgage),
(2) is a qualified mortgage, and (3) is not a higher-priced mortgage
loan. The proposal further provides, consistent with the Act, that the
prepayment penalty may not exceed three percent of the outstanding loan
balance during the first year after consummation, two percent during
the second year after consummation, and one percent during the third
year after consummation. Prepayment penalties are not permitted after
the end of the third year after consummation. Finally, pursuant to the
Act, the proposal requires a creditor offering a consumer a loan with a
prepayment penalty to also offer that consumer a loan without a
prepayment penalty.
Expansion of record retention rules. Currently, Regulation Z
requires creditors to retain evidence of compliance for two years after
disclosures must be made or action must be taken. The Dodd-Frank Act
extends the statute of limitations for civil liability for a violation
of the prepayment penalty provisions or ability-to-repay provisions
(including the qualified mortgage provisions) to three years after the
date of a violation. The proposal revises Regulation Z to lengthen the
record retention requirement to three years after consummation for
consistency with the Dodd-Frank Act.
Prohibition on evasion through open-end credit. Currently,
Regulation Z prohibits a creditor from structuring a closed-end loan as
an open-end plan to evade the requirements for higher-priced mortgage
loans. The Board is using its adjustment and exception authority and
discretionary regulatory authority to include a similar provision in
this proposal in order to prevent circumvention or evasion.
[[Page 27398]]
V. Section-by-Section Analysis
Section 226.25 Record Retention
25(a) General Rule
Currently, Sec. 226.25(a) requires that creditors retain evidence
of compliance with Regulation Z for two years after disclosures must be
made or action must be taken. Section 226.25(a) also clarifies that
administrative agencies responsible for enforcing Regulation Z may
require creditors under their jurisdictions to retain records for a
longer period, if necessary to carry out their enforcement
responsibilities under TILA Section 108. 15 U.S.C. 1607. Under TILA
Section 130(e), the statute of limitations for civil liability for a
violation of TILA is one year after the date a violation occurs. 15
U.S.C. 1640.
The proposal would implement the requirement to consider a
consumer's repayment ability under TILA Section 129C(a), alternative
requirements for ``qualified mortgages'' under TILA Section 129C(b),
and prepayment penalty requirements under TILA Section 129C(c) in
proposed Sec. 226.43, as discussed in detail below. Section 1416 of
the Dodd-Frank Act extends the statute of limitations for civil
liability for a violation of TILA Section 129C, among other provisions,
to three years after the date a violation occurs. Accordingly, the
Board proposes to revise Sec. 226.25(a) to require that creditors
retain records that evidence compliance with proposed Sec. 226.43 for
at least three years after consummation. Although creditors will take
action required under proposed Sec. 226.43 (underwriting covered
transactions and offering consumers the option of a covered transaction
without a prepayment penalty) before a transaction is consummated, the
Board believes calculating the record retention period from the time of
consummation would facilitate compliance by establishing a clear time
period for record retention. The proposal to extend the required period
for retention of evidence of compliance with Sec. 226.43 would not
affect the record retention period for other requirements under
Regulation Z. Increasing the period creditors must retain records
evidencing compliance with Sec. 226.43 from two to three years would
increase creditors' compliance burden. The Board believes many
creditors will retain such records for at least three years, even in
the absence of a change to record retention requirements, due to the
extension of the statute of limitations for civil liability.
Currently, comment 25(a)-2 clarifies that in general creditors need
retain only enough information to reconstruct the required disclosures
or other records. The Board proposes a new comment 25(a)-6 that
clarifies that if a creditor must verify and document information used
in underwriting a transaction subject to proposed Sec. 226.43, the
creditor should retain evidence sufficient to demonstrate compliance
with the documentation requirements of Sec. 226.25(a). Proposed
comment 25(a)-6 also clarifies that creditors need not retain actual
paper copies of the documentation used to underwrite a transaction, but
they should be able to reproduce those records accurately, for example,
by retaining a reproduction of a consumer's Internal Revenue Service
Form W-2 rather than merely the income information on the form. The
Board also proposes to revise comment 25(a)-2 to remove obsolete
references to particular documentation methods and to reflect that in
some cases creditors must be able to reproduce (not merely reconstruct)
records.
Proposed comment 25(a)-7 provides guidance regarding retention of
records evidencing compliance with the requirement to offer a consumer
an alternative covered transaction without a prepayment penalty,
discussed below in the section-by-section analyses of proposed Sec.
226.43(g)(3) through (5). Proposed comment 25(a)-7 clarifies that
creditors must retain records that document compliance with that
requirement if a transaction subject to proposed Sec. 226.43 is
consummated with a prepayment penalty, but need not retain such records
if a covered transaction is consummated without a prepayment penalty or
a covered transaction is not consummated. See proposed Sec.
226.43(g)(6). The Board believes the requirement to offer a transaction
without a prepayment penalty under TILA Section 129C(c)(4) is intended
to ensure that consumers can voluntarily choose an alternative covered
transaction with a prepayment penalty. The Board therefore believes it
is unnecessary for creditors to document compliance with the offer
requirement when a consumer does not choose a transaction with a
prepayment penalty, or if the covered transaction is not consummated.
As discussed in detail below in the section-by-section analysis of
proposed Sec. 226.43(g)(4), if the creditor offers a covered
transaction with a prepayment penalty through a mortgage broker, the
creditor must present the mortgage broker an alternative covered
transaction without a prepayment penalty. Also, the creditor must
provide, by agreement, for the mortgage broker to present the consumer
that transaction or an alternative covered transaction without a
prepayment penalty offered by another creditor that has a lower
interest rate or a lower total dollar amount of origination points or
fees and discount points. Proposed comment 25(a)-7 clarifies that, to
evidence compliance with proposed Sec. 226.43(g)(4), the creditor
should retain a record of (1) the alternative covered transaction
without a prepayment penalty presented to the mortgage broker pursuant
to proposed Sec. 226.43(g)(4)(i), such as a rate sheet, and (2) the
agreement with the mortgage broker required by proposed Sec.
226.34(g)(4)(ii).
Section 226.32 Requirements for Certain Closed-End Home Mortgages
Introduction
The Board proposes to revise the definition of ``points and fees''
in Sec. 226.32(b)(1) to incorporate amendments to this definition
under the Dodd-Frank Act.\6\ Formerly, the definition of ``points and
fees'' in both TILA and Regulation Z applied only for determining
whether a home mortgage is a ``high-cost mortgage'' under TILA. See
TILA Section 103(aa)(4), 15 U.S.C. 1602(aa)(4); Sec. 226.32. As
discussed earlier, however, the Dodd-Frank Act amended TILA to create a
new type of mortgage--a ``qualified mortgage''--to which certain limits
on the points and fees that may be charged apply.\7\ Under the new TILA
amendments, the term ``points and fees'' for qualified mortgages has
the same meaning as ``points and fees'' for high-cost mortgages.
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\6\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec. 1431.
\7\ Id. Sec. 1412; TILA Section 129C(b)(2)(A)(vii),
(b)(2)(C)(i); 15 U.S.C. 1639c(b)(2)(A)(vii), (b)(2)(C)(i).
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The Board proposes amendments to the definition of ``points and
fees'' to implement the limitation on points and fees for qualified
mortgages. The Board is not currently proposing regulations to
implement the Dodd-Frank Act's amendments to TILA's high-cost mortgage
rules generally.\8\ For example, the Board is not proposing at this
time to implement revisions to the points and fees thresholds for high-
cost mortgages that exclude from the threshold
[[Page 27399]]
calculation ``bona fide third party charges not retained by the
mortgage originator, creditor, or an affiliate of the creditor or
mortgage originator'' and that permit creditors to exclude certain
``bona fide discount points.'' \9\ By contrast, identical provisions in
the Dodd-Frank Act defining the points and fees threshold for qualified
mortgages are proposed to be implemented in new Sec. 226.43(e)(3),
discussed below.\10\
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\8\ Id. Sec. 1431-1433. The Dodd-Frank Act defines a high-cost
mortgage to include a mortgage for which ``the total points and fees
payable in connection with the transaction, other than bona fide
third party charges not retained by the mortgage originator,
creditor, or an affiliate of the creditor or mortgage originator,
exceed--(I) in the case of a transaction for $20,000 or more, 5
percent of the total transaction amount; or (II) in the case of a
transaction for less than $20,000, the lesser of 8 percent of the
total transaction amount or $1,000 (or such other dollar amount as
the Board shall prescribe by regulation.'' Id. Sec. 1431(a); TILA
Section 103(aa)(1)(A)(ii); 15 U.S.C. 1602(aa)(1)(A)(ii).
\9\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec. 1431(a)
and (d); TILA Section 103(aa)(1) and (dd); 15 U.S.C. 1602(aa)(1) and
(dd).
\10\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec. 1412;
TILA Section 129C(b)(2)(C); 15 U.S.C. 1639c(b)(2)(C). Thus, if the
rule on qualified mortgages is finalized prior to the rule on high-
cost mortgages, the calculation of the points and fees threshold for
each type of mortgage would be different, but the baseline
definition of ``points and fees'' would be the same.
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32(a) Coverage
32(a)(1) Calculation of the ``Total Loan Amount''
TILA Section 129C(b)(2)(A)(vii) defines a ``qualified mortgage'' as
a mortgage for which, among other things, ``the total points and fees
[] payable in connection with the loan do not exceed 3 percent of the
total loan amount'' (emphasis added).\11\ Therefore, for purposes of
implementing the qualified mortgage provisions, the Board proposes to
retain existing comment 32(a)(1)(ii)-1 explaining the meaning of the
term ``total loan amount,'' with the minor revisions discussed below.
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\11\ Similarly, prior to being revised by the Dodd-Frank Act,
TILA Section 103(aa)(1)(B) defined a high-cost mortgage to include a
mortgage for which ``the total points and fees payable by the
consumer at or before closing will exceed the greater of (i) eight
percent of the total loan amount; or (ii) $400'' (emphasis added).
Regulation Z currently defines a high-cost mortgage to include a
loan for which the total points and fees payable by the consumer at
or before closing exceed a certain percentage of the ``total loan
amount'' or a dollar amount adjusted annually for inflation. See
Sec. 226.32(a)(1)(ii). Commentary to Sec. 226.32(a)(1)(ii)
explains the term ``total loan amount.'' See comment 32(a)(1)(ii)-1.
Section 1431 of the Dodd-Frank Act now defines a high-cost mortgage
to include a mortgage for which the points and fees do not exceed a
certain percentage of the ``total transaction amount,'' rather than
using the term ``total loan amount.'' TILA Section
103(aa)(1)(A)(ii). The Dodd-Frank Act does not define the term
``total transaction amount.'' However, as discussed above, the Board
is not at this time proposing to revise the definition of high-cost
mortgage in Sec. 226.32 to implement Dodd-Frank Act amendments to
TILA's high-cost mortgage provisions.
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First, the proposal revises the ``total loan amount'' calculation
under current comment 32(a)(1)(ii)-1 to account for charges added to
TILA's definition of points and fees by the Dodd-Frank Act (proposed to
be implemented under revisions to Sec. 226.32(b)(1), discussed below).
Under Regulation Z, the ``total loan amount'' is calculated to ensure
that the allowable points and fees is a percentage of the amount of
credit extended to the consumer, without taking into account the
financed points and fees themselves. Specifically, under current
comment 32(a)(1)(ii)-1, the ``total loan amount'' is calculated by
``taking the amount financed, as determined according to Sec.
226.18(b), and deducting any cost listed in Sec. 226.32(b)(1)(iii) and
Sec. 226.32(b)(1)(iv) that is both included as points and fees under
Sec. 226.32(b)(1) and financed by the creditor.'' Section
226.32(b)(1)(iii) and (b)(1)(iv) pertain to ``real estate-related
fees'' listed in Sec. 226.4(c)(7) and premiums or other charges for
credit insurance or debt cancellation coverage, respectively.
The Board proposes to revise this comment to cross-reference
additional financed points and fees described in proposed Sec.
226.32(b)(1)(vi) as well. This addition would require a creditor also
to deduct from the amount financed any prepayment penalties that are
``incurred by the consumer if the mortgage loan refinances a previous
loan made or currently held by the creditor refinancing the loan or an
affiliate of the creditor''--to the extent that the prepayment
penalties are financed by the creditor into the new loan. See proposed
Sec. 226.32(b)(1)(vi), implementing TILA Section 103(aa)(4)(F). In
this way, the three percent limit on points and fees for qualified
mortgages will be based on the amount of credit extended to the
borrower without taking into account the financed points and fees
themselves.
The proposal also revises one of the commentary's examples of the
``total loan amount'' calculation. Specifically, the Board proposes to
revise the example of a $500 single premium for optional ``credit life
insurance'' used in comment 32(b)(1)(i)-1.iv to be a $500 single
premium for optional ``credit unemployment insurance.'' This change is
proposed because, under the Dodd-Frank Act, single-premium credit
insurance--including credit life insurance--is prohibited in covered
transactions except for certain limited types of credit unemployment
insurance.\12\ See TILA Section 129C(d); 15 U.S.C. 1639c(d).
---------------------------------------------------------------------------
\12\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec. 1414.
The Board is not at this time proposing to implement the
restrictions on single-premium credit insurance under the Dodd-Frank
Act.
---------------------------------------------------------------------------
Alternative calculation of ``total loan amount'' based on the
``principal loan amount.'' As noted, currently the ``total loan
amount'' is calculated by taking the ``amount financed'' (as determined
under Sec. 226.18(b)) and deducting any cost listed in Sec.
226.32(b)(1)(iii) and Sec. 226.32(b)(1)(iv) that is both included as
points and fees under Sec. 226.32(b)(1) and financed by the creditor.
The Board requests comment on whether to streamline the calculation to
better ensure that the ``total loan amount'' includes all credit
extended other than financed points and fees.
Specifically, the Board solicits comment on whether to revise the
calculation of ``total loan amount'' to be the following: ``principal
loan amount'' (as defined in Sec. 226.18(b) and accompanying
commentary), minus charges that are points and fees under Sec.
226.32(b)(1) and are financed by the creditor. The purpose of using the
``principal loan amount'' instead of the ``amount financed'' would be
to streamline the calculation to facilitate compliance and to ensure
that no charges other than financed points and fees are excluded from
the ``total loan amount.'' In general, the revised calculation would
yield a larger ``total loan amount'' to which the percentage points and
fees thresholds would have to be applied than would the proposed (and
existing) ``total loan amount'' calculation, because only financed
points and fees and no other financed amounts would be excluded. Thus,
creditors in some cases would be able to charge more points and fees on
the same loan than under the proposed (and existing) rule.
To illustrate, under the proposed (and current) rule, the ``total
loan amount'' for a loan with a ``principal loan amount'' of $100,000
and a $3,000 upfront mortgage insurance premium is $97,000. This is
because the ``amount financed,'' from which the ``total loan amount''
is derived, excludes prepaid finance charges. The $3,000 upfront
mortgage origination charge meets the definition of a prepaid finance
charge (see Sec. 226.2(a)(23)) and thus would be excluded from the
``principal loan amount'' to derive the ``amount financed.'' The
``total loan amount'' is the ``amount financed'' ($97,000) minus any
points and fees listed in Sec. 226.32(b)(1)(iii) or (b)(1)(iv) that
are financed. In this example, there are no charges under Sec.
226.32(b)(1)(iii) or (b)(1)(iv), so the ``total loan amount'' is
$97,000. The allowable points and fees under the qualified mortgage
test in this example is three percent of $97,000 or $2,910.
If the ``total loan amount'' is derived simply by subtracting from
the ``principal loan amount'' all points and fees that are financed,
however, a different result occurs. In the example above, assume that
the allowable upfront mortgage insurance premium
[[Page 27400]]
for FHA loans is $2,000. Under proposed Sec. 226.32(b)(1)(i)(B)
(discussed in detail below), only the $1,000 difference between the
$3,000 upfront private mortgage insurance premium and the $2,000 amount
that would be allowable for an FHA loan must be counted as points and
fees. To determine the ``total loan amount,'' the creditor would
subtract $1,000 from the ``principal loan amount'' ($100,000),
resulting in $99,000. The allowable points and fees under the qualified
mortgage test in this example is three percent of $99,000 or $2,970.
The Board requests comment on the proposed revisions to the comment
explaining how to calculate the ``total loan amount,'' including
whether additional guidance is needed.
32(b) Definitions
32(b)(1)
The proposed rule would revise existing elements of Regulation Z's
definition of ``points and fees'' (see proposed Sec. 226.32(b)(1)(i)-
(iv)) and add certain items not previously included in ``points and
fees'' but now mandated by statute to be included (see proposed Sec.
226.32(b)(1)(v) and (vi)). These changes are discussed in turn below.
32(b)(1)(i) Finance Charge
Current Sec. 226.32(b)(1)(i) requires that ``points and fees''
include ``all items required to be disclosed under Sec. 226.4(a) and
226.4(b)''--the provisions that define the term ``finance charge'' --
``except interest or the time-price differential.'' Proposed Sec.
226.32(b)(1)(i) would revise the current provision to include in points
and fees ``all items considered to be a finance charge under Sec.
226.4(a) and 226.4(b), except--
Interest or the time-price differential; and
Any premium or charge for any guarantee or insurance
protecting the creditor against the consumer's default or other credit
loss to the extent that the premium or charge is assessed--
[cir] in connection with any Federal or state agency program;
[cir] not in excess of the amount payable under policies in effect
at the time of origination under Section 203(c)(2)(A) of the National
Housing Act (12 U.S.C. 1709(c)(2)(A)) (i.e., for Federal Housing
Administration (FHA) loans), provided that the premium or charge is
required to be refundable on a pro-rated basis and the refund is
automatically issued upon notification of the satisfaction of the
underlying mortgage loan; or
[cir] payable after the loan closing.
See proposed Sec. 226.32(b)(1)(i)(A)-(C).
The Board proposes to revise the existing phrase, ``all items
required to be disclosed under Sec. 226.4(a) and 226.4(b)'' to read,
``all items considered to be a finance charge under Sec. 226.4(a) and
226.4(b)'' in part because Sec. 226.4 itself does not require
disclosure of the finance charge (see instead, for example, Sec.
226.18(d)).
The Board also proposes to revise comment 32(b)(1)(i)-1. Existing
comment 32(b)(1)(i)-1 states that Sec. 226.32(b)(1)(i) includes in the
total ``points and fees'' items defined as finance charges under Sec.
226.4(a) and 226.4(b). The comment explains that items excluded from
the finance charge under other provisions of Sec. 226.4 are not
included in the total ``points and fees'' under Sec. 226.32(b)(1)(i),
but may be included in ``points and fees'' under Sec. 226.32(b)(1)(ii)
and 226.32(b)(1)(iii). The Board proposes to revise this comment to
state that items excluded from the finance charge under other provision
of Sec. 226.4 may be included in ``points and fee'' under Sec.
226.32(b)(1)(ii) through 226.32(b)(1)(vi). This change is proposed to
reflect the additional items added to the definition of ``points and
fees'' by the Dodd-Frank Act and to correct the previous omission of
Sec. 226.32(b)(1)(iv).
In addition, the Board proposes to incorporate into this comment an
example of how this rule operates. Thus, the proposed comment notes
that a fee imposed by the creditor for an appraisal performed by an
employee of the creditor meets the definition of ``finance charge''
under Sec. 226.4(a) as ``any charge payable directly or indirectly by
the consumer and imposed directly or indirectly by the creditor as an
incident to or a condition of the extension of credit.'' However, Sec.
226.4(c)(7) expressly provides that appraisal fees are not finance
charges. Therefore, under the general rule regarding the finance
charges that must be counted as points and fees, a fee imposed by the
creditor for an appraisal performed by an employee of the creditor
would not be counted in points and fees. Section 226.32(b)(1)(iii),
however, expressly includes in points and fees items listed in Sec.
226.4(c)(7) (including appraisal fees) if the creditor receives
compensation in connection with the charge. A creditor would receive
compensation for an appraisal performed by its own employee. Thus, the
appraisal fee in this example must be included in the calculation of
points and fees. Comment 32(b)(1)(i)-1 is also proposed to be updated
to include cross-references that correspond to provisions added to the
definition of ``points and fees'' by the Dodd-Frank Act (see proposed
Sec. 226.32(b)(1)(v) and (b)(1)(vi)).
32(b)(1)(i)(B) Mortgage Insurance
Proposed Sec. 226.32(b)(1)(i)(B) adds a new provision to the
current definition of ``points and fees'' regarding charges for
mortgage insurance and similar products. As stated above, under this
provision, points and fees would include all items considered to be a
finance charge under Sec. 226.4(a) and 226.4(b) except mortgage
insurance premiums or mortgage guarantee charges or fees to the extent
that the premium or charge is--
assessed in connection with any Federal or state agency
program;
not in excess of the amount payable under FHA mortgage
insurance policies (provided that the premium or charge is required to
be refundable on a pro-rated basis and the refund is automatically
issued upon notification of the satisfaction of the underlying mortgage
loan); or
payable after the loan closing.
This provision implements TILA Section 103(aa)(1)(C), which specifies
how ``mortgage insurance'' should be treated in the statutory
definition of points and fees under TILA Section 103(aa)(4).
Exclusion of government insurance premiums and guaranty fees. The
Board proposes to incorporate the new statutory exclusion from points
and fees of ``any premium provided by an agency of the Federal
Government or an agency of a State,'' with revisions. TILA Section
103(aa)(1)(C)(i). Specifically, the proposal excludes ``any premium or
charge for any guaranty or insurance'' under a Federal or state
government program. See proposed Sec. 226.32(b)(1)(i)(B)(1). Proposed
comment 32(b)(1)(i)-2 explains that, under Sec. 226.32(b)(1)(i)(B)(1)
and (3), upfront mortgage insurance premiums or guaranty fees in
connection with a Federal or state agency program are not ``points and
fees,'' even though they are finance charges under Sec. 226.4(a) and
(b). The comment provides the following example: If a consumer is
required to pay a $2,000 mortgage insurance premium before or at
closing for a loan insured by the U.S. Federal Housing Administration,
the $2,000 must be treated as a finance charge but need not be counted
in ``points and fees.''
The Board interprets the statute to exclude from points and fees
not only upfront mortgage insurance premiums under government programs
but also charges for mortgage guaranties under government programs,
which typically are assessed upfront as well. The proposed exclusion
from points and fees of both mortgage insurance premiums and guaranty
fees under government
[[Page 27401]]
programs is also supported by the Board's authority under TILA Section
105(a) to make adjustments to facilitate compliance with TILA and to
effectuate the purposes of TILA. 15 U.S.C. 1604(a). The exclusion is
further supported by the Board's authority under TILA Section 129B(e)
to condition terms, acts or practices relating to residential mortgage
loans that the Board finds necessary or proper to effectuate the
purposes of TILA. 15 U.S.C. 1639b(e). The purposes of TILA include
``assur[ing] that consumers are offered and receive residential
mortgage loan on terms that reasonably reflect their ability to repay
the loans.'' TILA Section 129B(a)(2); 15 U.S.C. 1629b(a)(2).
Representatives of both the U.S. Department of Veterans Affairs
(VA) and the U.S. Department of Agriculture (USDA) expressed concerns
to Board staff that the statute, which excludes only ``premiums'' under
government programs, could be read to mean that upfront charges for
guaranties offered under loan programs of these agencies and any state
agencies must be counted in ``points and fees.'' The Board understands
that this interpretation of the statute could disrupt these loan
guaranty programs, jeopardizing an important home mortgage credit
resource for many consumers. According to VA representatives, for
example, if VA ``funding fees'' for the VA mortgage loan guaranty are
included in points and fees, for example, VA loans might exceed high-
cost mortgage thresholds and likely would exceed the points and fees
cap for a qualified mortgage.\13\ In sum, the Board believes that the
proposal is necessary to ensure consumer's access to credit through
state and Federal government programs.
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\13\ The statute authorizes certain agencies, including the VA
and USDA, to prescribe rules defining the loans under their programs
that are qualified mortgages; until those rules take effect,
however, it appears that even loans under government programs will
be subject to the general ability-to-repay requirements and the
criteria for qualified mortgages. See TILA Section 129C(b)(3)(ii).
---------------------------------------------------------------------------
The Board requests comment on the proposal to exclude from ``points
and fees'' upfront premiums as well as charges for any insurance or
guaranty under a Federal or state government program.
Inclusion of upfront private mortgage insurance. Proposed Sec.
226.32(b)(1)(i)(B)(2) excludes from points and fees any premium or
charge for any guaranty or insurance protecting the creditor against
the consumer's default or other credit loss to the extent the premium
or charge does not exceed the amount payable under policies in effect
at the time of origination under Section 203(c)(2)(A) of the National
Housing Act (12 U.S.C. 1709(c)(2)(A)) (i.e., for Federal Housing
Administration (FHA) loans). Upfront private mortgage insurance charges
may only be excluded from points and fees, however, if the premium or
charge is required to be refundable on a pro-rated basis and the refund
is automatically issued upon notification of the satisfaction of the
underlying mortgage loan. Proposed Sec. 226.32(b)(1)(i)(B)(3) excludes
from points and fees any premium or charge for any guarantee or
insurance protecting the creditor against the consumer's default or
other credit loss to the extent that the premium or charge is payable
after the loan closing.
Comment 32(b)(1)(i)-3 explains that, under proposed Sec.
226.32(b)(1)(i)(B)(2) and (3), upfront private mortgage insurance
premiums are not ``points and fees,'' even though they are finance
charges under Sec. 226.4(a) and (b)--but only to the extent that the
premium amount does not exceed the amount payable under policies in
effect at the time of origination under Section 203(c)(2)(A) of the
National Housing Act (12 U.S.C. 1709(c)(2)(A)). In addition, upfront
private mortgage insurance premiums are excluded from ``points and
fees'' only if they are required to be refunded on a pro rata basis and
the refund is automatically issued upon notification of the
satisfaction of the underlying mortgage loan. This comment provides the
following example: Assume that a $3,000 upfront private mortgage
insurance premium charged on a covered transaction is required to be
refunded on a pro rata basis and automatically issued upon notification
of the satisfaction of the underlying mortgage loan. Assume also that
the maximum upfront premium allowable under the National Housing Act is
$2,000. In this case, the creditor could exclude $2,000 from ``points
and fees'' but would have to include in points and fees the remaining
$1,000, because this is the amount that exceeds the allowable premium
under the National Housing Act. However, if the $3,000 upfront private
mortgage insurance premium were not required to be refunded on a pro
rata basis and automatically issued upon notification of the
satisfaction of the underlying mortgage loan, the entire $3,000 premium
must be included in ``points and fees.''
Proposed comment 32(b)(1)(i)-4 explains that upfront private
mortgage insurance premiums that do not qualify for an exclusion from
``points and fees'' under Sec. 226.32(b)(1)(i)(B)(2) must be included
in ``points and fees'' whether paid before or at closing, in cash or
financed, and whether the insurance is optional or required. This
comment further explains that these charges are also included whether
the amount represents the entire premium or an initial payment. This
proposed comment is consistent with existing comment 32(b)(1)(iv)-1
regarding the treatment of credit insurance premiums.
TILA's new mortgage insurance provision could plausibly be
interpreted to apply to the definition of points and fees solely for
purposes of high-cost mortgages and not for qualified mortgages. In
this regard, the Board notes that the statutory provision mandating a
three percent cap on points and fees for qualified mortgages
specifically cross-references TILA Section 103(aa)(4) for the
definition of ``points and fees'' applicable to qualified mortgages.
The provision on mortgage insurance, however, does not appear in TILA
Section 103(aa)(4), but appears rather as part of the general
definition of a high-cost mortgage. See TILA Section 103(aa)(1). The
Board also notes that certain provisions in the Dodd-Frank Act's high-
cost mortgage section regarding points and fees are repeated in the
qualified mortgage section on points and fees. For example, both the
high-cost mortgage provisions and the qualified mortgage provisions
expressly exclude from points and fees ``bona fide third party charges
not retained by the mortgage originator, creditor, or an affiliate of
the creditor or mortgage originator.'' TILA Sections 103(aa)(1)(A)(ii)
(for high-cost mortgages), 129C(b)(2)(C)(i) (for qualified mortgages).
The mortgage insurance provision, however, does not separately appear
in the qualified mortgage section.
Nonetheless, the Board believes that the better interpretation of
the statute is that the mortgage insurance provision in TILA Section
103(aa)(1)(C) applies to the meaning of points and fees for both high-
cost mortgages and qualified mortgages. The statute's structure
reasonably supports this view: By its plain language, the mortgage
insurance provision prescribes how points and fees should be computed
``for purposes of paragraph (4)''--namely, for purposes of TILA Section
103(aa)(4). The mortgage insurance provision contains no caveat
limiting its application solely to the points and fees calculation for
high-cost mortgages. The cross-reference in the qualified mortgage
provisions to TILA Section 103(aa)(4) appropriately can be read to
include provisions that expressly prescribe how points and fees should
be calculated under TILA Section 103(aa)(4), wherever located.
[[Page 27402]]
Applying the mortgage insurance provision to the meaning of points
and fees for both high-cost mortgages and qualified mortgages is also
supported by the Board's authority under TILA Section 105(a) to make
adjustments to facilitate compliance with TILA 15 U.S.C. 1604(a). The
exclusion is further supported by the Board's authority under TILA
Section 129B(e) to condition terms, acts or practices relating to
residential mortgage loans that the Board finds necessary or proper to
effectuate the purposes of TILA. 15 U.S.C. 1639b(e). The purposes of
TILA include ``assur[ing] that consumers are offered and receive
residential mortgage loan on terms that reasonably reflect their
ability to repay the loans.'' TILA Section 129B(a)(2); 15 U.S.C.
1629b(a)(2).
From a practical standpoint, the Board is concerned about the
increased risk of confusion and compliance error if points and fees has
two separate meanings in TILA--one for determining whether a loan is a
high-cost mortgage and another for determining whether a loan is a
qualified mortgage. The proposal is intended to facilitate compliance
by applying the mortgage insurance provision to the meaning of points
and fees for both high-cost mortgages and qualified mortgages.
In addition, the Board is concerned that market distortions could
result due to different treatment of mortgage insurance in calculating
points and fees for high-cost mortgages and qualified mortgages. As
noted, ``points and fees'' for both high-cost mortgages and qualified
mortgages generally excludes ``bona fide third party charges not
retained by the mortgage originator, creditor, or an affiliate of the
creditor or mortgage originator.'' TILA Sections 103(aa)(1)(A)(ii),
129C(b)(2)(C)(i). Under this general provision standing alone, premiums
for upfront private mortgage insurance would be excluded from points
and fees. However, as noted, the statute's specific provision on
mortgage insurance (TILA Section 103(aa)(1)(C)) requires that any
portion of upfront premiums for private mortgage insurance that exceeds
amounts allowable for upfront insurance premiums in FHA mortgage loan
transactions be counted in points and fees. It further provides that
upfront private mortgage insurance premiums must be included in points
and fees if they are not required to be refunded on a pro rata basis
and the refund is not automatically issued upon notification of the
satisfaction of the underlying mortgage loan.
Narrowly applying the mortgage insurance provision to the
definition of points and fees only for high-cost mortgages would mean
that any premium amount for upfront private mortgage insurance could be
charged on qualified mortgages; in most cases, none of that amount
would be subject to the cap on points and fees for qualified mortgages
because it would be excluded as a ``bona fide third party fee'' that is
not retained by the creditor, loan originator, or an affiliate of
either. As a result, consumers of qualified mortgages could be
vulnerable to paying excessive upfront private mortgage insurance
costs. In the Board's view, this outcome would undercut Congress's
clear intent to ensure that qualified mortgages are products with
limited fees and more safe features.
32(b)(1)(ii) Loan Originator Compensation
The Board proposes revisions to Sec. 226.32(b)(ii) to reflect
statutory amendments under the Dodd-Frank Act. Current Sec.
226.32(b)(ii) requires inclusion in points and fees of ``all
compensation paid to a mortgage broker.'' Proposed Sec. 226.32(b)(ii)
would implement a new statutory provision that requires inclusion in
points and fees of ``all compensation paid directly or indirectly by a
consumer or creditor to a mortgage originator from any source,
including a mortgage originator that is also the creditor in a table-
funded transaction.'' See TILA Section 103(aa)(4)(B), 15 U.S.C.
1602(aa)(4)(B). Consistent with the statute, the Board also proposes to
exclude from points and fees compensation paid to certain persons. See
proposed Sec. 226.32(b)(2), discussed below.
Proposed Sec. 226.32(b)(1)(ii) mirrors the statutory language,
with two exceptions. First, the statute requires inclusion of
``compensation paid directly or indirectly by a consumer or creditor to
a mortgage originator from any source. * * *'' The proposed rule does
not include the phrase ``from any source'' because the provision
expressly covers compensation paid ``directly or indirectly'' to the
loan originator, which would have the same effect. The Board requests
comment on whether any reason exists to include the phrase ``from any
source'' to describe loan originator compensation for purposes of
implementing TILA Section 103(aa)(4)(B).
Second, the proposal uses the term ``loan originator'' as defined
in Sec. 226.36(a)(1),\14\ not the term ``mortgage originator'' under
Section 1401 of the Dodd-Frank Act.\15\ See TILA Section 103(cc)(2); 15
U.S.C. 1602(cc)(2). The term ``loan originator'' is used for
consistency with existing Regulation Z provisions under Sec. 226.36.
The Board believes that the term ``loan originator,'' as defined in
Sec. 226.36(a)(1), is appropriately used in proposed Sec.
226.32(b)(1)(ii) because the meaning of ``loan originator'' under Sec.
226.36(a)(1) and the statutory definition of ``mortgage originator''
are consistent in several key respects, discussed below.
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\14\ Section 226.36(a)(1) defines the term ``loan originator''
to mean, ``with respect to a particular transaction, a person who
for compensation or other monetary gain, or in expectation of
compensation or other monetary gain, arranges, negotiates, or
otherwise obtains an extension of credit for another person. The
term `loan originator' includes an employee of the creditor if the
employee meets this definition. The term `loan originator' includes
the creditor only if the creditor does not provide the funds for the
transaction at consummation out of the creditor's own resources,
including drawing on a bona fide warehouse line of credit, or out of
deposits held by the creditor.'' Section 226.36(a)(1).
\15\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec. 1401.
---------------------------------------------------------------------------
In addition, new Sec. 226.32(b)(2) would account for the
distinctions between the Dodd-Frank Act's definition of ``mortgage
originator'' and the definition of ``loan originator'' under Sec.
226.36(a)(1). Proposed Sec. 226.32(b)(2) exempts from points and fees
compensation paid to certain persons expressly excluded from the
statutory definition of ``mortgage originator.'' See section-by-section
analysis of Sec. 226.32(b)(2), below. Use of the term ``loan
originator'' in proposed Sec. 226.32(b)(1)(ii).
Loan originator functions. The Dodd-Frank Act defines the term
``mortgage originator'' to mean ``any person who, for direct or
indirect compensation or gain, or in the expectation of direct or
indirect compensation or gain--(i) takes a residential mortgage loan
application; (ii) assists a consumer in obtaining or applying to obtain
a residential mortgage loan; or (iii) offers or negotiates terms of a
residential mortgage loan . * * *'' TILA Section 103(cc)(2)(A). The
statute further defines ``assists a consumer in obtaining or applying
to obtain a residential mortgage loan'' to mean, ``among other things,
advising on residential mortgage loan terms (including rates, fees, and
other costs), preparing residential mortgage loan packages, or
collecting information on behalf of the consumer with regard to a
residential mortgage loan.''
The definition of ``loan originator'' in Sec. 226.36 includes all
of the activities listed in the statute as part of the definition of
``mortgage originator,'' with one exception. Unlike the statutory
definition of ``mortgage originator,'' however, Regulation Z's
definition of ``loan originator'' does not include ``any
[[Page 27403]]
person who represents to the public, through advertising or other means
of communicating or providing information (including the use of
business cards, stationery, brochures, signs, rate lists, or other
promotional items), that such person can or will provide any of the
activities'' described above. TILA Section 103(cc)(2)(B); 15 U.S.C.
1602(cc)(2)(B). The Board does not believe that adding this element of
the definition of ``mortgage originator'' to Regulation Z's definition
of ``loan originator'' is necessary at this time because Sec. 226.36
and the proposed definition of ``points and fees'' are concerned solely
with loan originators that receive compensation for performing defined
origination functions. A person who solely represents to the public
that he is able to offer or negotiate mortgage terms for a consumer has
not yet received compensation for that function; thus, there is no
compensation to account for in calculating ``points and fees'' for a
particular transaction.
The Board solicits comment on the proposal not to include in the
definition of ``loan originator'' a ``person who represents to the
public, through advertising or other means of communicating or
providing information (including the use of business cards, stationery,
brochures, signs, rate lists, or other promotional items), that such
person can or will provide'' the services of a loan originator.
Administrative tasks. The Board also believes that the definition
of ``loan originator'' in Sec. 226.32(a)(1) is consistent with the
Dodd-Frank Act's definition of ``mortgage originator'' in that both
exclude persons that perform solely administrative or clerical tasks.
Specifically, the statute excludes any person who does not perform the
tasks in the paragraph above and ``who performs purely administrative
or clerical tasks on behalf of a person who [performs those tasks].''
TILA Section 103(cc)(2)(B); 15 U.S.C. 1602(cc)(2)(B). Similarly,
Regulation Z's current definition of ``loan originator'' excludes
``managers, administrative staff, and similar individuals who are
employed by a creditor or loan originator but do not arrange,
negotiate, or otherwise obtain an extension of credit for a consumer,
and whose compensation is not based on whether any particular loan is
originated.'' Comment 36(a)(1)-4.
Seller financing. In addition, the existing definition of ``loan
originator'' in Sec. 226.36(a)(1) is consistent with the statutory
definition of ``mortgage originator'' in that both exclude persons and
entities that provide seller financing for properties that they own.
See TILA Section 103(cc)(2)(E); 15 U.S.C. 1602(cc)(2)(E). Under the
definition of ``loan originator'' in Sec. 226.36(a)(1), these persons
would be ``creditors''--but they are not ``creditors'' that use table
funding. As noted below, creditors that use table funding are ``loan
originators'' under Sec. 226.36. However, all other ``creditors'' are
not ``loan originators.'' See 75 FR 58509, 58510 (Sept. 24, 2010).
Creditors in table-funded transactions. Both the existing
definition of ``loan originator'' in Sec. 226.36(a)(1) and the
statutory definition of ``mortgage originator'' exclude the creditor,
except for the creditor in a table-funded transaction. See TILA Section
103(cc)(2)(F); 15 U.S.C. 1602(cc)(2)(F); see also comment 36(a)-1.i.
Both also include employees of a creditor, individual brokers and
mortgage brokerage firms, including entities that close loans in their
own names that are table funded by a third party.
Secondary market transactions. Finally, neither the definition of
``loan originator'' in Sec. 226.36(a)(1) nor the statutory definition
of ``mortgage originator'' includes entities that earn compensation on
the sale of loans by creditors to secondary market purchasers--
transactions to which consumers are not a direct party. See generally
TILA Section 103(cc)(2); 15 U.S.C. 1602(cc)(2).
Comments 32(b)(1)(ii)-1, -2, and -3. Proposed comments
32(b)(1)(ii)-1, -2, and -3 provide guidance on the types of loan
originator compensation \16\ included in ``points and fees.'' Existing
comment 32(b)(1)(ii)-1 would be revised to clarify that compensation
paid by either a consumer or a creditor to a loan originator, as
defined in Sec. 226.32(a)(1), is included in ``points and fees.'' No
other substantive changes are intended.
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\16\ Loan originator compensation would, of course, need to be
consistent with the Interagency Guidance on Sound Incentive
Compensation Policies. 75 FR 36395, June 25, 2010.
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New comment 32(b)(1)(ii)-2.i would clarify that, in determining
``points and fees,'' loan originator compensation includes the dollar
value of compensation paid to a loan originator for a covered
transaction, such as a bonus, commission, yield spread premium, award
of merchandise, services, trips, or similar prizes, or hourly pay for
the actual number of hours worked on a particular transaction. The
proposed comment would further clarify that compensation paid to a loan
originator for a covered transaction must be included in the ``points
and fees'' calculation for that transaction whenever paid, whether at
or before closing or anytime after closing, as long as that
compensation amount can be determined at the time of closing. Thus,
loan originator compensation for a covered transaction includes
compensation that will be paid as part of a periodic bonus, commission,
or gift if a portion of the dollar value of the bonus, commission, or
gift can be attributed to that transaction.
Proposed comment 32(b)(1)(ii)-2.i then provides three examples of
compensation paid to a loan originator that must be included in the
points and fees calculation. The first example assumes that, according
to a creditor's compensation policies, the creditor awards its loan
officers a bonus every year based on the number of loan applications
taken by the loan officer that result in consummated transactions
during that year, and that each consummated transaction increases the
bonus by $100. In this case, the $100 bonus must be counted in the
amount of loan originator compensation that the creditor includes in
``points and fees.''
The second example assumes that, according to a creditor's
compensation policies, the creditor awards its loan officers a bonus
every year based on the dollar value of consummated transactions
originated by the loan officer during that year. Also assumed is that,
for each transaction of up to $100,000, the creditor awards its loan
officers a bonus of $100; for each transaction of more than $100,000 up
to $250,000, the creditor awards its loan officers $200; and for each
transaction of more than $250,000, the creditor awards its loan
officers $300. In this case, for a mortgage transaction of $300,000,
the $300 bonus is loan originator compensation that must be included in
``points and fees.''
The third example assumes that, according to a creditor's
compensation policies, the creditor awards its loan officers a bonus
every year based on the number of consummated transactions originated
by the loan officer during that year. Also assumed is that for the
first 10 transactions originated by the loan officer in a given year,
no bonus is awarded; for the next 10 transactions originated by the
loan officer up to 20, a bonus of $100 per transaction is awarded; and
for each transaction originated after the first 20, a bonus of $200 per
transaction is awarded. In this case, for the first 10 transactions
originated by a loan officer during a given year, no amount of loan
originator compensation need be included in ``points and fees.'' For
any mortgage transaction made after the first 10, up to
[[Page 27404]]
the 20th transaction, $100 must be included in ``points and fees.'' For
any mortgage transaction made after the first 20, $200 must be included
in ``points and fees.''
Proposed comment 32(b)(1)(ii)-2.ii clarifies that, in determining
``points and fees,'' loan originator compensation excludes compensation
that cannot be attributed to a transaction at the time of origination,
including, for example:
Compensation based on the performance of the loan
originator's loans.
Compensation based on the overall quality of a loan
originator's loan files.
The base salary of a loan originator who is also the
employee of the creditor, not accounting for any bonuses, commissions,
pay raises, or other financial awards based solely on a particular
transaction or the number or amount of covered transactions originated
by the loan originator.
Proposed comment 32(b)(1)(ii)-3 explains that loan originator
compensation includes amounts the loan originator retains and is not
dependent on the label or name of any fee imposed in connection with
the transaction. For example, if a loan originator imposes a
``processing fee'' and retains the fee, the fee is loan originator
compensation under paragraph 32(b)(1)(ii) whether the originator
expends the fee to process the consumer's application or uses it for
other expenses, such as overhead. The proposed comment is consistent
with comment 36(d)(1)-1.ii for loan originator compensation.
The Board requests comment on the proposal regarding the types of
loan originator compensation that must be included in points and fees,
including the appropriateness of specific examples given in the
commentary.
32(b)(1)(iii) Real Estate-Related Fees
Consistent with the statute, the Board proposes no changes to
existing Sec. 226.32(b)(1)(iii), which includes in points and fees
``all items listed in Sec. 226.4(c)(7) (other than amounts held for
future payment of taxes) unless the charge is reasonable, the creditor
receives no direct or indirect compensation in connection with the
charge, and the charge is not paid to an affiliate of the creditor.''
During outreach, creditor representatives raised concerns about the
inclusion in points and fees of real estate-related fees paid to an
affiliate of the creditor, such as an affiliated title company. These
fees have historically been included in points and fees for high-cost
mortgages under both TILA and Regulation Z, but the points and fees
threshold for qualified mortgages is much lower than for the high-cost
mortgage threshold. Thus, creditors that use affiliated settlement
service providers such as title companies are concerned that they will
have difficulty making loans that meet the qualified mortgage points
and fees threshold.
The Board is not proposing an exemption for fees paid to creditor-
affiliated settlement services providers. The Board notes that Congress
appears to have rejected excluding from points and fees real estate-
related fees where a creditor would receive indirect compensation as a
result of obtaining distributions of profits from an affiliated entity
based on the creditor's ownership interest in compliance with
RESPA.\17\ The Board requests comment on the proposal not to exclude
from the points and fees calculation for qualified mortgages fees paid
to creditor-affiliated settlement services providers. The Board invites
commenters favoring this exclusion to explain why excluding these fees
from the points and fees calculation would be consistent with the
purposes of the statute.
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\17\ See Mortgage Reform and Anti-Predatory Lending Act, H. Rep.
111-94, p. 121 (May 4, 2009). An earlier version of the Dodd-Frank
Act would have amended the statutory provision implemented by Sec.
226.32(b)(1)(iii) to read as follows (added language italicized):
* * * [P]oints and fees shall include--
* * *
(C) each of the charges listed in section 106(e) (except an
escrow for future payment of taxes), unless--
(i) the charge is reasonable;
(ii) the creditor receives no direct or indirect compensation,
except where applied to the charges set forth in section 106(e)(1)
where a creditor may receive indirect compensation solely as a
result of obtaining distributions of profits from an affiliated
entity based on its ownership interest in compliance with section
8(c)(4) of the Real Estate Settlement Procedures Act of 1974; and
(iii) the charge is paid to a third party unaffiliated with the
creditor.
See id.
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Payable at or before closing. The Dodd-Frank Act removed the phrase
``payable at or before closing'' from the high-cost mortgage points and
fees test in TILA Section 103(aa)(1)(B). See TILA Section
103(aa)(1)(A)(ii). The phrase ``payable at or before closing'' is also
not in TILA's provisions on the points and fees cap for qualified
mortgages. See TILA Section 129C(b)(2)(A)(vii), (b)(2)(C). Thus, with a
few exceptions, any item listed in the ``points and fees'' definition
under Sec. 226.32(b)(1) must be counted toward the limits on points
and fees for both high-cost mortgages and qualified mortgages, even if
it is payable after loan closing. The exceptions are mortgage insurance
premiums and charges for credit insurance and debt cancellation and
suspension coverage. The statute expressly states that these premiums
and charges are included in points and fees only if payable at or
before closing. See TILA Section 103(aa)(1)(C) (for mortgage insurance)
and TILA Section 103(aa)(4)(D) (for credit insurance and debt
cancellation and suspension coverage). The statute does not so limit
Sec. 226.4(c)(7) charges, possibly because these charges could
reasonably be viewed as charges that by definition are only payable at
or before closing.\18\
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\18\ Section 226.4(c)(7) implements TILA Section 106(e), which
states: ``The following items, when charged in connection with any
extension of credit secured by an interest in real property, shall
not be included in the computation of the finance charge with
respect to that transaction: (1) Fees or premiums for title
examination, title insurance, or similar purposes. (2) Fees for
preparation of loan-related documents. (3) Escrows for future
payments of taxes and insurance. (4) Fees for notarizing deeds and
other documents. (5) Appraisal fees, including fees related to any
pest infestation or flood hazard inspections conducted prior to
closing. (6) Credit reports'' (emphasis added). 15 U.S.C. 1605(e).
---------------------------------------------------------------------------
Nonetheless, regarding the mortgage loan transaction costs that are
deemed points and fees, the Board requests comment on whether any other
types of fees should be included in points and fees only if they are
``payable at or before closing.'' The Board is concerned that some fees
that occur after closing, such as fees to modify a loan, might be
deemed to be points and fees. If so, calculating the points and fees to
determine whether a transaction is a qualified mortgage may be
difficult because the amount of future fees (e.g., loan modification
fees) cannot be known prior to closing. Creditors might be exposed to
excessive litigation risk if consumers were able at any point during
the life of a mortgage to argue that the points and fees for the loan
exceed the qualified mortgage limits due to fees imposed after loan
closing. Creditors therefore might be discouraged from making qualified
mortgages, which would thwart Congress's goal of increasing incentives
for creditors to make more stable, affordable loans.
32(b)(1)(iv) Credit Insurance and Debt Cancellation or Suspension
Coverage
The Board proposes to revise Sec. 226.32(b)(1)(iv) to reflect
statutory changes under the Dodd-Frank Act. See TILA Section
103(aa)(4)(D). Specifically, proposed Sec. 226.32(b)(1)(iv) includes
in points and fees ``[p]remiums or other charges payable at or before
closing of the mortgage loan for any credit life, credit disability,
credit unemployment, or credit property insurance, or any other life,
accident, health, or loss-of-
[[Page 27405]]
income insurance, or any payments directly or indirectly for any debt
cancellation or suspension agreement or contract.'' Except for non-
substantive changes in the ordering of the items listed, this provision
mirrors the statutory language.
TILA's new points and fees provision regarding charges for credit
insurance and debt cancellation and suspension coverage adds certain
types of credit insurance-related products to the existing list of
credit insurance products for which payments at or before closing must
be considered points and fees in existing Sec. 226.32(b)(1)(iv).
Accordingly, proposed revisions to Sec. 226.32(b)(1)(iv) add to the
list of products the following new items: Credit disability, credit
unemployment, or credit property insurance and debt suspension
coverage. (Other life, accident, health, or loss-of-income insurance,
or any payments directly or indirectly for any debt cancellation or
suspension agreement or contract are included in the existing
provision.) In a separate provision, however, the Dodd-Frank Act bans
single-premium credit insurance and debt protection products of all the
types listed above, except for credit unemployment insurance meeting
certain conditions. See TILA Section 129C(d); 15 U.S.C. 1639c(d). The
Board notes that the practical result of these combined amendments is
that only single-premium credit unemployment insurance meeting certain
conditions is permitted; therefore only single-premium credit
unemployment insurance will be included in points and fees.\19\
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\19\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec. 1414.
The Board is not at this time proposing to implement the
restrictions on single-premium credit insurance under the Dodd-Frank
Act.
---------------------------------------------------------------------------
The proposal revises current comment 32(b)(1)(iv)-1 to clarify that
upfront charges for debt cancellation or suspension agreements or
contracts are expressly included in points and fees. Another proposed
revision clarifies that upfront credit insurance premiums and debt
cancellation or suspension charges must be included in ``points and
fees'' regardless of whether the insurance or coverage is optional or
voluntary. The proposal adds new comment 32(b)(1)(iv)-2 to clarify that
``credit property insurance'' includes insurance against loss of or
damage to personal property, such as a houseboat or manufactured home.
The comment states that ``credit property insurance'' as used in Sec.
226.32(b)(1)(iv) covers the creditor's security interest in the
property. The comment explains that ``credit property insurance'' does
not include homeowners insurance, which, unlike ``credit property
insurance,'' typically covers not only the dwelling but its contents,
and designates the consumer, not the creditor, as the beneficiary.
The Board requests comment on the proposal to implement the
statutory provision that includes upfront premiums and charges for
credit insurance and debt cancellation and suspension coverage in the
definition of ``points and fees.''
32(b)(1)(v) Prepayment Penalties That May be Charged on the Loan
Proposed Sec. 226.32(b)(1)(v) includes in points and fees ``the
maximum prepayment penalty, as defined in Sec. 226.43(b)(10), that may
be charged or collected under the terms of the mortgage loan.'' This
provision implements TILA Section 103(aa)(4)(E) and incorporates the
statutory language, with the exception of minor non-substantive
changes, such as that the proposed regulatory provision cross-
references proposed Sec. 226.43(b)(10) for the definition of
``prepayment penalty.'' See section-by-section analysis of Sec.
226.43(b)(10), below.
32(b)(1)(vi) Total Prepayment Penalties Incurred in a Refinance
Proposed Sec. 226.32(b)(1)(vi) includes in points and fees ``the
total prepayment penalty, as defined in Sec. 226.43(b)(10), incurred
by the consumer if the mortgage loan is refinanced by the current
holder of the existing mortgage loan, a servicer acting on behalf of
the current holder, or an affiliate of either.'' This provision
implements TILA Section 103(aa)(4)(F), which includes in points and
fees prepayment penalties incurred by a consumer ``if the mortgage loan
refinances a previous loan made or currently held by the creditor
refinancing the loan or an affiliate of the creditor.'' See 15 U.S.C.
1602(aa)(4)(F).
The Board believes that this statutory provision is intended in
part to curtail the practice of ``loan flipping,'' which involves a
creditor refinancing an existing loan for financial gain due to
prepayment penalties and other fees that a consumer must pay to
refinance the loan--regardless of whether the refinance is beneficial
to the consumer. The Board uses the phrases ``current holder of the
existing mortgage loan'' and ``servicer acting on behalf of the current
holder'' to describe the parties that refinance a loan subject to this
provision because, as a practical matter, these are the entities that
would refinance the loan and directly or indirectly gain from
associated prepayment penalties. The Board also uses the phrase ``an
affiliate of the current holder'' to describe a third party that
refinances a loan subject to this provision to be consistent with the
statute, which, as noted, applies to prepayment penalties incurred in
connection with refinances by ``the creditor * * * or an affiliate of
the creditor.''
The proposed regulatory provision also cross-references proposed
Sec. 226.43(b)(10) for the definition of ``prepayment penalty.'' See
section-by-section analysis of Sec. 226.43(b)(10), below.
The Board requests comment on the proposal to incorporate into the
definition of ``points and fees'' the prepayment penalty provisions of
TILA Section 103(aa)(4)(E) and (F) and solicits comment in particular
on whether additional guidance is needed to facilitate compliance with
these provisions.
32(b)(2) Exclusion From ``Points and Fees'' of Compensation Paid to
Certain Persons
The Board proposes new Sec. 226.32(b)(2) to reflect statutory
amendments under the Dodd-Frank Act. Current Sec. 226.32(b)(2),
defining ``affiliate,'' is proposed to be re-numbered as Sec.
226.32(b)(3). Proposed Sec. 226.32(b)(2) is intended to exempt from
``points and fees'' compensation paid to certain persons expressly
excluded from the meaning of ``mortgage originator'' under the Dodd-
Frank Act.
Employees of retailers of manufactured homes. Specifically,
proposed Sec. 226.32(b)(2)(i) excludes from ``points and fees''
compensation paid to ``an employee of a retailer of manufactured homes
who does not take a residential mortgage loan application, offer or
negotiate terms of a residential mortgage loan, or advise a consumer on
loan terms (including rates, fees, and other costs) but who, for
compensation or other monetary gain, or in expectation of compensation
or other monetary gain, assists a consumer in obtaining or applying to
obtain a residential mortgage loan.'' This proposed exemption is
necessary to implement the revised definition of ``points and fees''
under TILA Section 103(aa)(4)(B) (quoted above), because the statutory
definition of ``mortgage originator'' excludes ``an employee of a
retailer of manufactured homes'' who, for compensation or other
monetary gain, or in expectation of compensation or other monetary
gain, prepares residential mortgage loan packages or collects
information on behalf of a
[[Page 27406]]
consumer with regard to a residential mortgage loan.\20\
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\20\ Specifically, the statute excludes from the definition of
``mortgage originator'' ``any person who is * * * (ii) an employee
of a retailer of manufactured homes who is not described in clause
(i) [takes a residential mortgage loan application] or (iii) [offers
or negotiates terms of a residential mortgage loan] of subparagraph
(A) and who does not advise a consumer on loan terms (including
rates, fees, and other costs).'' TILA Section 103(cc)(2)(A)(i),
(cc)(2)(A)(iii) and (cc)(2)(A)(C); 15 U.S.C. 1602(cc)(2)(A) and (C).
Thus, an employee of a retailer of manufactured homes is not
considered a ``mortgage originator'' even if that person ``for
direct or indirect compensation or gain, or in the expectation of
direct or indirect compensation or gain * * * assists a consumer in
obtaining or applying for a residential mortgage loan.'' TILA
Section 103(cc)(2)(A)(ii). The statute further defines ``assists a
consumer in obtaining or applying for a residential mortgage loan''
to mean ``among other things, advising on residential mortgage loan
terms (including rates, fees, and other costs), preparing
residential mortgage loan packages, or collecting information on
behalf of the consumer with regard to a residential mortgage loan.''
TILA Section 103(cc)(4).
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Real estate brokers. Proposed Sec. 226.32(b)(2)(ii) excludes from
``points and fees'' compensation paid to ``a person that only performs
real estate brokerage activities and is licensed or registered in
accordance with applicable state law, unless such person is compensated
by a creditor or loan originator, as defined in Sec. 226.36(a)(1), or
by any agent of the creditor or loan originator.'' This proposed
exemption is necessary to implement the revised definition of ``points
and fees'' under TILA Section 103(aa)(4)(B), because the statutory
definition of ``mortgage originator'' contains a nearly identical
exclusion.\21\
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\21\ The statutory definition of ``mortgage originator''
excludes ``a person or entity that only performs real estate
brokerage activities and is licensed or registered in accordance
with applicable State law, unless such person or entity is
compensated by a lender, a mortgage broker, or other mortgage
originator or by any agent of such lender, mortgage broker, or other
mortgage originator.'' TILA Section 103(cc)(2)(D).
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Proposed Sec. 226.32(b)(2)(ii) uses the term ``person'' rather
than the phrase ``person or entity'' used in the statute because
``person'' is defined in Regulation Z to mean ``a natural person or an
organization, including a corporation, partnership, proprietorship,
association, cooperative, estate, trust, or government unit.'' Section
226.2(a)(22). The proposed regulation uses the term ``loan originator''
as defined in Sec. 226.36(a)(1) rather than the terms ``mortgage
broker, or other mortgage originator'' because the term ``loan
originator'' under Sec. 226.36(a)(1) includes a mortgage broker and is
consistent with the statutory definition of ``mortgage originator'' in
respects relevant to this provision. See section-by-section analysis of
Sec. 226.32(b)(1)(ii) for a discussion of consistencies between the
meaning of ``loan originator'' in Sec. 226.36(a)(1) and ``mortgage
originator'' in the Dodd-Frank Act.
The term ``loan originator'' in Sec. 226.36(a)(1) applies only to
parties who arrange, negotiate, or obtain an extension of mortgage
credit for a consumer in return for compensation or other monetary
gain. Thus, a ``loan originator'' would not include a person engaged
only in real estate brokerage activities. See 75 FR 58509, 58510 (Sept.
24, 2010). However, the exemption for real estate brokers from the
meaning of ``mortgage originator'' is more precise in the Dodd-Frank
Act. First, for the compensation of a real estate broker to be exempt,
the broker must be licensed or registered under state law. In addition,
the Dodd-Frank Act does not exclude real estate brokers from the
definition of ``mortgage originator'' if they are compensated by the
``lender, mortgage broker, or other mortgage originator'' or an agent
of any of these parties.
Servicers. Proposed Sec. 226.32(b)(2)(ii) excludes from ``points
and fees'' compensation paid to ``a servicer or servicer employees,
agents and contractors, including but not limited to those who offer or
negotiate terms of a covered transaction for purposes of renegotiating,
modifying, replacing and subordinating principal of existing mortgages
where borrowers are behind in their payments, in default or have a
reasonable likelihood of being in default or falling behind.'' This
proposed exemption is necessary to implement the revised definition of
``points and fees'' under TILA Section 103(aa)(4)(B), because the
statutory definition of ``mortgage originator'' excludes this
compensation. TILA Section 103(cc)(2)(G).
The term ``loan originator'' (as defined in Sec. 226.36(a)(1)),
which is used in proposed Sec. 226.32(b)(1)(ii) to describe the
persons whose compensation must be counted in points and fees, does not
apply to a loan servicer when the servicer modifies an existing loan on
behalf of the current owner of the loan. See TILA Section
103(cc)(2)(G); 15 U.S.C. 1602(cc)(2)(G). See also comment 36(a)-1.iii.
However, a ``loan originator'' under existing Sec. 226.36(a)(1)
includes a servicer who refinances a mortgage. See comment 36(a)-1.iii.
A ``refinancing'' under Sec. 226.36(a)(1) is defined as the
satisfaction and replacement of an existing obligation subject to TILA
by a new obligation by the same consumer. See Sec. 226.20(a) and
accompanying commentary.
By contrast, the exclusion for servicers under the statutory
definition of ``mortgage originator'' appears to be broader than the
definition of ``loan originator'' under existing Sec. 226.36(a)(1).
First, the exclusion expressly applies to ``a servicer or servicer
employees, agents and contractors.'' Second, the exclusion applies not
only when these persons offer or negotiate terms of residential
mortgage loan for purposes of modifying a loan, but also for purposes
of ``replacing and subordinating principal of existing mortgages where
borrowers are behind in their payments, in default or have a reasonable
likelihood of being in default or falling behind.'' TILA Section
103(cc)(2)(G).
The Board requests comment on the proposed exemptions from the
definition of ``points and fees'' for compensation paid to certain
persons not considered ``mortgage originators'' under the Dodd-Frank
Act.
32(b)(3) Definition of ``Affiliate''
Current Sec. 226.32(b)(2) defining the term ``affiliate'' is re-
numbered as Sec. 226.32(b)(3) to accommodate the new proposed Sec.
226.32(b)(2) regarding compensation for the purposes of points and
fees. No substantive change is intended.
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
Currently, Regulation Z prohibits creditors making high-cost loans
from extending credit without regard to a consumer's ability to repay.
See Sec. 226.34(a)(4). As discussed in greater detail in the section-
by-section analysis to Sec. 226.43 below, the Dodd-Frank Act now
requires creditors to consider a consumer's ability to repay prior to
making any residential mortgage loan, as defined in TILA Section
103(cc)(5). Proposed Sec. 226.43 would implement this requirement and
render unnecessary Sec. 226.34(a)(4). The Board therefore proposes to
remove Sec. 226.34(a)(4) and its accompanying commentary. For ease of
reading, the Board is not reprinting Sec. 226.34(a)(4) and its
accompanying commentary in this proposed rule.
Section 226.35 Prohibited Acts or Practices in Connection With Higher-
Priced Mortgage Loans
Currently, Sec. 226.35 prohibits certain acts or practices in
connection with higher-priced mortgage loans. Section 226.35(a)
provides the coverage test for
[[Page 27407]]
higher-priced mortgage loans. Section 226.35(b)(1) contains the ability
to repay requirement for higher-priced mortgage loans. Section
226.35(b)(2) sets forth restrictions on prepayment penalties for
higher-priced mortgage loans. Section 226.35(b)(3) contains escrow
rules for higher-priced mortgage loans. Section 226.35(b)(4) prohibits
evasion of the higher-priced mortgage loan protections by structuring a
transaction as open-end credit.
The proposed changes to Regulation Z in the 2011 Escrow Proposal
and this proposal would render all of current Sec. 226.35 unnecessary.
The 2011 Escrow Proposal would adopt in proposed Sec. 226.45(a) the
coverage test for higher-priced mortgage loans in 226.35(a); would
revise and adopt in Sec. 226.45(b) the escrow requirements in Sec.
226.35(b)(3); and would adopt in proposed Sec. 226.45(d) the
prohibition of evasion of the higher-priced mortgage loan protections
by structuring a transaction as open-end credit, now in Sec.
226.35(b)(4). This proposal, as discussed below, would supersede in
Sec. 226.43(a)-(f) the ability to repay requirement in Sec.
226.35(b)(1), and would supersede in Sec. 226.43(g) the prepayment
penalty rules in Sec. 226.34(b)(2). Accordingly, the Board proposes to
remove and reserve Sec. 226.35 and its accompanying commentary. For
ease of reading, the Board is not reprinting Sec. 226.35 and its
accompanying commentary in this proposed rule.
Section 226.43 Minimum Standards for Transactions Secured by a Dwelling
TILA Sections 129C(a), (b), and (c) establish, for residential
mortgage loans: (1) A requirement to consider a consumer's repayment
ability; (2) alternative requirements for ``qualified mortgages''; and
(3) limits on prepayment penalties, respectively. The Board proposes to
implement TILA Section 129C(a) through (c) in new Sec. 226.43, as
discussed in detail below.
43(a) Scope
Background
Section 1411 of the Dodd-Frank Act adds a new TILA Section 129C
that requires creditors to determine a consumer's ability to repay a
``residential mortgage loan.'' Section 1401 of the Act adds a new TILA
Section 103(cc) that defines ``residential mortgage loan'' to mean,
with some exceptions, any consumer credit transaction secured by a
mortgage, deed of trust, or other equivalent consensual security
interest on ``a dwelling or on residential real property that includes
a dwelling.'' TILA Section 103(v) defines ``dwelling'' to mean a
residential structure or mobile home which contains one- to four-family
housing units, or individual units of condominiums or cooperatives.
Thus, a ``residential mortgage loan'' is a dwelling-secured consumer
credit transaction, which can include: (1) A home purchase,
refinancing, or home equity loan; (2) a loan secured by a first lien or
a subordinate lien on a dwelling; (3) a loan secured by a dwelling that
is a principal residence, second home, or vacation home (other than a
timeshare residence); or (4) a loan secured by a one-to-four unit
residence, condominium, cooperative, mobile home, or manufactured home.
However, the term ``residential mortgage loan'' does not include an
open-end credit plan or an extension of credit relating to a timeshare
plan, for purposes of the Act's repayment ability and prepayment
penalty provisions under TILA Section 129C, among other provisions. See
TILA Section 103(cc)(5); see also TILA Section 129C(i) (providing that
timeshare transactions are not subject to TILA Section 129C). Further,
the repayment ability provisions of TILA Section 129C(a) do not apply
to reverse mortgages or temporary or ``bridge'' loans with a loan term
of 12 months or less, including a loan to purchase a new dwelling where
the consumer plans to sell another dwelling within 12 months. See TILA
Section 129C(a)(8). The repayment ability provisions of TILA Section
129C(a) also do not apply to consumer credit transactions secured by
vacant land and not by a dwelling.
The scope of the 2008 HOEPA Final Rule differs from the scope of
TILA Section 129C in three respects. First, as discussed above, the
2008 HOEPA Final Rule applies only to loans designated ``higher-priced
mortgage loans'' or ``high-cost mortgages'' based on their APR or
points and fees. Section 226.34(a)(4), 226.35(b)(1). By contrast, TILA
Sections 129C(a) through (c) apply regardless of the residential
mortgage loan's cost. Second, the 2008 HOEPA Final Rule is limited to
loans secured by the consumer's principal dwelling. Section
226.32(a)(1), 226.35(a)(1). Finally, the 2008 HOEPA Final Rule does not
exempt transactions secured by a consumer's interest in a timeshare
plan.
The Board's Proposal
Proposed Sec. 226.43(a) describes the scope of the requirement to
determine a consumer's ability to repay a residential mortgage loan.
Proposed Sec. 226.43(a)(1) and (2) provide that the repayment ability
provisions under proposed Sec. 226.43 apply to consumer credit
transactions secured by a dwelling, as defined in Sec. 226.2(a)(19),
except for (1) a home equity line of credit (HELOC) subject to Sec.
226.5b, and (2) a mortgage transaction secured by a consumer's interest
in a timeshare plan, as defined in 11 U.S.C. 101(53(D)). The exemptions
under proposed Sec. 226.43(a)(1) and (2) implement the exclusions from
the definition of ``residential mortgage loan'' under TILA Section
103(cc)(5). Proposed Sec. 226.43(a)(3) provides that the following
transactions are exempt from coverage by proposed Sec. 226.43(c)
through (f): (1) A reverse mortgage subject to Sec. 226.33; and (2) a
temporary or ``bridge loan'' with a term of 12 months or less, such as
a loan to finance the purchase of a new dwelling where the consumer
plans to sell a current dwelling within 12 months or a loan to finance
the initial construction of a dwelling.
As discussed in detail below, proposed Sec. 226.43(c) and (d)
implement repayment ability provisions and special rules for
refinancings of ``non-standard'' mortgages into ``standard'' mortgages
under TILA Section 129C(a). TILA Section 129C(a)(8) specifically
provides that reverse mortgages and temporary or ``bridge'' loans with
a term of 12 months or less are not subject to TILA Section 129C(a).
The Board also proposes to apply this exception for purposes of
alternative requirements for ``qualified mortgages'' and balloon-
payment qualified mortgages pursuant to TILA Section 129C(b). Although
TILA Section 129C(b) does not specifically exempt reverse mortgages or
temporary or ``bridge'' loans with a term of 12 months or less from
coverage by the alternative requirements for qualified mortgages, the
Board believes the alternative requirements for qualified mortgages are
relevant only if a transaction is subject to the repayment ability
requirements. Accordingly, proposed Sec. 226.43(a)(3) provides that
reverse mortgages and temporary or ``bridge'' loans with a term of 12
months or less are not subject to the alternative requirements for
qualified mortgages and balloon-payment qualified mortgages, under
proposed Sec. 226.43(e) or (f). Such transactions nevertheless are
subject to the prepayment penalty restrictions under proposed Sec.
226.43(g), discussed in detail below.
``Residential mortgage loan.'' Proposed Sec. 226.43(a) clarifies
that requirements under proposed Sec. 226.43 apply to any consumer
credit transaction secured by a dwelling, as defined in Sec.
226.2(a)(19), with certain exceptions discussed above. Proposed Sec.
226.43(a) does not use the term ``residential mortgage loan,''
[[Page 27408]]
for two reasons. First, the usefulness of the defined term
``residential mortgage loan'' is limited, because the coverage of
provisions applicable to ``residential mortgage loans'' varies under
different TILA provisions. For example, TILA Section 103(cc) excludes
transactions secured by a consumer's interest in a timeshare
transaction from the definition of ``residential mortgage loan'' for
purposes of some, but not all, TILA provisions, and the Dodd-Frank Act
provides or authorizes other specific exemptions from coverage by
requirements for ``residential mortgage loans.'' \22\ Specifying which
transactions are subject to and exempt from coverage by proposed Sec.
226.43 in a scope provision thus would facilitate compliance better
than using the defined term ``residential mortgage loan.''
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\22\ See, e.g., TILA Section 129C(a)(8) (providing an exemption
from repayment ability requirements for reverse mortgages and
temporary or ``bridge'' loans with a term of 12 months or less);
TILA Section 129D(d), (e) (authorizing an exemption from escrow
requirements for certain creditors operating predominantly in rural
or underserved areas and providing an exemption from escrow
requirements for transactions secured by shares in a cooperative).
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Second, the term ``residential mortgage loan'' could be confused
with the similar term ``residential mortgage transaction,'' which means
a transaction in which a mortgage or equivalent consensual security
interest is created or retained against the consumer's dwelling to
finance the acquisition or initial construction of the dwelling. See 15
U.S.C. 1602(w). The term ``residential mortgage transaction,'' used in
connection with rescission provisions under Sec. 226.15 and 226.23,
does not encompass such transactions as refinance transactions and home
equity loans. Using the similar term ``residential mortgage loan,''
which encompasses refinance transactions and home equity loans, could
confuse creditors subject to proposed Sec. 226.43.
Owner occupancy; consumer credit transaction. If a transaction is a
dwelling-secured extension of consumer credit, proposed Sec. 226.43
applies regardless of whether or not the consumer occupies the dwelling
(unless an exception from coverage applies under proposed Sec.
226.43(a)(1)-(3)). However, TILA and Regulation Z do not apply to
credit extensions that are primarily for business purposes. 15 U.S.C.
1603(l); Sec. 226.3(a)(1). Current guidance in comment 3(a)-2
clarifies the factors to be considered to determine whether a credit
extension is business or consumer credit. Further, comment 3(a)-3
states that credit extended to acquire, improve, or maintain rental
property that is not owner-occupied (that is, in which the owner does
not expect to live for more than fourteen days during the coming year)
is deemed to be for business purposes. Proposed comment 43(a)-1
clarifies that Sec. 226.43 does not apply to an extension of credit
primarily for a business, commercial, or agricultural purpose and
cross-references the existing guidance on determining the primary
purpose of an extension of credit in commentary on Sec. 226.3.
Dwelling. TILA Section 129(cc) defines ``residential mortgage
loan'' to mean a consumer credit transaction secured by a mortgage or
equivalent consensual security interest ``on a dwelling or on
residential real property that includes a dwelling.'' Under TILA and
Regulation Z, the term ``dwelling'' means a residential structure with
one to four units, whether or not the structure is attached to real
property, and includes a condominium or cooperative unit, mobile home,
and trailer, if used as a residence. See 15 U.S.C. 1602(v); Sec.
226.2(a)(19). To facilitate compliance by using consistent terminology
throughout Regulation Z, the proposal uses the term ``dwelling,'' as
defined in Sec. 226.2(a)(19), and not the phrase ``residential real
property that includes a dwelling.'' Proposed comment 43(a)-2 clarifies
that, for purposes of Sec. 226.43, the term ``dwelling'' includes any
real property to which the residential structure is attached that also
secures the covered transaction.
Renewable temporary or ``bridge'' loan. As discussed above,
proposed Sec. 226.43(a)(3)(ii) provides that a temporary or ``bridge''
loan with a term of 12 months or less, such as a loan to finance the
purchase of a new dwelling where the consumer plans to sell a current
dwelling within 12 months and a loan to finance the initial
construction of a dwelling, is excluded from coverage by Sec.
226.43(c) through (f). Proposed comment 43(a)-3 clarifies that, where a
temporary or ``bridge loan'' is renewable, the loan term does not
include any additional period of time that could result from a renewal
provision. Proposed comment 43(a)-3 also provides an example where a
construction loan has an initial loan term of 12 months but is
renewable for another 12-month loan term. In that example, the loan is
excluded from coverage by Sec. 226.43(c) through (f), because the
initial loan term is 12 months.
The Board recognizes the risk that determining coverage by ability-
to-repay requirements for a renewable temporary or ``bridge'' loan with
an initial loan term of 12 months or less based only on the initial
loan term may allow circumvention of those requirements. The Board
solicits comment on whether or not renewal loan terms should be
considered under proposed Sec. 226.43(a)(3)(ii). In particular, the
Board requests comment on whether the proposed exclusion should be
limited to certain types of temporary or ``bridge'' loans, such as
loans to finance the initial construction of a dwelling, or should not
apply for certain types of temporary or ``bridge'' loans, such as
balloon-payment loans.
Interaction with RESPA. TILA Section 129C applies to dwelling-
secured consumer credit transactions (other than those specifically
excluded from coverage), even if they are not ``federally related
mortgage loans'' subject to the Real Estate Settlement Procedures Act
(RESPA). See 12 U.S.C. 2602(1); 24 CFR 3500.2(b), 3500.5. Consistent
with TILA Section 129C, proposed Sec. 226.43(a) applies broadly to
consumer credit transactions secured by a dwelling (other than
transactions excepted from coverage under Sec. 226.43(a)(1)-(3)).
43(b) Definitions
Section Sec. 226.43(b) provides several definitions for purposes
of implementing the ability-to-repay, qualified mortgage, and
prepayment penalty provisions under Sec. 226.43(b) through (g), which
implement TILA Sections 129C(a) through (c), as added by Sections 1411,
1412 and 1414 of the Dodd-Frank Act. These proposed defined terms are
discussed in detail below.
43(b)(1) Covered Transaction
As discussed above in the section-by-section analysis of the scope
provisions under proposed Sec. 226.43(a), the Board proposes to apply
Sec. 226.43 to consumer credit transactions secured by a dwelling,
other than (1) a HELOC; (2) a mortgage transaction secured by a
consumer's interest in a timeshare plan; and (3) except for purposes of
prepayment penalty requirements under proposed Sec. 226.43(g), a
reverse mortgage or a temporary or ``bridge'' loan with a loan term of
12 months or less. Accordingly, proposed Sec. 226.43(b)(1) defines
``covered transaction'' to mean a consumer credit transaction that is
secured by a dwelling, other than a transaction exempt from coverage
under proposed Sec. 226.43(a), for purposes of proposed Sec. 226.43.
43(b)(2) Fully Amortizing Payment
TILA Section 129C(a)(3) requires, in part, that the creditor
determine the consumer's ability to repay a loan ``using a payment
schedule that fully amortizes
[[Page 27409]]
the loan over the term of the loan.'' TILA Section 129C(a)(6)(D)
provides that for purposes of making the repayment ability
determination required under TILA Section 129C(a), the creditor must
calculate the payment on the mortgage obligation assuming the loan is
repaid in ``monthly amortizing payments for principal and interest over
the entire term of the loan.'' The Board proposes to use the term
``fully amortizing payment'' to refer to periodic amortizing payments
for principal and interest over the entire term of the loan, for
simplicity.
Accordingly, consistent with statutory language, and with minor
modifications for clarity, proposed Sec. 226.43(b)(2) would define
``fully amortizing payment'' to mean a periodic payment of principal
and interest that will fully repay the loan amount (as defined in
proposed Sec. 226.43(b)(5)) over the loan term (as defined in proposed
Sec. 226.43(b)(6)). This term appears primarily in proposed Sec.
226.43(c)(5) and (d)(5), which provides, respectively, that (1) the
creditor determine the consumer's ability to repay the covered
transaction using the fully indexed rate or introductory rate,
whichever is greater, and monthly, fully amortizing payments that are
substantially equal; and (2) the creditor can refinance the consumer
from a non-standard to standard mortgage if, among other things, the
calculation of the payments for the non-standard and standard mortgage
are based on monthly, fully amortizing payments that are substantially
equal.
43(b)(3) Fully Indexed Rate
TILA Section 129C(a)(6)(D) requires that for purposes of making the
repayment ability determination required under TILA Section 129C(a),
the creditor must calculate the monthly payment on the mortgage
obligation based on several assumptions, including that the monthly
payment be calculated using the fully indexed rate at the time of loan
closing, without considering the introductory rate. See TILA Section
129C(a)(6)(D)(iii). TILA Section 129C(a)(7) defines the term ``fully
indexed rate'' as ``the index rate prevailing on a residential mortgage
loan at the time the loan is made plus the margin that will apply after
the expiration of any introductory interest rates.'' The term ``fully
indexed rate'' appears in proposed Sec. 226.43(c)(5), which implements
TILA Section 129C(a)(6)(iii) and provides the payment calculation rules
for covered transactions. The term also appears in Sec. 226.43(d)(5),
which provides special rules for creditors that refinance a consumer
from a non-standard mortgage to a standard mortgage. These proposed
provisions are discussed below.
The Board proposes Sec. 226.43(b)(3) to define the term ``fully
indexed rate'' as ``the interest rate calculated using the index or
formula at the time of consummation and the maximum margin that can
apply at any time during the loan term.'' This proposed definition is
consistent with the statutory language of TILA Sections
129C(a)(6)(D)(iii) and 129C(a)(7), but revises certain statutory text
to provide clarity.\23\ First, for consistency with current Regulation
Z and to facilitate compliance, the Board proposes to replace the
phrases ``at the time of the loan closing'' in TILA Section
129C(a)(6)(D)(iii) and ``at the time the loan is made'' in TILA Section
129C(a)(7) with the phrase ``at the time of consummation'' for purposes
of identifying the fully indexed rate. The Board interprets these
statutory phrases to have the same meaning as the phrase ``at the time
of consummation.'' See current Sec. 226.2(a)(7), defining the term
``consummation'' for purposes of Regulation Z requirements as ``the
time that a consumer becomes contractually obligated on a credit
transaction.''
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\23\ See current 12 CFR Sec. 226.17(c)(1) and comment 17(c)(1)-
10, and 12 CFR Sec. 226.18(s)(7)(vi), which identify the index in
effect at consummation as the index value to be used in determining
the fully indexed rate.
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Second, the Board interprets the reference to the margin that will
apply ``after the expiration of any introductory interest rates'' as a
reference to the maximum margin that can apply ``at any time during the
loan term,'' for simplicity and consistency with TILA Section 103(a),
discussed above. Referencing the entire loan term as the relevant
period of time during which the creditor must identify the maximum
margin that can occur under the loan makes the phrase ``after the
expiration of any introductory interest rates'' unnecessary.
Third, the Board clarifies that the creditor should use the
``maximum'' margin that can apply when determining the fully indexed
rate. Accordingly, the creditor would be required to take into account
the largest margin that could apply under the terms of the legal
obligation. The approach of using the maximum margin that can apply at
any time during the loan term is consistent with the statutory language
contained in TILA Section 103(aa), as amended by Section 1431 of the
Dodd-Frank Act, which defines a high-cost mortgage. This statutory
provision provides that, for purposes of the definition of a ``high-
cost mortgage,'' for a mortgage with an interest rate that varies
solely in accordance with an index, the annual percentage rate must be
based on ``the interest rate determined by adding the index rate in
effect on the date of consummation of the transaction to the maximum
margin permitted at any time during the loan agreement.'' Furthermore,
although the Board is not aware of any loan products used today that
possess more than one margin that may apply over the loan term, the
Board proposes this clarification to address the possibility that
creditors may create products that permit different margins to take
effect at different points throughout the loan term. The Board solicits
comment on this approach.
The proposed definition of ``fully indexed rate'' is also generally
consistent with the definition of fully-indexed rate, as used in the
MDIA Interim Final Rule,\24\ and with the Federal banking agencies' use
of the term ``fully indexed rate'' in the 2006 Nontraditional Mortgage
Guidance and 2007 Subprime Mortgage Statement.
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\24\ See the 2010 MDIA Interim Final Rule, 75 FR 58470, 58484,
Sept. 24, 2010, which defines fully indexed rate as ``the interest
rate calculated using the index value and margin''; see also 75 FR
81836, Dec. 29, 2010 (revising the MDIA Interim Final Rule.
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Proposed comment 43(b)(3)-1 notes that in some adjustable-rate
transactions, creditors may set an initial interest rate that is not
determined by the index or formula used to make later interest rate
adjustments. This comment would explain that, typically, this initial
rate charged to consumers is lower than the rate would be if it were
calculated using the index or formula at consummation (i.e., a
``discounted rate''); in some cases, this initial rate may be higher
(i.e., a ``premium rate''). The comment would clarify that when
determining the fully indexed rate where the initial interest rate is
not determined using the index or formula for subsequent interest rate
adjustments, the creditor must use the interest rate that would have
applied had the creditor used such index or formula plus margin at the
time of consummation. This comment would further clarify that this
means, in determining the fully indexed rate, the creditor must not
take into account any discounted or premium rate.
Proposed comment 43(b)(3)-1 provides an illustration of this
principle. This comment first assumes an adjustable-rate transaction
where the initial interest rate is not based on an index or formula,
and is set at 5% for the first five years. The loan agreement provides
that future interest rate
[[Page 27410]]
adjustments will be calculated based on the London Interbank Offered
Rate (LIBOR) plus a 3% margin. This comment explains that if the value
of the LIBOR at consummation is 5%, the interest rate that would have
been applied at consummation had the creditor based the initial rate on
this index is 8% (5% plus 3% margin), and therefore, the fully indexed
rate is 8%. To facilitate compliance, this comment would direct
creditors to commentary that addresses payment calculations based on
the greater of the fully indexed rate or ``premium rate'' for purposes
of the repayment ability determination under Sec. 226.43(c). See Sec.
226.43(c)(5)(i) and comment 43(c)(5)(i)-2.
This proposed comment differs from guidance in current comment
17(c)(1)-10.i, which provides that in cases where the initial interest
rate is not calculated using the index or formula for later rate
adjustments, the creditor should disclose a composite annual percentage
rate that reflects both the initial rate and the fully indexed rate.
The Board believes the different approach taken in proposed comment
43(b)(3)-1 is required by the statutory language which specifies that,
for purposes of determining the consumer's repayment ability, the fully
indexed rate must be determined ``without considering the introductory
rate,'' and is the rate ``that will apply after the expiration of any
introductory interest rates.'' See TILA Sections 129C(a)(6)(D)(iii) and
(7). Furthermore, the Board believes this approach is appropriate in
the present case where the purpose of the statute is to determine
whether the consumer can repay the loan according to its terms,
including any potential increases in required payments. TILA Section
129B(a)(2); 15 U.S.C 1639b(a)(2).
The Board notes that the choice of which market index to use for
later interest rate adjustments has become more germane for both
creditors and consumers due to recent market developments. For example,
in recent years consumers of adjustable-rate mortgages that are tied to
a LIBOR index have paid more than they would have had their loans been
tied to the U.S. Treasury index.\25\ This divergence in index values is
recent, and has not occurred historically. Given the increasing
relevance of market indices, the Board solicits comment on whether loan
products currently exist that base the interest rate on a specific
index at consummation, but then base subsequent rate adjustments on a
different index, and whether further guidance addressing how to
calculate the fully indexed rate for such loan products is needed.
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\25\ See Mark Schweitzer and Guhan Venkatu, Adjustable-Rate
Mortgages and the LIBOR Surprise, at http://www.clevelandfed.org/research/commentary/2009/012109.cfm.
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Proposed comment 43(b)(3)-2 further clarifies if the contract
provides for a delay in the implementation of changes in an index value
or formula, the creditor need not use that the index or formula in
effect at consummation, and provides an illustrative example. This
proposed comment is consistent with current guidance in Regulation Z
regarding the use of the index value at the time of consummation where
the contract provides for a delay. See comments 17(c)(1)-10.i and
18(s)(2)(iii)(C)-1, which addresses the fully indexed rate for purposes
of disclosure requirements.
Proposed comment 43(b)(3)-3 explains that the creditor must
determine the fully indexed rate without taking into account any
periodic interest rate adjustment cap that may limit how quickly the
fully indexed rate may be reached at any time during the loan term
under the terms of the legal obligation. To illustrate, assume an
adjustable-rate mortgage has an initial fixed rate of 5% for the first
three years of the loan, after which the rate will adjust annually to a
specified index plus a margin of 3%. The loan agreement provides for a
2% annual interest rate adjustment cap, and a lifetime maximum interest
rate of 10%. The index value in effect at consummation is 4.5%. The
fully indexed rate is 7.5% (4.5% plus 3%), regardless of the 2% annual
interest rate adjustment cap that would limit when the fully indexed
rate would take effect under the terms of the legal obligation.
The Board notes that guidance contained in proposed comment
43(b)(3)-3 also differs from guidance contained in current comment
17(c)(1)-10.iii, which addresses disclosure of the annual percentage
rate on the TILA. Comment 17(c)(1)-10.iii states that when disclosing
the annual percentage rate, creditors should give effect to periodic
interest rate adjustment caps provided under the terms of the legal
obligation (i.e., to take into account any caps that would prevent the
initial rate at the time of first adjustment from changing to the
fully-indexed rate).
The Board believes the approach in proposed comment 43(b)(3)-3 is
consistent with, and required by, the statutory language that states
the fully indexed rate must be determined without considering any
introductory rate and by using the margin that will apply after
expiration of any introductory interest rates. See TILA Sections
129C(a)(6)(D)(iii) and (7). In addition, the Board notes the proposed
definition of fully indexed rate, and its use in the proposed payment
calculation rules, is designed to assess whether the consumer has the
ability to repay the loan according to its terms. TILA Section
129B(a)(2); 15 U.S.C. 1639b(a)(2). This purpose differs from the
principal purpose of disclosure requirements, which is to help ensure
that consumers avoid the uninformed use of credit. TILA Section 102(a);
15 U.S.C. 1601(a). The Board believes disregarding the operation of
adjustment caps in determining the payment for the covered transaction
helps to ensure that the consumer can reasonably repay the loan once
the interest rate adjusts. Furthermore, the guidance contained in
proposed comment 43(b)(3)-3 is consistent with the Federal banking
agencies' use of the term fully indexed rate in the 2006 Nontraditional
Mortgage Guidance and 2007 Subprime Mortgage Statement.
Proposed comment 43(b)(3)-4 clarifies that when determining the
fully indexed rate, a creditor may choose, in its sole discretion, to
take into account the lifetime maximum interest rate provided under the
terms of the legal obligation. This comment would explain, however,
that where the creditor chooses to use the lifetime maximum interest
rate, and the loan agreement provides a range for the maximum interest
rate, the creditor must use the highest rate in that range as the
maximum interest rate. To illustrate, assume an adjustable-rate
mortgage has an initial fixed rate of 5% for the first three years of
the loan, after which the rate will adjust annually to a specified
index plus a margin of 3%. The loan agreement provides for a 2% annual
interest rate adjustment cap, and a lifetime maximum interest rate of
7%. The index value in effect at consummation is 4.5%; the fully
indexed rate is 7.5% (4.5% plus 3%). The creditor can choose to use the
lifetime maximum interest rate of 7%, instead of the fully indexed rate
of 7.5%, for purposes of this section.
The Board notes that the statutory construct of the payment
calculation rules, and the requirement to calculate payments based on
the fully indexed rate, apply to all loans that are subject to the
ability-to-repay provisions, including loans that do not base the
interest rate on an index and therefore, do not have a fully indexed
rate. Specifically, the statute states that ``[f]or purposes of making
any determination under this subsection, a creditor shall calculate the
monthly payment amount for principal and interest on any
[[Page 27411]]
residential mortgage loan by assuming'' several factors, including the
fully indexed rate, as defined in the statute (emphasis added). See
TILA Section 129C(a)(6)(D). The statutory definition of ``residential
mortgage loan'' includes loans with variable-rate features that are not
based on an index or formula, such as step-rate mortgages. See TILA
Section 103(cc); see also proposed Sec. 226.43(a), addressing the
proposal's scope, and proposed Sec. 226.43(b)(1), defining ``covered
transaction.'' However, because step-rate mortgages do not have a fully
indexed rate, it is unclear what interest rate the creditor must assume
when calculating payment amounts for purposes of determining the
consumer's ability to repay the covered transaction.
As discussed above, the Board interprets the statutory requirement
to use the ``margin that can apply at any time after the expiration of
any introductory interest rates'' to mean that the creditor must use
the ``maximum margin that can apply at any time during the loan term''
when determining the fully indexed rate. Accordingly, consistent with
this approach, Board proposes to clarify in proposed comment 43(b)(3)-5
that where the interest rate offered in the loan is not based on, and
does not vary with, an index or formula (i.e., there is no fully
indexed rate), the creditor must use the maximum interest rate that may
apply at any time during the loan term. Proposed comment 43(b)(3)-5
provides illustrative examples for a step-rate and fixed-rate mortgage.
This comment, for example, would assume a step-rate mortgage with an
interest rate fixed at 6.5% for the first two years of the loan, 7% for
the next three years, and 7.5% thereafter for the remainder of loan
term. This comment would explain that, for purposes of determining the
consumer's repayment ability, the creditor must use 7.5%, which is the
maximum rate that may apply during the loan term. This comment would
also provide an illustrative example for a fixed-rate mortgage.
The Board believes this approach is appropriate because the purpose
of TILA Section 129C is to require creditors to assess whether the
consumer can repay the loan according to its terms, including any
potential increases in required payments. TILA Section 129B(a)(2), 15
U.S.C. 1639b(a)(2). Requiring creditors to use the maximum interest
rate helps to ensure that consumers can repay the loan, without needing
to refinance, for example. However, for the reasons discussed more
fully below under proposed Sec. 226.43(c)(5)(i), which discusses the
general rule for payment calculations, the Board is equally concerned
that by requiring creditors to use the maximum interest rate in a step-
rate mortgage, the monthly payments used to determine the consumer's
repayment ability will be overstated and may inappropriately restrict
credit availability. For these reasons, the Board is soliciting comment
on this approach, and whether the Board should exercise its authority
under TILA Sections 105(a) and 129B(e) to provide an exception for
step-rate mortgages. For example, should the Board require creditors to
use the maximum interest rate that occurs in the first 5 or 10 years,
or some other appropriate time horizon?
43(b)(4) Higher-Priced Covered Transaction
Proposed Sec. 226.43(b)(4) defines ``higher-priced covered
transaction'' to mean a covered transaction 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 a first-lien covered transaction, or by 3.5 or
more percentage points for a subordinate-lien covered transaction. The
proposed definition of ``higher-priced covered transaction'' replicates
the statutory language used in TILA Section 129C(a)(6)(D)(ii)(I) and
(II), which grants the Board the authority to implement special payment
calculation rules for a balloon loan that ``has an annual percentage
rate that does not exceed the average prime offer rate for a comparable
transaction'' by certain rate spreads. These rules appear in proposed
Sec. 226.43(c)(5)(ii)(A), and are discussed below.
The proposed definition of ``higher-priced covered transaction''
uses the term ``average prime offer rate.'' To facilitate compliance
and maintain consistency, the term ``average prime offer rate'' has the
same meaning as in the Board's proposed Sec. 226.45(a)(2)(ii).
Proposed Sec. 226.45(a)(2)(ii) defines ``average prime offer rate''
for purposes of determining the applicability of escrow requirements to
``higher-priced mortgage loans'' (as defined in proposed Sec.
226.45(a)(1)), and states that the ``average prime offer rate'' means
``an annual percentage rate that is derived from average interest rate,
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.'' See 2011 Escrow Proposal, 76 FR 11598, Mar. 2,
2011, which implements new TILA Section 129D for escrow requirements.
As discussed in the Board's 2011 Escrow Proposal, the proposed
definition of ``average prime offer rate'' is identical to the
definition of ``average prime offer rate'' in current Sec.
226.35(a)(2), which the Board is proposing to remove, and consistent
with the provisions of the Dodd-Frank Act, which generally codify the
regulation's current definition of ``average prime offer rate.'' See
TILA Sections 129C(b)(2)(B) and 129D(b)(3).
However, the proposed definition of ``higher-priced covered
transaction'' differs from the proposed definition of ``higher-priced
mortgage loan'' included in the Board's 2011 Escrow Proposal in three
respects: (1) To reflect statutory text, the proposed definition of
``higher-priced covered transaction'' would provide that the annual
percentage rate, rather than the ``transaction coverage rate,'' is the
loan pricing metric to be used to determine whether a transaction is a
higher-priced covered transaction; (2) consistent with the scope of the
ability-to-repay provisions, ``higher-priced covered transaction''
would cover consumer credit transactions secured by a dwelling, and
would not be limited to transactions secured by the consumer's
principal dwelling; and (3) consistent with the statutory authority,
the applicable thresholds in ``higher-priced covered transaction''
would not reflect the special, separate coverage threshold of 2.5
percentage points above the average prime offer rate for ``jumbo''
loans,\26\ as provided for by the Board's 2011 Escrow Proposal and 2011
Jumbo Loan Escrow Final Rule. See 76 FR 11598, 11608-09, Mar. 2, 2011;
76 FR 11319, Mar. 2, 2011.\27\ As a result of these differences,
proposed commentary to ``average prime offer rate'' that clarifies the
meaning of ``comparable transaction'' and ``rate set'' for purposes of
higher-priced mortgage loans uses the
[[Page 27412]]
terms ``transaction coverage rate,'' and refers to the consumer's
principal dwelling. See proposed comments 45(a)(2)(ii)-2 and -3.\28\
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\26\ A ``jumbo'' loan includes a loan whose original principal
balance exceeds the current maximum loan balance for loans eligible
for sale to Freddie Mac as of the date the transaction's rate is
set. See TILA Section 129D(b)(3)(B), as enacted by Section 1461 of
the Dodd-Frank Act; see also Board's March 2011 Jumbo Loan Escrow
Final Rule, 76 FR 11319, 11324 (Mar. 2, 2011), which establishes the
``jumbo'' threshold in existing Sec. 226.35(a)(1)(v).
\27\ The Board's Jumbo Loan Escrow Final Rule added new Sec.
226.35(a)(1)(v) to provide a separate, higher rate threshold for
determining when the Board's escrow requirement applies to higher-
priced mortgage loans that are ``jumbo loans.'' The Board
incorporated the identical provision regarding the ``jumbo''
threshold in its 2011 Escrow Proposal for the reasons stated
therein, and in anticipation of the Board proposing to remove Sec.
226.35 in its entirety, as discussed above. See proposed Sec.
226.45(a)(1).
\28\ 2011 Escrow Proposal, 76 FR 11598, 11626-11627, Mar. 2,
2011.
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To reduce the risk of confusion that may occur by cross-referencing
to proposed commentary in the Board's 2011 Escrow Proposal that uses
different terminology, the Board proposes commentary to proposed Sec.
226.43(b)(4) to clarify the meaning of the terms ``average prime offer
rate,'' ``comparable transaction'' and ``rate set,'' as those terms are
used in the proposed definition of ``higher-priced covered
transaction.''
Proposed comment 43(b)(4)-1 explains that the term ``average prime
offer rate'' generally has the same meaning as in proposed Sec.
226.45(a)(2)(ii), and would cross-reference proposed comments
45(a)(2)(ii)-1,-4, and -5, for further guidance on how to determine the
average prime offer rate and for further explanation of the Board
table. Proposed comment 43(b)(4)-2 states that the table of average
prime offer rates published by the Board indicates how to identify the
comparable transaction for a higher-priced covered transaction, as
defined. Proposed comment 43(b)(4)-3 clarifies that 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. This proposed comment also explains that sometimes
a creditor sets the interest rate initially and then re-sets it at a
different level before consummation, and clarify that in these cases,
the creditor should use the last date the interest rate is set before
consummation.
As discussed above, the Board is proposing to replace the term
``annual percentage rate'' with the ``transaction coverage rate'' for
reasons stated in the Board's 2011 Escrow Proposal and 2010 Closed-End
Proposal. See the Board's 2011 Escrow Proposal at 76 FR 11598, 11609,
Mar. 2, 2011 and the Board's 2010 Closed-End Mortgage Proposal at 75 FR
58539, 58660-61, Sept. 24, 2010. As discussed more fully in these
proposals, the Board recognized that the use of the annual percentage
rate as the coverage metric for the higher-priced mortgage loan
protections posed a risk of over inclusive coverage; the protections
were intended to be limited to the subprime market. Specifically, the
Board recognized that the term annual percentage rate would include a
broader set of charges, causing the spread between the annual
percentage rate and the average prime offer rate to widen.
Although the purpose differs, the Board similarly recognizes that
the use of the term annual percentage rate in ``higher-priced covered
transaction'' means that the scope of balloon loans that may exceed the
applicable loan pricing thresholds will likely be greater. The Board is
concerned that using an over inclusive metric to compare to the average
prime offer rate may cover some prime loans and unnecessarily limit
credit access to these loan products, contrary to statutory intent. For
these reasons and also for consistency, the Board solicits comment on
whether it should exercise its authority under Section TILA Sections
105(a) and 129B(e) to similarly replace ``annual percentage rate'' with
``transaction coverage rate'' as the loan pricing benchmark for higher-
priced covered transactions. 15 U.S.C. 1604(a).
In addition, the Board notes that ``jumbo'' loans typically carry a
premium interest rate to reflect the increased credit risk of such
loans.\29\ These loans are more likely to exceed the average prime
offer rate coverage threshold and be considered higher-priced covered
transactions under the thresholds established by TILA Section
129C(a)(6)(D)(ii). Accordingly, under this proposal creditors would
have to underwrite such loans using the scheduled payments, including
any balloon payment, regardless of the loan term. See proposed Sec.
226.43(c)(5)(ii)(A)(2), discussed below. The Board is concerned that
this approach may unnecessarily restrict credit access and choice in
the ``jumbo'' balloon loan market. Thus, the Board also solicits
comment on whether it should exercise its authority under TILA Sections
105(a) and 129B(e) to incorporate the special, separate coverage
threshold of 2.5 percentage points in the proposed definition of
``higher-priced covered transaction'' to permit more ``jumbo'' balloon
loans that have ``prime'' loan pricing to benefit from the special
payment calculation rule set forth under proposed Sec.
226.43(c)(5)(ii)(A)(1) for balloon loans. 15 U.S.C. 1604(a). See 76 FR
11598, 11608, Mar. 2 2011, which discusses the proposed ``jumbo''
threshold in relation to the proposed escrow requirements.
---------------------------------------------------------------------------
\29\ See, e.g., Shane M. Sherland, ``The Jumbo-Conforming
Spread: A Semiparametric Approach,'' Finance and Economics
Discussion Series, Divisions of Research & Statistics and Monetary
Affairs, Federal Reserve Board (2008-01).
---------------------------------------------------------------------------
The Board similarly recognizes that loans secured by non-principal
dwellings also generally carry a higher interest rate to reflect
increased credit risk, regardless of loan size. As discussed above, the
scope of this proposal extends to any dwelling-secured transaction, not
just principal dwellings, and therefore second homes (e.g., vacation
homes) would be covered. A non-``jumbo'' balloon loan for a vacation
home, for example, would be subject to the same rate threshold that
would apply to a non-``jumbo'' loan secured by a principal dwelling. As
a result, balloon loans secured by non-principal dwellings would be
more likely to exceed the applicable rate threshold and be subject to
the more stringent underwriting requirements discussed above. The Board
is concerned that this approach may inappropriately restrict credit
access in this market. Accordingly, the Board solicits comment, and
supporting data, on whether it should exercise its authority under TILA
Sections 105(a) and 129B(e) to incorporate a special, separate coverage
threshold in the proposed definition of ``higher-priced covered
transaction'' for loans secured by non-principal dwellings, and what
rate threshold would be appropriate for such loans.
43(b)(5) Loan Amount
TILA Section 129C(a)(6)(D) requires that when the creditor makes
the repayment ability determination under TILA Section 129C(a), it must
calculate the monthly payment on the mortgage obligation based on
several assumptions, including calculating the monthly payment assuming
that ``the loan proceeds are fully disbursed on the date of
consummation of the loan.'' See TILA Section 129C(a)(6)(D)(i). This
proposal replaces the phrase ``loan proceeds are fully disbursed on the
date of consummation of the loan'' with the term ``loan amount'' for
simplicity, and also to provide clarity.
Proposed Sec. 226.43(b)(5) defines ``loan amount'' to mean the
principal amount the consumer will borrow as reflected in the
promissory note or loan contract. The Board believes that the loan
contract or promissory note would accurately reflect all loan proceeds
to be disbursed under the loan agreement to the consumer, including any
proceeds the consumer uses to cover costs of the transaction. In
addition, the term ``loan amount'' is generally used by industry and
consumers to refer to the amount the consumer borrows and is obligated
to repay under the loan agreement. The proposed term ``loan amount'' is
consistent with the Board's 2009 Closed-End Mortgage Proposal, which
proposed to define the term ``loan amount'' for purposes of disclosure.
See 74 FR 43232, 43333, Aug. 26, 2009.
[[Page 27413]]
The statute further requires that creditors assume that the loan
amount is ``fully disbursed on the date of consummation of the loan.''
See TILA Section 129C(a)(6)(D)(i). The Board recognizes that some loans
do not disburse the entire loan amount to the consumer at consummation,
but may, for example, provide for multiple disbursements up to an
amount stated in the loan agreement. See current Sec. 226.17(c)(6),
discussing multiple-advance loans and comment 17(c)(6)-2 and -3,
discussing construction-to-permanent financing loans. In these cases,
the loan amount, as reflected in the promissory note or loan contract,
does not accurately reflect the amount disbursed at consummation. Thus,
to reflect the statutory requirement that the creditor assume the loan
amount is fully disbursed at consummation, the Board would clarify that
creditors must use the entire loan amount as reflected in the loan
contract or promissory note, even where the loan amount is not fully
disbursed at consummation. See proposed comment 43(b)(5)-1. This
comment would provide an illustrative example. The example assumes the
consumer enters into a loan agreement where the consumer is obligated
to repay the creditor $200,000 over 15 years, but only $100,000 is
disbursed at consummation and the remaining $100,000 will be disbursed
during the year following consummation ($25,000 each quarter). This
comment would explain that the creditor must use the loan amount of
$200,000 even though the loan agreement provides that only $100,000
will be disbursed to the consumer at consummation. This comment would
state that generally, creditors should rely on Sec. 226.17(c)(6) and
associated commentary regarding treatment of multiple-advance and
construction loans that would be covered by this proposal (i.e., loans
with a term greater than 12 months). See proposed Sec. 226.43(a)(3)
discussing scope of coverage and term length. The Board solicits
comment on whether further guidance regarding treatment of loans that
provide for multiple disbursements, such as construction-to-permanent
loans that are treated as as a single transaction, is needed.
The term ``loan amount'' appears in proposed Sec. 226.43(b)(2),
which defines ``fully amortizing payment,'' and in proposed Sec.
226.43(c)(5)(ii)(B), which implements the requirement under TILA
Section 129C(a)(6)(D)(i) that the creditor assume that ``the loan
proceeds are fully disbursed on the date of consummation of the loan''
when determining the consumer's ability to repay a loan. In addition,
the term ``loan amount'' appears in proposed Sec.
226.43(d)(5)(i)(C)(2) which implements TILA Section 129C(a)(6)(E) and
provides the payment calculation for a non-standard mortgage with
interest-only payments. The term ``loan amount'' also appears in
proposed Sec. 226.43(e)(2)(iv), which implements the requirement under
TILA Sections 129C(b)(iv) and (v) that the creditor underwrite the loan
using a periodic payment of principal and interest that will repay the
loan to meet the definition of a qualified mortgage.
43(b)(6) Loan Term
TILA Section 129C(a)(3) requires that a creditor determine a
consumer's repayment ability on a loan ``using a payment schedule that
fully amortizes the loan over the term of the loan.'' TILA Section
129C(a)(6)(D)(ii) also requires that for purposes of making the
repayment ability determination under TILA Section 129C(a), the
creditor calculate the monthly payment on the mortgage obligation
assuming that the loan is repaid ``over the entire term of the loan
with no balloon payment.'' In addition, TILA Section 129C(b)(2)(A)(iv)
and (v) require that a creditor underwrite the loan using ``a payment
schedule that fully amortizes the loan over the loan term'' to meet the
definition of a qualified mortgage. The Dodd-Frank Act does not define
the term ``loan term.''
This proposal refers to the term of the loan as the ``loan term,''
as defined, for simplicity. Proposed Sec. 226.43(b)(6) provides that
the ``loan term'' means the period of time to repay the obligation in
full. This proposed definition is consistent with the proposed
definition of ``loan term'' for disclosure purposes in the Board's 2009
Closed-End Mortgage Proposal. See 74 FR 43232, 43333, Aug. 26, 2009.
This term primarily appears in proposed Sec. 226.43(c)(5)(i), which
implements TILA Section 129(a)(6)(D)(ii) and requires creditors to
determine a consumer's ability to repay the loan based on fully
amortizing payments. See proposed Sec. 226.43(b)(2), which defines
``fully amortizing payments'' as periodic payments that will fully
repay the loan amount over the loan term. ``Loan term'' also is used in
proposed Sec. 226.43(e)(2)(iv), which implements TILA Section
129C(b)(2)(iv) and (v) and requires creditors to underwrite the loan
using the periodic payment of principal and interest that will repay
the loan over the loan term to meet the definition of a qualified
mortgage.
Proposed comment 43(b)(6)-1 clarifies that the loan term is the
period of time it takes to repay the loan amount in full. For example,
a loan with an initial discounted rate that is fixed for the first two
years, and that adjusts periodically for the next 28 years has a loan
term of 30 years, which is the amortization period on which the
periodic amortizing payments are based.
43(b)(7) Maximum Loan Amount
Proposed Sec. 226.43(b)(7) defines ``maximum loan amount'' to mean
the loan amount plus any increase in principal balance that results
from negative amortization (defined in current Sec. 226.18(s)(7)(v)),
based on the terms of the legal obligation assuming that: (1) The
consumer makes only the minimum periodic payments for the maximum
possible time, until the consumer must begin making fully amortizing
payments; and (2) the maximum interest rate is reached at the earliest
possible time. The term ``maximum loan amount'' implements, in part,
TILA Section 129(a)(6)(C), which states that when making the payment
calculation for loans with negative amortization, ``a creditor shall
also take into consideration any balance increase that may accrue from
any negative amortization provision.''
Loans with negative amortization typically permit consumers to make
payments that cover only part of the interest accrued each month, and
none of the principal. The unpaid but accrued interest is added to the
principal balance, causing negative equity (i.e., negative
amortization). This accrued but unpaid interest can be significant if
the loan terms do not provide for any periodic interest rate adjustment
caps, thereby permitting the accrual interest rate to quickly escalate
to the lifetime maximum interest rate. As a result of these loan
features, consumers of loans with negative amortization are more likely
to encounter payment shock once fully amortizing payments are required.
For these reasons, the Board believes it is appropriate to interpret
the phrase ``any balance increase that may accrue'' as requiring the
creditor to account for the greatest potential increase in the
principal balance that could occur under in a loan with negative
amortization. See TILA Section 129(a)(6)(C). The Board also believes
this interpretation is consistent with the overall statutory construct
that requires creditors to determine whether the consumer is able to
manage payments that may be required at any time during the loan term,
especially where payments can escalate significantly in amount. The
proposed definition of ``maximum loan amount'' is also consistent with
the approach in the
[[Page 27414]]
MDIA Interim Final Rule,\30\ which addresses disclosure requirements
for negative amortization loans, and the 2006 Nontraditional Mortgage
Guidance, which provides guidance to creditors regarding underwriting
negative amortization loans.\31\
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\30\ See 12 CFR 226.18(s)(2)(ii) and comment 18(s)(2)(ii)-2,
which discusses assumptions made for the interest rates in
adjustable-rate mortgages that are negative amortization loans.
\31\ See 2006 Nontraditional Mortgage Guidance at 58614, n.7.
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The term ``maximum loan amount'' is used in proposed Sec.
226.43(c)(5)(ii)(C), which implements the statutory requirements under
new TILA Section 129C(a)(6)(C) and (D) regarding payment calculations
for negative amortization loans. See proposed Sec.
226.43(c)(5)(ii)(C), which discusses more fully the scope of loans
covered by the term ``negative amortization loan,'' as defined in
current Sec. 226.18(s)(7)(v). The term also appears in proposed Sec.
226.43(d), which addresses the exception to the repayment ability
provision for the refinancing of a non-standard mortgage.
Proposed comment 43(b)(7)-1 clarifies that in determining the
maximum loan amount, the creditor must assume that the consumer makes
the minimum periodic payment permitted under the loan agreement for as
long as possible, until the consumer must begin making fully amortizing
payments, and that the interest rate rises as quickly as possible after
consummation under the terms of the legal obligation. The proposed
comment further clarifies that creditors must assume the consumer makes
the minimum periodic payment until any negative amortization cap is
reached or until the period permitting minimum periodic payments
expires, whichever occurs first. This comment would cross-reference
proposed Sec. 226.43(b)(5) and Sec. 226.18(s)(7)(v) for the meaning
of the terms ``loan amount'' and ``negative amortization loan,''
respectively.
Proposed comment 43(b)(7)-2 provides further guidance to creditors
regarding the assumed interest rate to use when determining the maximum
loan amount. This comment would explain that when calculating the
maximum loan amount for an adjustable-rate mortgage that is a negative
amortization loan, the creditor must assume that the interest rate will
increase as rapidly as possible after consummation, taking into account
any periodic interest rate adjustment caps provided in the loan
agreement. This comment would further explain that for an adjustable-
rate mortgage with a lifetime maximum interest rate but no periodic
interest rate adjustment cap, the creditor must assume the interest
rate increases to the maximum lifetime interest rate at the first
adjustment.
Proposed comment 43(b)(7)-3 provides examples illustrating the
application of the proposed definition of ``maximum loan amount'' for a
negative amortization loan that is an adjustable-rate mortgage and for
a fixed-rate, graduated payment mortgage. For example, proposed comment
43(b)(7)-3.i assumes an adjustable-rate mortgage in the amount of
$200,000 with a 30-year loan term. The loan agreement provides that the
consumer can make minimum monthly payments that cover only part of the
interest accrued each month until the principal balance reaches 115% of
its original balance (i.e., a negative amortization cap of 115%) or for
the first five years of the loan (60 monthly payments), whichever
occurs first. The introductory interest rate at consummation is 1.5%.
One month after consummation, the interest rate adjusts and will adjust
monthly thereafter based on the specified index plus a margin of 3.5%.
The maximum lifetime interest rate is 10.5%; there are no other
periodic interest rate adjustment caps that limit how quickly the
maximum lifetime rate may be reached. The minimum monthly payment for
the first year is based on the initial interest rate of 1.5%. After
that, the minimum monthly payment adjusts annually, but may increase by
no more than 7.5% over the previous year's payment. The minimum monthly
payment is $690 in the first year, $740 in the second year, and $798 in
the first part of the third year. See proposed comment 43(b)(7)-3.i(A).
This comment then states that to determine the maximum loan amount,
creditors should assume that the interest rate increases to the maximum
lifetime interest rate of 10.5% at the first adjustment (i.e., the
second month) and accrues at that rate until the loan is recast. This
proposed comment further assumes the consumer makes the minimum monthly
payments as scheduled, which are capped at 7.5% from year-to-year. This
comment would explain that as a result, the consumer's minimum monthly
payments are less than the interest accrued each month, resulting in
negative amortization (i.e., the accrued but unpaid interest is added
to the principal balance).
This comment concludes that on the basis of these assumptions (that
the consumer makes the minimum monthly payments for as long as possible
and that the maximum interest rate of 10.5% is reached at the first
rate adjustment (i.e., the second month)), the negative amortization
cap of 115% is reached on the due date of the 27th monthly payment and
the loan is recast. The maximum loan amount as of the due date of the
27th monthly payment is $229,243. See proposed comment 43(b)(7)-3.i(B).
43(b)(8) Mortgage-Related Obligations
The Board proposes to use the term ``mortgage-related obligations''
to refer to ``all applicable taxes, insurance (including mortgage
guarantee insurance), and assessments'' for purposes of TILA Sections
129C(a)(1) through (3) and (b)(2)(A)(iv) and (v). TILA Sections
129C(a)(1) and (2) require that a creditor determine a consumer's
ability to repay the loan ``according to [the loan's] terms, and all
applicable taxes, insurance (including mortgage guarantee insurance),
and assessments.'' TILA Section 129C(a)(3) further states that the
creditor must consider the consumer's debt-to-income ratio after
allowing for ``non-mortgage debt and mortgage-related obligations.'' In
addition, TILA Sections 129C(b)(2)(A)(iv) and (v) provide that to meet
the qualified mortgage standard, the creditor must underwrite the loan
``tak[ing] into account all applicable taxes, insurance, and
assessments[.]'' The Dodd-Frank Act does not define the term
``mortgage-related obligations.'' However, these statutory requirements
are substantially similar to current Sec. 226.34(a)(4) of the Board's
2008 HOEPA Final Rule, which requires the creditor to consider
mortgage-related obligations when determining the consumer's repayment
ability on a loan. Current Sec. 226.34(a)(4)(i) defines ``mortgage-
related obligations'' as expected property taxes, premiums for
mortgage-related insurance required by the creditor as set forth in
current Sec. 226.35(b)(3)(i), and similar expenses, such as
homeowners' association dues and condominium or cooperative fees. See
comment 34(a)(4)(i)-1.
Proposed Sec. 226.43(b)(8) defines the term ``mortgage-related
obligations'' to mean property taxes; mortgage-related insurance
premiums required by the creditor as set forth in proposed Sec.
226.45(b)(1); homeowner's association, condominium, and cooperative
fees; ground rent or leasehold payments; and special assessments.
Proposed Sec. 226.43(b)(8) is consistent with TILA Sections
129C(a)(1)-(3) and 129C(b)(2)(A)(iv) and (v), with modifications to the
statutory language to provide greater clarity to creditors regarding
what items are included in the phrase ``taxes, insurance (including
mortgage guarantee insurance), and assessments.'' Based on outreach,
the Board believes greater specificity in
[[Page 27415]]
defining the term ``mortgage-related obligations'' would address
concerns that some creditors may have difficulty determining which
items should be included as mortgage-related obligations when
determining the total monthly debt a consumer will owe in connection
with a loan. The proposed term would also track the current meaning of
the term mortgage-related obligations in current Sec. 226.34(a)(4)(i)
and comment 34(a)(4)(i)-1, which the Board is proposing to remove, with
several clarifications.
The Board proposes to define the term ``mortgage-related
obligations'' with three clarifications. First, consistent with current
underwriting practices, the proposed definition of ``mortgage-related
obligations'' would include reference to ground rent or leasehold
payments, which are payments made to the land owner or leaseholder for
use of the land. Second, the proposed term would include reference to
``special assessments.'' Proposed comment 43(b)(8)-1 clarifies that
special assessments include, for example, assessments that are imposed
on the consumer at or before consummation, such as a one-time
homeowners' association fee that will not be paid by the consumer in
full at or before consummation. Third, the term ``mortgage-related
obligations'' would reference proposed Sec. 226.45(b)(1) to include
mortgage-related insurance premiums 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. Proposed Sec. 226.45(b)(1) parallels current Sec.
226.35(b)(3)(i), which the Board is proposing to remove. See 76 FR
11598, 11610, Mar. 2, 2011 for discussion of proposed Sec.
226.45(b)(1). The Board solicits comment on how to address any issues
that may arise in connection with homeowners' association transfer fees
and costs associated with loans for energy-efficient improvement.
Proposed comment 43(b)(8)-1 further clarifies that mortgage-related
obligations include expected property taxes and premiums for mortgage-
related insurance required by the creditor as set forth in Sec.
226.45(b)(1), such as insurance against loss of or damage to property
or against liability arising out of the ownership or use of the
property, and insurance protecting the creditor against the consumer's
default or other credit loss. This comment would explain that the
creditor need not include premiums for mortgage-related insurance that
it does not require, such as earthquake insurance or credit insurance,
or fees for optional debt suspension and debt cancellation agreements.
To facilitate compliance, this comment would refer to commentary
associated with proposed Sec. 226.43(c)(2)(v), which discusses the
requirement to take into account any mortgage-related obligations for
purposes of the repayment ability determination required under proposed
Sec. 226.43(b)(2).
The term ``mortgage-related obligations'' appears in proposed Sec.
226.43(c)(2)(v), which implements new TILA Sections 129C(a)(1) through
(3) and requires that the creditor determine a consumer's ability to
repay a covered transaction, taking into account mortgage-related
obligations. The term also appears in proposed Sec. 226.43(e)(2)(iv),
which implements new TILA Section 129C(b)(2)(A)(iv) and (v) and
requires that the creditor underwrite a loan taking into account
mortgage-related obligations to meet the qualified mortgage definition.
Proposed Sec. 226.43(c) and (e) are discussed in further detail below.
43(b)(9) Points and Fees
For ease of reference, proposed Sec. 226.43(b)(9) states that the
term ``points and fees'' has the same meaning as in Sec. 226.32(b)(1).
43(b)(10) Prepayment Penalty
TILA Section 129C(c), as added by Section 1414 of the Dodd-Frank
Act, limits the transactions that may include a ``prepayment penalty,''
the period during which a prepayment penalty may be imposed, and the
maximum amount of a prepayment penalty. TILA Section 129C(c) also
requires creditors to offer a consumer a covered transaction without a
prepayment penalty if they offer the consumer a covered transaction
with a prepayment penalty. Qualified mortgages are subject to
additional limitations on prepayment penalties, pursuant to points and
fees limitations under Section 1412 of the Act. TILA Section
129C(b)(2)(A)(viii) limits the points and fees that may be charged for
a qualified mortgage to three percent of the total loan amount. TILA
Section 103(aa)(4)(E) and (F), as added by Section 1431(c) of the Dodd-
Frank Act, define ``points and fees'' to include (1) the maximum
prepayment fees and penalties that may be charged under the terms of
the covered transaction; and (2) all prepayment fees or penalties that
are incurred by the consumer if the loan refinances a previous loan
made or currently held by the same creditor or an affiliate of the
creditor.
TILA establishes certain disclosure requirements for transactions
for which a penalty is imposed upon prepayment but does not define the
term ``prepayment penalty.'' TILA Section 128(a)(11) requires that the
transaction-specific disclosures for closed-end consumer credit
transactions disclose a ``penalty'' imposed upon prepayment in full of
a closed-end transaction, without using the term ``prepayment
penalty.'' 15 U.S.C. 1638(a)(11).\32\ Current commentary on Sec.
226.18(k)(1), which implements TILA Section 128(a)(11), clarifies that
a ``penalty'' imposed upon prepayment in full is a charge assessed
solely because of the prepayment of an obligation and includes, for
example, ``interest'' charges for any period after prepayment in full
is made and a minimum finance charge.\33\ See comment 18(k)-1. The
Board's 2009 Closed-End Mortgage Proposal clarifies that prepayment
penalties include origination or other charges that a creditor waives
unless the consumer prepays, but do not include fees imposed for
preparing a payoff statement, among other clarifications. See 74 FR
43232, 43413, Aug. 29, 2009. Also, the Board's 2010 Mortgage Proposal
clarifies that prepayment penalties include ``interest'' charges after
prepayment in full even if the charge results from the interest accrual
amortization method used on the transaction. See 75 FR 58539, 58756,
Sept. 24, 2010.
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\32\ Also, TILA Section 128(a)(12) requires that the
transaction-specific disclosures state that the consumer should
refer to the appropriate contract document for information regarding
certain loan terms or features, including ``prepayment * * *
penalties.'' 15 U.S.C. 1638(a)(12). In addition, TILA Section 129(c)
limits the circumstances in which a high-cost mortgage may include a
``prepayment penalty.'' 15 U.S.C. 1639(c).
\33\ Prepayment penalty disclosure requirements under Sec.
226.18(k) apply to closed-end mortgage and non-mortgage
transactions. In the 2009 Closed-End Mortgage Proposal, the Board
proposed to establish a new Sec. 226.38(a)(5) for disclosure of
prepayment penalties specifically for closed-end mortgage
transactions.
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Proposed Sec. 226.43(b)(10) defines ``prepayment penalty'' as a
charge imposed for paying all or part of a covered transaction's
principal before the date on which the principal is due. Also, proposed
Sec. 226.43(b)(10)(i) provides the following examples of ``prepayment
penalties'' for purposes of Sec. 226.43: (1) A charge determined by
treating the loan balance as outstanding for a period of time after
prepayment in full and applying the interest rate to such ``balance,''
even if the charge results from the interest accrual amortization
method used for other payments in the transaction; and (2) a fee, such
as a loan closing cost, that is
[[Page 27416]]
waived unless the consumer prepays the covered transaction. Proposed
comment 43(b)(10)(A)-1 clarifies that ``interest accrual amortization''
refers to the method used to determine the amount of interest due for
each period (for example, a month) in a transaction's term. The
proposed comment also provides an example where a prepayment penalty of
$1,000 is imposed because a full month's interest of $3,000 is charged
even though only $2,000 in interest was earned in the month during
which the consumer prepaid. Proposed Sec. 226.43(b)(10)(ii) provides
that a prepayment penalty does not include fees imposed for preparing
and providing documents when a loan is paid in full, whether or not the
loan is prepaid, such as a loan payoff statement, a reconveyance
document, or another document releasing the creditor's security
interest in the dwelling that secures the loan.
Proposed Sec. 226.43(b)(10) uses language substantially similar to
the language used in TILA Section 129C(c), but proposed Sec.
226.43(b)(10) refers to charges for payment ``before the date on which
the principal is due'' rather than ``after the loan is consummated,''
for clarity. Proposed Sec. 226.43(b)(10)(i) and (ii) are substantially
similar to the current guidance on prepayment penalties in comment
18(k)-1 and in proposed Sec. 226.38(a)(5) under the Board's 2009
Closed-End Mortgage Proposal and 2010 Mortgage Proposal, discussed
above. However, proposed Sec. 226.43(b)(10) omits commentary
providing: (1) Examples of prepayment penalties include a minimum
finance charge because such charges typically are imposed with open-
end, rather than closed-end, transactions; and (2) examples of
prepayment penalties do not include loan guarantee fees because loan
guarantee fees are not charges imposed for paying all or part of a
loan's principal before the date on which the principal is due. See
comment 18(k)(1)-1. The term ``prepayment penalty'' appears in the
``points and fees'' definition in proposed Sec. 226.32(b)(1)(v) and
(vi) and in the requirements for prepayment penalties in Sec.
226.43(g).
The Board recognizes that the effect of including particular types
of charges in the proposed definition of a ``prepayment penalty'' is to
apply the limitations on prepayment penalties under TILA Section
129C(c) to those types of charges, which in turn could limit the
availability of credit. In particular, if ``prepayment penalty'' is
defined to include a provision that requires the consumer to pay
``interest'' for a period after prepayment in full, or a provision that
waives fees unless the consumer prepays, pursuant to TILA Section
129C(c) a covered transaction may not include such provisions unless
the transaction: (1) Has an APR that cannot increase, (2) is a
qualified mortgage, and (3) is not a higher-priced mortgage loan, as
discussed in detail in the section-by-section analysis of proposed
Sec. 226.43(g). Also, the amount of the ``interest'' charged after
prepayment, or the amount of fees waived unless the consumer prepays,
would be limited. Finally, the creditor would have to offer an
alternative covered transaction for which ``interest'' will not be
charged after prepayment or for which fees are waived even if the
consumer prepays (although under the Board's proposal the alternative
covered transaction could have a different interest rate). Thus, the
Board solicits comment on whether or not it is appropriate to include
``interest'' charged for a period after prepayment, or fees waived
unless the consumer prepays, in the definition of ``prepayment
penalty'' under proposed Sec. 226.43(b)(10). Specifically, the Board
requests comment on the possible effects of including those charges on
the availability of particular types of covered transactions.
43(b)(11) Recast
Proposed Sec. 226.43(b)(11) defines the term ``recast,'' which is
used in two paragraphs of proposed Sec. 226.43: (1) Proposed Sec.
226.43(c)(5)(ii) regarding certain required payment calculations that
creditors must consider in determining a consumer's ability to repay a
covered transaction; and (2) proposed Sec. 226.43(d) regarding payment
calculations required for refinancings that are exempt from the
ability-to-repay requirements in Sec. 226.43(c).
Specifically, Sec. 226.43(b)(11) defines the term ``recast'' as
follows: (1) For an adjustable-rate mortgage, as defined in Sec.
226.18(s)(7)(i),\34\ the expiration of the period during which payments
based on the introductory interest rate are permitted under the terms
of the legal obligation; (2) for an interest-only loan, as defined in
Sec. 226.18(s)(7)(iv),\35\ the expiration of the period during which
interest-only payments are permitted under the terms of the legal
obligation; and (3) for a negative amortization loan, as defined in
Sec. 226.18(s)(7)(v),\36\ the expiration of the period during which
negatively amortizing payments are permitted under the terms of the
legal obligation.
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\34\ ``The term `adjustable-rate mortgage' means a transaction
secured by real property or a dwelling for which the annual
percentage rate may increase after consummation.'' 12 CFR
226.18(s)(7)(i).
\35\ ``The term `interest-only' means that, under the terms of
the legal obligation, one or more of the periodic payments may be
applied solely to accrued interest and not to loan principal; an
`interest-only loan' is a loan that permits interest-only
payments.'' 12 CFR 226.18(s)(7)(iv).
\36\ ``[T]he term `negative amortization' means payment of
periodic payments that will result in an increase in the principal
balance under the terms of the legal obligation; the term `negative
amortization loan' means a loan that permits payments resulting in
negative amortization, other than a reverse mortgage subject to
section 226.33.'' 12 CFR 226.18(s)(7)(v).
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Proposed comment 43(b)(11)-1 explains that the date on which the
``recast'' occurs is the due date of the last monthly payment based on
the introductory fixed rate, the interest-only payment, or the
negatively amortizing payment, as applicable. Proposed comment
43(b)(11)-1 also provides an illustration of this rule for a loan in an
amount of $200,000 with a 30-year loan term, where the loan agreement
provides for a fixed interest rate and permits interest-only payments
for the first five years of the loan (60 months). Under proposed Sec.
226.43(b)(11), the loan is ``recast'' on the due date of the 60th
monthly payment. Thus, the term of the loan remaining as of the date
the loan is recast is 25 years (300 months).
The statute uses the term ``reset'' to suggest the time at which
the terms of a mortgage loan are adjusted, resulting in higher required
payments. For example, TILA Section 129C(a)(6)(E)(ii) states that a
creditor that refinances a loan may, under certain conditions,
``consider if the extension of new credit would prevent a likely
default should the original mortgage reset and give such concerns a
higher priority as an acceptable underwriting practice.'' 15 U.S.C.
1639c(a)(6)(E)(ii). The legislative history further indicates that, for
adjustable-rate mortgages with low, fixed introductory rates, Congress
understood the term ``reset'' to mean the time at which the low teaser
rates converted to fully indexed rates, resulting in ``significantly
higher monthly payments for homeowners.'' \37\
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\37\ See U.S. House of Reps., Comm. on Fin. Services, Report on
H.R. 1728, Mortgage Reform and Anti-Predatory Lending Act, No. 111-
94, 52 (May 4, 2009).
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Outreach participants indicated that the term ``recast'' is
typically used to reference the time at which fully amortizing payments
are required for interest-only and negative amortization loans and that
the term ``reset'' is more frequently used to indicate the time at
which adjustable-rate mortgages with an introductory fixed rate convert
to a variable rate. For simplicity and clarity, however, the Board
proposes to use the term ``recast'' to cover the conversion to less
favorable terms and higher
[[Page 27417]]
payments not only for interest-only loans and negative amortization
loans but also for adjustable-rate mortgages.
The Board solicits comment on the proposed definition of ``recast''
for purposes of proposed Sec. 226.43(c) and (d).
43(b)(12) Simultaneous Loan
The Board proposes to use the term ``simultaneous loan'' to refer
to loans that are subject to TILA Section 129C(a)(2), which states that
``if a creditor knows, or has reason to know, that 1 or more
residential mortgage loans secured by the same dwelling will be made to
the same consumer, the creditor shall make a reasonable and good faith
determination, based on verified and documented information, that the
consumer has a reasonable ability to repay the combined payments of all
loans on the same dwelling according to the terms of those loans and
all applicable taxes, insurance (including mortgage guarantee
insurance), and assessments.'' TILA Section 129C(a)(2) uses the term
``residential mortgage loan,'' which is defined in TILA Section
103(cc)(5) as excluding home equity lines of credit (HELOCs) for
purposes of TILA Section 129C. See proposed Sec. 226.43(a), discussing
the scope of the ability-to-repay provisions. Thus, TILA Section
129C(a)(2) does not require a creditor to consider a simultaneous HELOC
when determining a consumer's repayment ability on the covered
transaction.
By contrast, Sec. 226.34(a)(4) of the Board's 2008 HOEPA Final
Rule requires the creditor to consider the consumer's current
obligations when making its repayment ability determination. Current
comment 34(a)(4)-3 clarifies the meaning of the term ``current
obligations,'' and provides that it includes other dwelling-secured
credit obligations undertaken prior to or at consummation of the
transaction subject to Sec. 226.34(a)(4) of which the creditor has
knowledge. This comment does not distinguish between closed-end and
open-end credit transactions for purposes of ``other dwelling-secured
obligations.'' Accordingly, under current comment 34(a)(4)-3 the
creditor must consider in the repayment ability assessment a HELOC of
which it has knowledge if the HELOC will be undertaken at or before
consummation and will be secured by the same dwelling that secures the
transaction.
Proposed Sec. 226.43(b)(12) would define the term ``simultaneous
loan'' to refer to other loans that are secured by the same dwelling
and made to the same consumer at or before consummation of the covered
transaction. The term would include HELOCs as well as closed-end
mortgages for purposes of TILA Section 129C(a)(2). The Board believes
TILA Section 129C(a)(2) is meant to help ensure that creditors account
for the increased risk of consumer delinquency or default on the
covered transaction where more than one loan secured by the same
dwelling is originated concurrently, and therefore requires creditors
to consider the combined payments on such loans. The Board believes
this increased risk is present whether the other mortgage obligation is
a closed-end credit transaction or a HELOC.
The Board proposes to broaden the scope of TILA Section 129C(a)(2)
to include HELOCs, and accordingly proposes to define the term
``simultaneous loan'' to include HELOCs, using its authority under TILA
Section 105(a). 15 U.S.C. 1604(a). TILA Section 105(a), as amended by
Section 1100A of the Dodd-Frank Act, authorizes the Board to prescribe
regulations to carry out the purposes of TILA and Regulation Z, to
prevent circumvention or evasion, or to facilitate compliance. 15
U.S.C. 1604(a). The inclusion of HELOCs is further supported by the
Board's authority under TILA Section 129B(e) to condition terms, acts
or practices relating to residential mortgage loans that the Board
finds necessary or proper to effectuate the purposes of TILA. 15 U.S.C.
1639b(e). One purpose of the statute is set forth in TILA Section
129B(a)(2), which states that ``[i]t is the purpose[] of * * *
[S]ection 129C to assure that consumers are offered and receive
residential mortgage loans on terms that reasonably reflect their
ability to repay the loans.'' 15 U.S.C. 1639b. For the reasons stated
below, the Board believes requiring creditors to consider simultaneous
loans that are HELOCs for purposes of TILA Section 129C(a)(2) would
help to ensure that consumers are offered, and receive, loans on terms
that reasonably reflect their ability to repay.
First, the Board is proposing in Sec. 226.43(c)(2)(vi) that the
creditor must consider current debt obligations in determining a
consumer's ability to repay a covered transaction. Consistent with
current Sec. 226.34(a)(4), proposed Sec. 226.43(c)(2)(vi) would not
distinguish between pre-existing closed-end and open-end mortgage
obligations. The Board believes consistency requires that it take the
same approach when determining how to consider mortgage obligations
that come into existence concurrently with a first-lien loan as is
taken for pre-existing mortgage obligations, whether the first-lien is
a purchase or non-purchase transaction (i.e., refinancing). Including
HELOCs in the proposed definition of ``simultaneous loan'' for purposes
of TILA Section 129C(a)(2) is also generally consistent with current
comment 34(a)(4)-3, and the 2006 Nontraditional Mortgage Guidance
regarding simultaneous second-lien loans.\38\
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\38\ See 2006 Nontraditional Mortgage Guidance, 71 FR 58609,
58614 (Oct.4, 2006).
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Second, data indicate that where a subordinate loan is originated
concurrently with a first-lien loan to provide some or all of the
downpayment (i.e., ``piggyback loan''), the default rate on the first-
lien loan increases significantly, and in direct correlation to
increasing combined loan-to-value ratios.\39\ The data does not
distinguish between ``piggyback loans'' that are closed-end or open-end
credit transactions, or between purchase and non-purchase transactions.
However, empirical evidence demonstrates that approximately 60% of
consumers who open a HELOC concurrently with a first-lien loan borrow
against the line of credit at the time of origination,\40\ suggesting
that in many cases the HELOC may be used to provide some, or all, of
the downpayment on the first-lien loan.
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\39\ Kristopher Gerardi, Andreas Lehnert, Shane Sherlund, and
Paul S. Willen, ``Making Sense of the Subprime Crisis,'' Brookings
Papers on Economic Activity (Fall 2008), at 40, Table 3.
\40\ The Board conducted independent analysis using data
obtained from the FRBNY Consumer Credit Panel to determine the
proportion of piggyback HELOCs taken out in the same month as the
first-lien loan that have a draw at the time of origination. Data
used is extracted from credit record data in years 2003 through
2010. See Donghoon Less and Wilbert van der Klaauw, ``An
Introduction to the FRBNY Consumer Credit Panel,'' Staff Rept. No.
479 (Nov. 2010), at http://data.newyorkfed.org/research/staff_reports/sr479.pdf, for further description of the database.
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The Board recognizes that consumers have varied reasons for
originating a HELOC concurrently with the first-lien loan, for example,
to reduce overall closing costs or for the convenience of having access
to an available credit line in the future. However, the Board believes
concerns relating to HELOCs originated concurrently for savings or
convenience, and not to provide payment towards the first-lien home
purchase loan, may be mitigated by the Board's proposal to require that
a creditor consider the periodic payment on the simultaneous loan based
on the actual amount drawn from the credit line by the consumer. See
proposed Sec. 226.43(c)(6)(ii), discussing payment calculation
requirements for simultaneous loans that are HELOCs. Still, the Board
recognizes that in the case of a non-purchase transaction (e.g.,
[[Page 27418]]
a refinancing) a simultaneous loan that is a HELOC is unlikely to be
originated and drawn upon to provide payment towards the first-lien
loan, except perhaps towards closing costs. The Board solicits comment
on whether it should narrow the requirement to consider simultaneous
loans that are HELOCs to apply only to purchase transactions. See
discussion under proposed Sec. 226.43(c)(6).
Third, in developing this proposal staff conducted outreach with a
variety of participants that consistently expressed the view that
second-lien loans significantly impact a consumer's performance on the
first-lien loan, and that many second-lien loans are HELOCs. One
industry participant explained that the vast majority of ``piggyback
loans'' it originated were HELOCs that were fully drawn at the time of
origination and used to assist in the first-lien purchase transaction.
Another outreach participant stated that HELOCs make up approximately
90% of their simultaneous loan book-of-business. Industry outreach
participants generally indicated that it is a currently an accepted
underwriting practice to include HELOCs in the repayment ability
assessment on the first-lien loan, and generally confirmed that the
majority of simultaneous liens considered during the underwriting
process are HELOCs. Thus, for these reasons, the Board proposes to use
its authority under TILA Sections 105(a) and 129B(e) to broaden the
scope of TILA Section 129C(a)(2), and accordingly proposes to define
the term ``simultaneous loan'' to include HELOCs.
Proposed Sec. 226.43(b)(12) defines a ``simultaneous loan'' to
mean another covered transaction or home equity line of credit subject
to Sec. 226.5b that will be secured by the same dwelling and made to
the same consumer at or before consummation of the covered transaction.
The proposed definition generally tracks the meaning of ``other
dwelling-secured obligations'' under current comment 34(a)(4)-3, as
well as the statutory language of TILA Section 129C(a)(2) with the
notable difference that the proposed term would include HELOCs, as
discussed above. The Board proposes to replace the term ``residential
mortgage loan'' with the term ``covered transaction,'' as defined in
proposed Sec. 226.43(b)(1), for clarity. The Board also proposes to
add a reference to the phrase ``at or before consummation of the
covered transaction'' to further clarify that the definition does not
include pre-existing mortgage obligations. Pre-existing mortgage
obligations would be included as current debt obligations under
proposed Sec. 226.43(c)(2)(vi), which is discussed below. Last, the
Board proposes to not include the statutory language that ``the
creditor shall make a reasonable and good faith determination, based on
verified and documented information, that the consumer has a reasonable
ability to repay the combined payments of all loans on the same
dwelling according to the terms of those loans and all applicable
taxes, insurance (including mortgage guarantee insurance), and
assessments,'' because these statutory requirements are addressed in
the repayment ability provisions in proposed Sec. 226.43(c)(2)(iv) and
(v), which are discussed more fully below.
Proposed comment 43(b)(12)-1 clarifies that the definition of
``simultaneous loan'' includes any loan that meets the definition,
whether made by the same creditor or a third-party creditor, and
provides an illustrative example of this principle. This proposed
comment assumes a consumer will enter into a legal obligation that is a
covered transaction with Creditor A. Immediately prior to consummation
of the covered transaction with Creditor A, the consumer opens a HELOC
that is secured by the same dwelling with Creditor B. This proposed
comment explains that for purposes of this section, the loan extended
by Creditor B is a simultaneous loan. To facilitate compliance, the
comment would cross-reference to Sec. 226.43(c)(2)(iv) and (c)(6) and
associated commentary for further discussion of the requirement to
consider the consumer's payment obligation on any simultaneous loan for
purposes of determining the consumer's ability to repay the covered
transaction subject to this section.
Proposed comment 43(b)(12)-2 further clarifies the meaning of the
term ``same consumer, and explains that for purposes of the definition
of ``simultaneous loan,'' the term ``same consumer'' includes any
consumer, as that term is defined in Sec. 226.2(a)(11), that enters
into a loan that is a covered transaction and also enters into another
loan (e.g., second-lien covered transaction or HELOC) secured by the
same dwelling. This comment further explains that where two or more
consumers enter into a legal obligation that is a covered transaction,
but only one of them enters into another loan secured by the same
dwelling, the ``same consumer'' includes the person that has entered
into both legal obligations. This proposed comment provides the
following illustrative example: Assume Consumer A and Consumer B will
both enter into a legal obligation that is a covered transaction with a
creditor. Immediately prior to consummation of the covered transaction,
Consumer B opens a HELOC that is secured by the same dwelling with the
same creditor; Consumer A is not a signatory to the HELOC. For purposes
of the definition of ``simultaneous loan,'' Consumer B is the same
consumer and the creditor must include the HELOC as a simultaneous
loan. The Board believes this comment reflects statutory intent to
include any loan that could impact the consumer's ability to repay the
covered transaction according to its terms (i.e., to require the
creditor to consider the combined payment obligations of the
consumer(s) obligated to repay the covered transaction). See TILA
129C(a)(2).
The term ``simultaneous loan'' appears in the following provisions:
(1) Proposed Sec. 226.43(c)(2)(iv), which implements the requirement
under TILA Sec. 129C(a)(2) that a creditor consider a consumer's
monthly payment obligation on a simultaneous loan that the creditor
``knows or has reason to know'' will be made to the consumer; (2)
proposed Sec. 226.43(c)(6), which addresses the payment calculations
for a simultaneous loan for purposes of proposed Sec.
226.43(c)(2)(iv); and (3) proposed Alternative 2--Sec.
226.43(e)(2)(v)(C), which requires the creditor to consider a
simultaneous loan as a condition to meeting the definition of a
qualified mortgage.
43(b)(13) Third-Party Record
TILA Section 129C(a)(1) requires that creditors determine a
consumer's repayment ability using ``verified and documented
information,''and TILA Section 129C(a)(4) specifically requires
verifying a consumer's income or assets relied on to determine
repayment ability using a consumer's tax return or ``third-party
documents'' that provide reasonably reliable evidence of the consumer's
income or assets, as discussed in detail below in the section-by-
section analysis of proposed Sec. 226.43(c)(3) and (4). The Board
believes that in general creditors should rely on reasonably reliable
records prepared by a third party to verify repayment ability under
TILA Section 129C(a), consistent with verification requirements under
the Board's 2008 HOEPA Final Rule. See Sec. 226.34(a)(4)(ii). However,
the Board believes that in some cases a record prepared by the creditor
for a covered transaction can provide reasonably reliable evidence of a
consumer's repayment ability, such as a creditor's records regarding a
consumer's savings account held by the creditor or employment records
for a consumer
[[Page 27419]]
employed by the creditor. Further, TILA Section 129C(a)(4) allows
creditors to use a consumer-prepared tax return to verify the
consumer's income or assets. Proposed Sec. 226.43(b)(13) therefore
would define the term ``third-party records'' to include certain
records prepared by the consumer or creditor, for consistency and
simplicity in implementing verification requirements under TILA
Sections 129C(a)(1) and (4).
Proposed Sec. 226.43(b)(13) provides that ``third-party record''
means: (1) A document or other record prepared or reviewed by a person
other than the consumer, the creditor, any mortgage broker, as defined
in Sec. 226.36(a)(2), or any agent of the creditor or mortgage broker;
(2) a copy of a tax return filed with the Internal Revenue Service or a
state taxing authority; (3) a record the creditor maintains for an
account of the consumer held by the creditor; or (4) if the consumer is
an employee of the creditor or the mortgage broker, a document or other
record regarding the consumer's employment status or income. See
proposed Sec. 226.43(b)(13)(i)-(iv).
Proposed comment 43(b)(13)-1 clarifies that third party records
include records transmitted or viewed electronically, for example, a
credit report prepared by a consumer reporting agency and transmitted
or viewed electronically. Proposed comment 43(b)(13)-2 explains that a
third-party record includes a form a creditor provides to a third party
for providing information, even if the creditor completes parts of the
form unrelated to the information sought. Proposed comment 43(b)(13)-2
provides an example where the creditor gives the consumer's employer a
form for verifying the consumer's employment status and income and
clarifies that the creditor may fill in the creditor's name and other
portions of the form unrelated to the consumer's employment status or
income. Proposed comment 43(b)(13)(i)-1 clarifies that a third-party
record includes a document or other record prepared by the consumer,
the creditor, the mortgage broker, or an agent of the creditor or
mortgage broker, if the record is reviewed by a third party. For
example, a profit-and-loss statement prepared by a self-employed
consumer and reviewed by a third-party accountant is a third-party
record under Sec. 226.43(b)(13)(i). Finally, proposed comment
43(b)(13)(iii)-1 clarifies that a third-party record includes a record
the creditor maintains for an account of the consumer held by the
creditor, and provides the examples of checking accounts, savings
accounts, and retirement accounts. Proposed comment 43(b)(13)(iii)-1
also provides the example of a creditor's records for an account
related to a consumer's outstanding obligations to the creditor, such
as the creditor's records for a first-lien mortgage to a consumer who
applies for a subordinate-lien home equity loan.
43(c) Repayment Ability
TILA Section 129C(a)(1) provides that no creditor may make a
residential mortgage loan unless the creditor makes a reasonable and
good faith determination that, at the time the loan is consummated, the
consumer has a reasonable ability to repay the loan according to its
terms and all applicable taxes, insurance, and assessments. TILA
Section 129C(a)(2) provides that if a creditor knows or has reason to
know that one or more residential mortgage loans secured by the
dwelling that secures the covered transaction will be made to the same
consumer, the creditor must make a reasonable and good faith
determination that the consumer has a reasonable ability to repay the
other loan(s) and all taxes, insurance, and assessments applicable to
the other loan(s). TILA Section 129C(a)(3) provides that to determine
the consumer's repayment ability creditors must consider: The
consumer's (1) credit history; (2) current income and reasonably
expected income; (3) current obligations; (4) debt-to-income ratio or
the residual income the consumer will have after paying non-mortgage
debt and mortgage-related obligations; (5) employment status; and (6)
financial resources other than the consumer's equity in the dwelling
that secures repayment of the loan. Further, creditors must base their
determination of the consumer's repayment ability on verified and
documented information. Finally, TILA Section 129C(a)(3) provides that
creditors must use a payment schedule that fully amortizes the loan
over the loan term in determining the consumer's repayment ability.
These TILA provisions are substantially similar to the repayment
ability requirements under the Board's 2008 HOEPA Final Rule. See Sec.
226.34(a)(4), 226.35(b)(1).
Proposed Sec. 226.43(c) would implement TILA Section 129C(a)(1)-
(3) and is substantially similar to those provisions. Specifically,
proposed Sec. 226.43(c) provides that a creditor:
Must not make a covered transaction unless the creditor makes
a reasonable and good faith determination at or before consummation
that the consumer will have a reasonable ability, at the time of
consummation, to repay the loan according to its terms, including any
mortgage-related obligations;
Must make the repayment ability determination by considering
the consumer's:
[cir] Current or reasonably expected income or assets other than
the value of the dwelling, or of any real property to which the
dwelling is attached, that secures the loan;
[cir] Employment status, if the creditor relies on income from the
consumer's employment in determining repayment ability;
[cir] Monthly payment on the covered transaction;
[cir] Monthly payment on any simultaneous loan that the creditor
knows or has reason to know will be made;
[cir] Monthly payment for mortgage-related obligations;
[cir] Current debt obligations;
[cir] Monthly debt-to-income ratio or residual income; and
[cir] Credit history; and
Must verify a consumer's repayment ability using reasonably
reliable third-party records.
Proposed comment 43(c)-1 clarifies that, to evaluate a consumer's
repayment ability, creditors may look to widely accepted governmental
or non-governmental underwriting standards, such as the Federal Housing
Administration's Handbook on Mortgage Credit Analysis for Mortgage
Insurance on One-to-Four Unit Mortgage Loans. Proposed comment 43(c)-1
states, for example, that creditors may use such standards in
determining: (1) Whether to classify particular inflows, obligations,
or property as ``income,'' ``debt,'' or ``assets''; (2) factors to
consider in evaluating the income of a self-employed or seasonally-
employed consumer; and (3) factors to consider in evaluating the credit
history of a consumer who has obtained few or no extensions of
traditional ``credit,'' as defined in Sec. 226.2(a)(14). Proposed
comment 43(c)-1 is consistent with, but broader than, current
commentary on determining a consumer's debt-to-income ratio to meet the
presumption of compliance with the repayment ability requirement of the
Board's 2008 HOEPA Final Rule. See Sec. 226.34(a)(4)(iii)(C),
226.35(b)(1). Currently, comment 34(a)(4)(iii)(C)-1 states that
creditors may look to widely accepted underwriting standards to
determine whether to classify particular inflows or obligations as
``income'' or ``debt.''
The Board's proposed rule provides flexibility in underwriting
standards so
[[Page 27420]]
that creditors may adapt their underwriting processes to a consumer's
particular circumstances, such as to the needs of self-employed
consumers and consumers heavily dependent on bonuses and commissions,
consistent with the Board's 2008 HOEPA Final Rule. See 73 FR 44522,
44547, July 30, 2008. For example, the proposed rule does not
prescribe: How many years of tax returns or other information a
creditor must consider to determine the consumer's repayment ability;
which income figure on tax returns creditors must use; the elements of
credit history to be considered, such as late payments or bankruptcies;
the way in which to verify credit history, such as by using a tri-merge
report or records of rental payments; or a specific maximum debt-to-
income ratio or the compensating factors to allow a consumer to exceed
such a ratio. The Board believes such flexibility is necessary because
the rule would cover such a wide variety of consumers and mortgage
products.
Removal of Sec. 226.34(a)(4) and 226.35(b)(1). Repayment ability
requirements under TILA Section 129C(a) apply to all dwelling-secured
consumer credit transactions, other than HELOCs, reverse mortgages,
temporary or ``bridge'' loans with a loan term of 12 months or less,
and timeshare transactions, as discussed in detail above in the
section-by-section analysis of proposed Sec. 226.43(a). Accordingly,
the Board proposes to implement TILA Section 129C in a new Sec. 226.43
and remove requirements to consider repayment ability for high-cost
mortgages under Sec. 226.34(a)(4) and for higher-priced mortgage loans
under Sec. 226.35(b)(1), as discussed in detail above in the section-
by-section analysis of Sec. 226.34 and 226.35.
43(c)(1) General Requirement
Proposed Sec. 226.43(c)(1) would implement TILA Section 129C(a)(1)
and provides that no creditor may make a covered transaction unless the
creditor makes a reasonable and good faith determination at or before
consummation that the consumer will have a reasonable ability, at the
time of consummation, to repay the covered transaction according to its
terms, including any mortgage-related obligations. Proposed comment
43(c)(1)-1 clarifies that a change in the consumer's circumstances
after consummation (for example, a significant reduction in income due
to a job loss or a significant obligation arising from a major medical
expense) that is not reflected in the consumer's application or the
records used to determine repayment ability is not relevant to
determining a creditor's compliance with the rule. However, proposed
comment 43(c)(1)-1 states further that if such application or records
state there will be a change in the consumer's repayment ability after
consummation (for example, if a consumer's application states that the
consumer plans to retire within twelve months without obtaining new
employment or transition from full-time to part-time employment), the
creditor must consider that information. Proposed comment 43(c)(1)-1 is
substantially similar to current comment 34(a)(4)-5 adopted by the
Board's 2008 HOEPA Final Rule.
Proposed comment 43(c)(1)-2 clarifies that proposed Sec.
226.43(c)(1) does not require or permit the creditor to make inquiries
prohibited by Regulation B, 12 CFR part 202, consistent with current
comment 34(a)(4)-7 adopted by the Board's 2008 HOEPA Final Rule.
43(c)(2) Basis for Determination
TILA Section 129C(a)(3) provides that to determine a consumer's
repayment ability, creditors must consider a consumer's credit history,
current and reasonably expected income, current obligations, debt-to-
income ratio or the residual income the consumer will have after paying
non-mortgage debt and mortgage-related obligations, employment status,
and ``financial resources'' other than the consumer's equity in the
dwelling or real property that secures repayment of the loan. TILA
Section 129C(a)(3) also provides that creditors must determine
repayment ability using a repayment schedule that fully amortizes the
loan over the loan term. Proposed Sec. 226.43(c)(2) would implement
the requirement to consider specific factors in determining repayment
ability. Proposed Sec. 226.43(c)(2) is substantially similar to TILA
Section 129C(a)(3), except for some minor terminology changes, as
discussed below.
43(c)(2)(i) Income or Assets
TILA Section 129C(a)(3) provides that in making the repayment
ability determination, creditors must consider, among other factors, a
consumer's current income, reasonably expected income, and ``financial
resources'' other than the consumer's equity in the dwelling or real
property that secures loan repayment. Furthermore, under TILA Section
129C(a)(9), creditors may consider the seasonality or irregularity of a
consumer's income in determining repayment ability.
Proposed Sec. 226.43(c)(2)(i) generally mirrors TILA Section
129C(a)(3) but differs in two respects. First, proposed Sec.
226.43(c)(2)(i) uses the term ``assets'' rather than ``financial
resources,'' to conform with terminology used in other provisions under
TILA Section 129C(a) and Regulation Z. See, e.g. TILA Section
129C(a)(4) (requiring that creditors consider a consumer's assets in
determining repayment ability); Sec. 226.51(a) (requiring
consideration of a consumer's assets in determining a consumer's
ability to repay a credit extension under a credit card account). The
Board believes the terms ``financial resources'' and ``assets'' are
synonymous as used in TILA Section 129C(a), and the term ``assets'' is
used throughout the proposal for consistency.
Second, proposed Sec. 226.43(c)(2)(i) provides that creditors may
not look to the value of the dwelling that secures the covered
transaction, instead of providing that creditors may not look to the
consumer's equity in the dwelling. The Board believes that TILA Section
129C(a)(3) is intended to address the risk that creditors will consider
the amount that could be obtained through a foreclosure sale of the
dwelling, which may exceed the amount of the consumer's equity in the
dwelling. This approach is consistent with the Board's 2008 HOEPA Final
Rule, which prohibits a creditor from extending credit ``based on the
value of the consumer's collateral.'' See Sec. 226.34(a)(4),
226.35(b)(1). The Board proposes this adjustment pursuant to its
authority under TILA Section 105(a), which provides that the Board's
regulations may contain such additional requirements, classifications,
differentiations, or other provisions, and may provide for such
adjustments and exceptions for all or any class of transactions as in
the Board's judgment are necessary or proper to effectuate the purposes
of TILA, prevent circumvention or evasion thereof, or facilitate
compliance therewith. 15 U.S.C. 1604(a). This approach is further
supported by the Board's authority under TILA Section 129B(e) to
condition terms, acts or practices relating to residential mortgage
loans that the Board finds necessary or proper to effectuate the
purposes of TILA. 15 U.S.C. 1639b(e). One of the purposes of TILA is to
``assure that consumers are offered and receive residential mortgage
loan on terms that reasonably reflect their ability to repay the
loans.'' TILA Section 129B(a)(2); 15 U.S.C. 1629b(a)(2). The Board
believes providing that creditors may not consider the value of the
dwelling is proper to effectuate the purposes of TILA Section 129C(a)
that creditors extend credit based on the consumer's
[[Page 27421]]
repayment ability rather than on the dwelling's foreclosure value. See
TILA Section 129B(a)(2).
Proposed comment 43(c)(2)(i)-1 clarifies that creditors may base a
determination of repayment ability on current or reasonably expected
income from employment or other sources, assets other than the dwelling
that secures the covered transaction, or both. Proposed comment
43(c)(2)(i)-2 cross-references proposed comment 43(a)-2 to clarify that
the value of the dwelling includes the value of the real property to
which the dwelling is attached, if the real property also secures the
covered transaction. Proposed comment 43(c)(2)(i)-1 also provides
examples of types of income the creditor may consider, including
salary, wages, self-employment income, military or reserve duty income,
tips, commissions, and retirement benefits; and examples of assets the
creditor may consider, including funds in a savings or checking
account, amounts vested in a retirement account, stocks, and bonds. The
proposed comment is substantially similar to comment 34(a)(4)-6 adopted
by the Board's 2008 HOEPA Final Rule, but adds additional examples of
income and assets to facilitate compliance. Proposed comment
43(c)(2)(i)-2 clarifies that if a creditor bases its determination of
repayment ability entirely or in part on a consumer's income, the
creditor need consider only the income necessary to support a
determination that the consumer can repay the covered transaction. For
example, if a consumer earns income from a full-time job and a part-
time job and the creditor reasonably determines that the consumer's
income from a full-time job is sufficient to repay the covered
transaction, the creditor need not consider the consumer's income from
the part-time job. Further, the creditor need verify only the income
(and assets) relied on to determine the consumer's repayment ability,
as discussed below in the section-by-section analysis of proposed Sec.
226.43(c)(4). Proposed comment 43(c)(2)(i)-2 cross-references proposed
comment 43(c)(4)-1, which is substantially similar to current comment
34(a)(4)(ii)-1, adopted by the Board's 2008 HOEPA Final Rule.
Expected income. TILA Section 129C(a) provides that creditors must
consider a consumer's current and reasonably expected income to
determine repayment ability. This is consistent with current Sec.
226.34(a)(4), but commentary on Sec. 226.34(a)(4) clarifies that
creditors need consider a consumer's reasonably expected income only if
the creditor relies on such income in determining repayment ability.
See comments 34(a)(4)(ii)-1, -3. The Board believes that the
requirement to consider a consumer's reasonably expected income under
TILA Section 129C(a) should be interpreted consistent with current
Sec. 226.34(a)(4), in light of the substantial similarity between the
provisions. Accordingly, proposed Sec. 226.43(c)(2)(i) provides that
creditors must consider a consumer's current income or reasonably
expected income. Proposed comment 43(c)(2)(i)-3 clarifies that the
creditor may rely on the consumer's reasonably expected income either
in addition to or instead of current income.
Proposed comment 43(c)(2)(i)-3 further clarifies that if creditors
rely on expected income, the expectation that the income will be
available for repayment must be reasonable and verified with third-
party records that provide reasonably reliable evidence of the
consumer's expected income. Proposed comment 43(c)(2)(i)-3 also gives
examples of expected bonuses verified with documents demonstrating past
bonuses, and expected salary from a job verified with a written
statement from an employer stating a specified salary, consistent with
current comment 34(a)(4)(ii)-3 adopted by the Board's 2008 HOEPA Final
Rule. As the Board stated in connection with the 2008 HOEPA Final Rule,
in some cases a covered transaction may have a likely payment increase
that would not be affordable at the borrower's income at the time 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. See 73 FR 44522, 44544, July 30,
2008.
Seasonal or irregular income. TILA Section 129C(a)(9) provides that
creditors may consider the seasonality or irregularity of a consumer's
income in determining repayment ability. Accordingly, proposed comment
43(c)(2)(i)-4 clarifies that a creditor reasonably may determine that a
consumer can make periodic loan payments even if the consumer's income,
such as self-employment income, is seasonal or irregular. Proposed
comment 43(c)(2)(i)-4 states, for example, that if the creditor
determines that the income a consumer receives a few months each year
from selling crops is sufficient to make monthly loan payments when
divided equally across 12 months, the creditor reasonably may determine
that the consumer can repay the loan, even though the consumer may not
receive income during certain months. Comment 43(c)(2)(i)-4 is
consistent with current comment 34(a)(4)-6 adopted by the Board's 2008
HOEPA Final Rule but provides an example of seasonal or irregular
income that is not employment income.
43(c)(2)(ii) Employment Status
TILA Section 129C(a)(3) requires that creditors consider a
consumer's employment status in determining the consumer's repayment
ability, among other requirements. Proposed Sec. 226.43(c)(2)(ii)
implements this requirement and clarifies that creditors need consider
a consumer's employment status only if they rely on income from the
consumer's employment in determining repayment ability. Proposed
comment 43(c)(2)(ii)-1 states, for example, that if a creditor relies
wholly on a consumer's investment income to determine the consumer's
repayment ability, the creditor need not verify the consumer's
employment status. Proposed comment 43(c)(2)(ii)-1 clarifies that
employment may be full-time, part-time, seasonal, irregular, military,
or self-employment. This comment is consistent with current comment
34(a)(4)-6 adopted by the Board's 2008 HOEPA Final Rule.
Employment status of military personnel. Creditors in general must
verify information relied on to determine repayment ability using
reasonably reliable third-party records but may verify employment
status orally as long as they prepare a record of the oral information,
as discussed below in the section-by-section analysis of proposed Sec.
226.43(c)(3)(ii). Proposed comment 43(c)(2)(ii)-2 clarifies that
creditors also may verify the employment status of military personnel
using the electronic database maintained by the Department of Defense
(DoD) to facilitate identification of consumers covered by credit
protections provided pursuant to 10 U.S.C. 987, also known as the
``Talent Amendment.'' \41\ The Board solicits comment on whether
additional flexibility in verifying the employment status of military
personnel is necessary to facilitate compliance and whether comment
43(c)(2)(ii)-2 also should state that creditors may verify the
employment status of a member of the military using a Leave and
Earnings Statement. Is a Leave and Earnings Statement as reliable a
means of
[[Page 27422]]
verifying the employment status of military personnel as using the
electronic database maintained by the DoD? Is a Leave and Earnings
Statement equally reliable for determining employment status for a
civilian employee of the military as for a service member?
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\41\ The Talent Amendment is contained in the John Warner
National Defense Authorization Act. See Public Law 109-364, 120
Stat. 2083, 2266, Oct. 17, 2006; see also 72 FR 50580, 5088, Aug.
31, 2007 (discussing the DoD database in a final rule implementing
the Talent Amendment). Currently, the DoD database is available at
https://www.dmdc.osd.mil/appj/mla/.
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The Board solicits comment on this approach, and on whether there
are other specific employment situations for which additional guidance
should be provided.
43(c)(2)(iii) Monthly Payment on the Covered Transaction
Proposed Sec. 226.43(c)(2)(iii) would implement the requirements
under TILA Section 129C(a)(1) and (3), in part, by requiring that the
creditor consider the consumer's monthly payment on the covered
transaction, calculated in accordance with proposed Sec. 226.43(c)(5)
for purposes of determining the consumer's repayment ability on a
covered transaction. See proposed Sec. 226.43(c)(5) for a discussion
of the proposed payment calculation requirements. Proposed comment
43(c)(2)(iii)-1 would clarify that for purposes of the repayment
ability determination, the creditor must consider the consumer's
monthly payment on a covered transaction that is calculated as required
under proposed Sec. 226.43(c)(5), taking into account any mortgage-
related obligations. This comment would also provide a cross-reference
to proposed Sec. 226.43(b)(8) for the meaning of the term ``mortgage-
related obligations.''
43(c)(2)(iv) Simultaneous Loans
Proposed Sec. 226.43(c)(2)(iv) requires that the creditor consider
the consumer's monthly payment obligation on any simultaneous loan that
the creditor knows or has reason to know will be made to the consumer.
Proposed Sec. 226.43(c)(2)(iv) also requires that the consumer's
monthly payment obligation on the simultaneous loan be calculated in
accordance with proposed Sec. 226.43(c)(6), which is discussed below.
Proposed Sec. 226.43(c)(2)(iv) implements TILA Section 129C(a)(2),
which provides that ``if a creditor knows, or has reason to know, that
1 or more residential mortgage loans secured by the same dwelling will
be made to the same consumer, the creditor shall make a reasonable and
good faith determination, based on verified and documented information,
that the consumer has a reasonable ability to repay the combined
payments of all loans on the same dwelling according to the terms of
those loans and all applicable taxes, insurance (including mortgage
guarantee insurance), and assessments.'' As discussed under proposed
Sec. 226.43(b)(12), the Board is proposing to use its authority under
TILA Sections 105(a) and 129B(e) to broaden the scope of TILA Section
129C(a)(2) to include HELOCs, and define the term ``simultaneous loan''
accordingly, for purposes of the requirements under proposed Sec.
226.43(c)(2)(iv) and (c)(6). 15 U.S.C. 1604(a).
Proposed comment 43(c)(2)(iv)-1 clarifies that for purposes of the
repayment ability determination, a simultaneous loan includes any
covered transaction or HELOC that will be made to the same consumer at
or before consummation of the covered transaction and secured by the
same dwelling that secures the covered transaction. This comment
explains that a HELOC that is a simultaneous loan that the creditor
knows or has reason to know about must be considered as a mortgage
obligation in determining a consumer's ability to repay the covered
transaction, even though the HELOC is not a covered transaction subject
to Sec. 226.43. To facilitate compliance, this comment cross-
references proposed Sec. 226.43(a), which discusses the scope of the
ability-to-repay provisions, proposed Sec. 226.43(b)(12) for the
meaning of the term ``simultaneous loan,'' and proposed comment
43(b)(12)-2 for further explanation of the term ``same consumer.''
Proposed comment 43(c)(2)(iv)-2 provides additional guidance
regarding the standard ``knows or has reason to know'' for purposes of
proposed Sec. 226.43(c)(2)(iv) and explains that, for example, where a
covered transaction is a home purchase loan, the creditor must consider
the consumer's periodic payment obligation for any ``piggyback''
second-lien loan that the creditor knows or has reason to know will be
used to finance part of the consumer's down payment. This comment would
provide that the creditor complies with this requirement where, for
example, the creditor follows policies and procedures that show at or
before consummation that the same consumer has applied for another
credit transaction secured by the same dwelling.
This proposed comment would provide the following illustrative
example: Assume a creditor receives an application for a home purchase
loan where the requested loan amount is less than the home purchase
price. The creditor's policies and procedures require the consumer to
state the source of the downpayment. If the creditor determines the
source of the downpayment is another extension of credit that will be
made to the same consumer at consummation and secured by the same
dwelling, the creditor knows or has reason to know of the simultaneous
loan and must consider the simultaneous loan. Alternatively, if the
creditor has information that suggests the downpayment source is the
consumer's income or existing assets, the creditor would be under no
further obligation to determine whether a simultaneous loan will be
extended at or before consummation of the covered transaction.
Proposed comment 43(c)(2)(iv)-3 clarifies the scope of timing and
the meaning of the phrase ``at or before consummation'' with respect to
simultaneous loans that the creditor must consider for purposes of
proposed Sec. 226.43(c)(2)(iv). This comment would explain that a
simultaneous loan includes a loan that comes into existence
concurrently with the covered transaction subject to proposed Sec.
226.43(c). The comment would further state that, in all cases, a
simultaneous loan does not include a credit transaction that occurs
after consummation of the covered transaction subject to proposed Sec.
226.43(c).
Proposed comment 43(c)(2)(iv)-4 provides further guidance regarding
verification of simultaneous loans. This comment would state that
although a credit report may be used to verify current obligations, it
will not reflect a simultaneous loan that has not yet been consummated
or has just recently been consummated. This comment would explain that
if the creditor knows or has reason to know that there will be a
simultaneous loan extended at or before consummation, the creditor may
verify the simultaneous loan by obtaining third-party verification from
the third-party creditor of the simultaneous loan. The comment would
provide, as an example, that the creditor may obtain a copy of the
promissory note or other written verification from the third-party
creditor in accordance with widely accepted governmental or non-
governmental standards. To facilitate compliance, the comment would
cross-reference proposed comments 43(c)(3)-1 and -2, which discuss
verification using third-party records. Based on outreach, the Board
believes it is feasible for creditors to obtain copies of promissory
notes or other written verification from third-party creditors, but
solicits comment on other examples the Board could provide to
facilitate creditors' compliance with the proposed verification
requirement with respect to simultaneous loans.
[[Page 27423]]
The Board notes that proposed Sec. 226.43(c)(2)(iv) requires
creditors to consider a simultaneous loan when assessing the consumer's
ability to repay a covered transaction, regardless of whether the
simultaneous loan is made in connection with a purchase or non-purchase
covered transaction (i.e., refinancing). As discussed more fully below
under proposed Sec. 226.43(c)(6), which addresses payment calculation
requirements for simultaneous loans, the Board recognizes that in the
case of a non-purchase transaction, a simultaneous loan that is a HELOC
is unlikely to be originated and drawn upon to provide payment towards
the first-lien loan being refinanced, except perhaps towards closing
costs. The Board is soliciting comment on whether it should narrow the
requirement to consider simultaneous loans that are HELOCs to apply
only to purchase transactions. See discussion under proposed Sec.
226.43(c)(6) regarding payment calculations for simultaneous loans.
43(c)(2)(v) Mortgage-Related Obligations
Proposed Sec. 226.43(c)(2)(v) implements the requirement under
TILA Sections 129C(a)(1)-(3) that the creditor determine a consumer's
repayment ability taking into account the consumer's monthly payment
for any mortgage-related obligations, based on verified and documented
information as required under proposed Sec. 226.43(c)(3). TILA
Sections 129C(a)(1) and (2) require that the creditor determine a
consumer's repayment ability on a covered transaction based on verified
and documented information, ``according to [the loans's] terms, and all
applicable taxes, insurance (including mortgage guarantee insurance),
and assessments.'' TILA Section 129C(a)(3) further requires that a
consumer's debt-to-income ratio be considered as part of the repayment
ability determination after allowing for ``non-mortgage debt and
mortgage-related obligations.'' The Dodd-Frank Act does not define the
term ``mortgage-related obligations.'' As discussed in proposed Sec.
226.43(b)(8), the Board proposes to use the term ``mortgage-related
obligations'' to refer to ``all applicable taxes, insurance (including
mortgage guarantee insurance), and assessments.'' Proposed Sec.
226.43(b)(8) would define the term ``mortgage-related obligations'' to
mean property taxes; mortgage-related insurance premiums required by
the creditor as set forth in proposed Sec. 226.45(b)(1); \42\
homeowner association, condominium, and cooperative fees; ground rent
or leasehold payments; and special assessments.
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\42\ See 2011 Escrow Proposal, 76 FR 11598, 11621, Mar. 2, 2011.
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Proposed Sec. 226.43(c)(2)(v) is generally consistent with the
requirement under current Sec. 226.34(a)(4) of the Board's 2008 HOEPA
Final Rule that the creditor include mortgage-related obligations when
determining the consumer's repayment ability on the loan, except that
Sec. 226.34(a)(4) does not extend the verification requirement to
mortgage-related obligations. In contrast, under proposed Sec.
226.43(c)(3) creditors would need to verify mortgage-related
obligations for purposes of the repayment ability determination. See
proposed Sec. 226.43(c)(3) and associated commentary discussing the
verification requirement generally.
Proposed comment 43(c)(2)(v)-1 states that the creditor must
include in its repayment ability assessment the consumer's mortgage-
related obligations, such as the expected property taxes and premiums
for mortgage-related insurance required by the creditor as set forth in
proposed Sec. 226.45(b)(1). This comment would clarify, however, that
creditors need not include mortgage-related insurance premiums that the
creditor does not require, such as credit insurance or fees for
optional debt suspension and debt cancellation agreements. This comment
would also explain that mortgage-related obligations must be included
in the creditor's determination of repayment ability regardless of
whether the amounts are included in the monthly payment or whether
there is an escrow account established. To facilitate compliance, this
comment would cross-reference proposed Sec. 226.43(b)(8) for the
meaning of the term ``mortgage-related obligations.''
As discussed more fully below under proposed Sec. 226.43(c)(5),
the Dodd-Frank Act provisions require creditors to determine the
consumer's ability to repay based on monthly payments, taking into
account mortgage-related obligations. However, the Board recognizes
that creditors will need to convert mortgage-related obligations that
are not monthly to pro rata monthly amounts to comply with this
proposed requirement. Thus, proposed comment 43(c)(2)(v)-2 clarifies
that, in considering mortgage-related obligations that are not paid
monthly, the creditor may look to widely accepted governmental or non-
governmental standards in determining the pro rata monthly payment
amount. The Board solicits comment on operational difficulties
creditors may encounter when complying with this ``monthly''
requirement, and whether additional guidance is necessary.
Proposed comment 43(c)(2)(v)-3 explains that estimates of mortgage-
related obligations should be based upon information that is known to
the creditor at the time the creditor underwrites the mortgage
obligation. This comment would further explain that information is
known if it is ``reasonably available'' to the creditor at the time of
underwriting the loan, and would cross-reference current comment
17(c)(2)(i)-1 for the meaning of ``reasonably available.'' The Board
believes it is appropriate to permit creditors to use estimates of
mortgage-related obligations because actual amounts may be unknown at
the time of underwriting. For example, outreach participants confirmed
that the current underwriting practice is to use estimates of property
taxes because actual property tax amounts are typically unknown until
consummation. Proposed comment 43(c)(2)(v)-3 further clarifies that for
purposes of proposed Sec. 226.43(c), the creditor would not need to
project potential changes, such as by estimating possible increases in
taxes and insurance.
Proposed comment 43(c)(2)(v)-4 states that creditors must make the
repayment ability determination required under proposed Sec. 226.43(c)
based on information verified from reasonably reliable records. This
comment would explain that guidance regarding verification of mortgage-
related obligations can be found in proposed comments 43(c)(3)-1 and -
2, which discuss verification using third-party records. The Board
solicits comment on any special concerns regarding the requirement to
document certain mortgage-related obligations, such as for ground rent
or leasehold payments, or special assessments. The Board also solicits
comment on whether it should provide, by way of example, that the HUD-1
or 1A, or a successor form, can serve as verification of certain
mortgage-related obligations reflected therein (e.g., title insurance),
where a legal obligation exists to complete the HUD-1 or 1A accurately.
See 24 CFR 3500.1 et seq. of Regulation X, which implements the Real
Estate Settlement Procedures Act (RESPA), 15 U.S.C. 2601 et seq.
43(c)(2)(vi) Current Debt Obligations
TILA Section 129C(a)(1) and (3) requires creditors to consider and
verify ``current obligations'' as part of the repayment ability
determination. This new TILA provision is consistent with the 2008
HOEPA Final Rule, which prohibits creditors from extending
[[Page 27424]]
credit without regard to a consumer's repayment ability, including a
consumer's current obligations, and requires creditors to verify the
consumer's current obligations. Sections 226.34(a)(4) and
(a)(4)(ii)(C), 226.35(b)(1). In addition, current comment
34(a)(4)(iii)(C)-1 provides that creditors may look to widely accepted
governmental and non-governmental underwriting standards in defining
``debt,'' including, for example, those set forth in the Federal
Housing Administration's (FHA) handbook on Mortgage Credit Analysis for
Mortgage Insurance on One- to Four-Unit Mortgage Loans. Finally,
current comment 34(a)(4)(ii)(C)-1 provides that a credit report may be
used to verify current obligations. If, however, a credit report does
not reflect an obligation that a consumer has listed on an application,
then the creditor is responsible for considering the obligation, but is
not required to verify the existence or amount of the obligation
through another source. If a creditor nevertheless verifies an
obligation, the creditor must consider the obligation based on the
information from the verified source.
Proposed Sec. 226.43(c)(2)(vi) implements TILA Section 129C(a)(1)
and (3) and requires creditors to consider the consumer's current debt
obligations as part of the repayment ability determination. As
discussed below, proposed Sec. 226.43(c)(3) implements TILA Section
129C(a)(1) by requiring that a creditor verify a consumer's repayment
ability, which would include the consumer's current debt obligations.
Proposed comment 43(c)(2)(vi)-1 clarifies that creditors may look
to widely accepted governmental and non-governmental underwriting
standards in determining how to define ``current debt obligations'' and
how to verify such obligations. For example, a creditor would be
required to consider student loans, automobile loans, revolving debt,
alimony, child support, and existing mortgages. To verify current debt
obligations as required by Sec. 226.43(c)(3), a creditor would be
permitted, for instance, look to credit reports, student loan
statements, automobile loan statements, credit card statements, alimony
or child support court orders, and existing mortgage statements. This
approach would parallel the 2008 HOEPA Final Rule's model for
consideration and verification of income and would preserve flexibility
for creditors. The Board solicits comment on this approach, and on
whether more specific guidance should be provided.
Proposed comment 43(c)(2)(vi)-2 states that if a credit report
reflects a current debt obligation that a consumer has not listed on
the application, the creditor must consider the obligation. The credit
report is deemed a reasonably reliable third-party record under Sec.
226.43(b)(3). Consistent with commentary to the 2008 HOEPA Final Rule,
the proposed comment further provides that if a credit report does not
reflect a current debt obligation that a consumer has listed on the
application, the creditor must consider the obligation. However, the
creditor need not verify the existence or amount of the obligation
through another source, as discussed in the section-by-section analysis
for Sec. 226.43(c)(3) below. If a creditor nevertheless verifies an
obligation, the creditor must consider the obligation based on the
information from the verified source. The Board solicits comment on the
feasibility of requiring creditors independently to verify current debt
obligations not reflected in the credit report that a consumer has
listed on the application. Such a requirement would be consistent with
TILA Section 129C(a)(1), which requires the repayment ability
determination to be based on verified information. On the other hand,
requiring creditors to verify these obligations may result in increased
compliance and litigation costs without offsetting benefits.
The Board solicits comment on three additional issues. First, the
Board solicits comment on whether it should provide additional guidance
on considering debt obligations that are almost paid off. For example,
some underwriting standards limit the consideration of current debt
obligations to recurring obligations extending 10 months or more, and
recurring obligations extending less than 12 months if they affect the
consumer's repayment ability in the months immediately after
consummation. Requiring creditors to consider debts that are almost
paid off would advance safe and responsible lending, but may unduly
limit access to credit.
Second, the Board solicits comment on whether it should provide
additional guidance on considering debt obligations that are in
forbearance or deferral. For example, some underwriting standards do
not include consideration of projected obligations deferred for at
least 12 months, in particular student loans. Many creditors, however,
consider all projected obligations. Permitting creditors not to
consider debt obligations that are in forbearance or deferral may
further limit access to credit, but may also run counter to safe and
responsible lending.
Finally, the Board solicits comment on whether it should provide
guidance on consideration and verification of current debt obligations
for joint applicants. The Board also solicits comment on whether the
guidance should differ for non-occupant joint applicants and occupant
joint applicants.
43(c)(2)(vii) Debt-to-Income Ratio or Residual Income
TILA Section 129C(a)(3) requires creditors, as part of the
repayment ability determination, to consider the debt-to-income ratio
or the residual income the consumer will have after paying mortgage-
related obligations and current debt obligations. This new TILA
provision is consistent with the Board's 2008 HOEPA Final Rule, in
which a creditor is presumed to have complied with the repayment
ability requirement if, among other things, the creditor ``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.'' Section
226.34(a)(4)(iii)(C), 226.35(b)(1). In addition, comment
34(a)(4)(iii)(C)-1 provides that creditors may look to widely accepted
governmental and non-governmental underwriting standards in defining
``income'' and ``debt,'' including, for example, those set forth in the
Federal Housing Administration's (FHA) handbook on Mortgage Credit
Analysis for Mortgage Insurance on One- to Four-Unit Mortgage Loans.
Proposed Sec. 226.43(c)(2)(vii) implements TILA Section 129C(a)(3)
and requires creditors, as part of the repayment ability determination,
to consider the consumer's monthly debt-to-income ratio, or residual
income. Proposed comment 43(c)(2)(vii)-1 cross-references Sec.
226.43(c)(7) regarding the definitions and calculations for the monthly
debt-to-income ratio and residual income.
Consistent with the 2008 HOEPA Final Rule, TILA Section 129C(a)(3)
requires creditors to consider either the consumer's debt-to-income
ratio or the consumer's residual income. As in the 2008 HOEPA Final
Rule, the proposal provides creditors flexibility to determine whether
using a debt-to-income ratio or 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 requiring creditors
to use both metrics could reduce access to credit without an offsetting
increase in
[[Page 27425]]
consumer protection. 73 FR 44550, July 30, 2008. Outreach conducted by
Board staff also indicates that residual income appears not to be as
widely used or tested as the debt-to-income ratio.
43(c)(2)(viii) Credit History
TILA Section 129C(a)(1) and (3) requires creditors to consider and
verify credit history as part of the ability-to-repay determination.
Creditors must accordingly assess willingness to repay and not simply
ability to repay. By contrast, the 2008 HOEPA Final Rule does not
require consideration of credit history.
Proposed Sec. 226.43(c)(2)(vii) implements TILA Section 129C(a)(3)
and requires creditors to consider the consumer's credit history as
part of the repayment ability determination. As discussed below,
proposed Sec. 226.43(c)(3) implements TILA Section 129C(a)(1) by
requiring that a creditor verify a consumer's repayment ability, which
would include the consumer's credit history.
Proposed comment 43(c)(2)(viii)-1 clarifies that creditors may look
to widely accepted governmental and non-governmental underwriting
standards to define and verify ``credit history.'' For example, a
creditor may consider factors such as the number and age of credit
lines, payment history, and any judgments, collections, or
bankruptcies. To verify credit history as required by Sec.
226.43(c)(3), a creditor may, for instance, look to credit reports from
credit bureaus, or other nontraditional credit references contained in
third-party documents, such as rental payment history or public utility
payments. The Board solicits comment on this approach.
43(c)(3) Verification Using Third-Party Records
TILA Section 129C(a)(1) requires that creditors make a reasonable
and good faith determination, based on ``verified and documented
information,'' that a consumer has a reasonable ability to repay the
covered transaction. The Board's 2008 HOEPA Final Rule requires that
creditors verify the consumer's income or assets relied on to determine
repayment ability and the consumer's current obligations. See Sec.
226.34(a)(4)(ii)(A), (C). Thus, TILA Section 129C(a)(1) differs from
the Board's 2008 HOEPA Final Rule by requiring creditors to verify
information relied on in considering each of the specific factors
required to be considered under TILA Section 129C(a)(3), which are
discussed above in the section-by-section analysis of proposed Sec.
226.43(c)(2).
Proposed Sec. 226.43(c)(3) would implement the general requirement
to verify a consumer's repayment ability under TILA Section 129C(a)(1)
and requires that creditors verify a consumer's repayment ability using
reasonably reliable third-party records, with two exceptions. First,
creditors may orally verify a consumer's employment status, if they
prepare a record of the oral employment status information. See
proposed Sec. 226.43(c)(3)(i). The Board believes that creditors in
general should use reasonably reliable third-party records to verify
information they rely on to determine repayment ability, to document
that independent information supports their determination. Based on
outreach to several creditors and secondary market investors, however,
the Board believes that allowing creditors to verify a consumer's
employment status orally may increase the efficiency of the process of
verifying employment status without reducing the reliability of the
information obtained. Over time, many creditors and secondary market
investors have come to allow oral verification of employment status as
long as the consumer's employment income is verified using third-party
records. The Board is not aware of a reduction in the reliability of
employment status information as a result of the shift from written to
oral verification of employment status. Also, some employers may prefer
to orally verify a consumer's employment status, for example, because
of efficiency considerations or concerns about appearing to commit to
continuing to employ the consumer. Proposed Sec. 226.43(c)(3)(ii) does
not allow creditors to orally verify a consumer's employment income,
however.
The second exception to the requirement to verify repayment ability
using third-party records applies in cases where a creditor relies on a
consumer's credit report to verify a consumer's current debt
obligations, and the consumer's application states a current debt
obligation not shown in the consumer's credit report. Under proposed
Sec. 226.43(c)(3)(ii), the creditor need not independently verify such
current debt obligations. Proposed Sec. 226.43(c)(3)(ii) is consistent
with current comment 34(a)(4)(ii)(C)-1 adopted by the Board's 2008
HOEPA Final Rule.
Proposed comment 43(c)(3)-1 explains that records used to verify a
consumer's repayment ability under proposed Sec. 226.43(c)(1)(ii) must
be specific to the individual consumer. Records regarding average
incomes in the consumer's geographic location or average incomes paid
by the consumer's employer, for example, would not be specific to the
individual consumer and are not sufficient. Proposed comment 43(c)(3)-2
explains that creditors may obtain third-party records from a third-
party service provider, as long as the records are reasonably reliable
and specific to the individual consumer. Creditors also may obtain
third-party records, for example, payroll statements, directly from the
consumer. Proposed comments 43(c)(3)-1 and -2 are consistent with
current commentary and the supplementary information discussing how
creditors may obtain records relied on to determine repayment ability
under the Board's 2008 HOEPA Final Rule. See comments 34(a)(4)(ii)(A)-
1, -2, and -4; 73 FR 44522, 44547, July 30, 2008 (``Creditors may [* *
*] rely on third party documentation the consumer provides directly to
the creditor.'')
The Board solicits comment on whether any documents or records
prepared by the consumer and not reviewed by a third party
appropriately can be considered in determining repayment ability, for
example, because a particular record provides information not
obtainable using third-party records. In particular, the Board solicits
comment on methods currently used to ensure that documents prepared by
self-employed consumers (such as a year-to-date profit and loss
statement for the period after the period covered by the consumer's
latest income tax return, or an operating income statement prepared by
a consumer whose income includes rental income) are reasonably reliable
for use in determining repayment ability.
43(c)(4) Verification of Income or Assets
TILA Section 129C(a)(4) requires that creditors verify amounts of
income or assets relied upon to determine repayment ability by
reviewing the consumer's Internal Revenue Service (IRS) Form W-2, tax
returns, payroll statements, financial institution records, or other
third-party documents that provide reasonably reliable evidence of the
consumer's income or assets. TILA Section 129C(a)(4) provides further
that, to safeguard against fraudulent reporting, creditors must
consider either (1) IRS transcripts of tax returns or (2) an
alternative method that quickly and effectively verifies third-party
income documentation, subject to rules prescribed by the Board. TILA
Section 129C(a)(4) is substantially similar to Sec.
226.34(a)(4)(ii)(A), adopted by the Board's 2008 HOEPA Final Rule.
However, TILA Section 129C(a)(4)(B) provides for the alternative
methods of
[[Page 27426]]
third-party income documentation (other than use of an IRS tax-return
transcript) to be both ``reasonably reliable'' and to ``quickly and
effectively'' verify a consumer's income. The Board proposes to adjust
the requirement that such alternative method ``quickly and
effectively'' verify a consumer's income. See TILA Section
129C(a)(4)(B). Specifically, the Board proposes to implement TILA
Section 129C(a)(4) without using the phrase ``quickly and effectively''
and instead to (1) require the use of third-party records that are
reasonably reliable; and (2) provide examples of reasonably reliable
records that creditors can use to efficiently verify income, as well as
assets. See proposed Sec. 226.43(c)(4).
The Board proposes this approach pursuant to the Board's authority
under TILA Section 105(a) to prescribe regulations that contain such
additional requirements, classifications, differentiations, or other
provisions or provide for such adjustments and exceptions for all or
any class of transactions as in the judgment of the Board are necessary
or proper to effectuate the purposes of TILA, prevent circumvention or
evasion thereof, or to facilitate compliance therewith. 15 U.S.C.
1604(a). This approach is further supported by the Board's authority
under TILA Section 129B(e) to condition terms, acts or practices
relating to residential mortgage loans that the Board finds necessary
or proper to effectuate the purposes of TILA. 15 U.S.C. 1639b(e). One
of the purposes of TILA Section 129C is to assure that consumers are
offered and receive covered transactions on terms that reasonably
reflect their ability to repay the loan. See TILA Section 129B(a)(2).
The Board believes that considering reasonably reliable records is an
effective means of verifying a consumer's income and helps ensure that
consumers are offered and receive loans on terms that reasonably
reflect their repayment ability. The Board believes further that TILA
Section 129C(a)(4) is intended to safeguard against fraudulent
reporting, rather than to speed the process of verifying a consumer's
income. Indeed, there is a risk that requiring that creditors use quick
methods to verify the consumer's income would undermine the
effectiveness of the ability-to-repay requirement by sacrificing speed
for thoroughness. The Board believes that, by contrast, requiring the
use of reasonably reliable records effectuates the purposes of TILA
Section 129C(a)(4) without suggesting that creditors must obtain
records or complete income verification within a specific period of
time. The Board also believes that providing examples of reasonably
reliable records creditors may use to efficiently verify income or
assets facilitates compliance by providing clear guidance to creditors.
In addition, providing examples of such records is consistent with TILA
Section 129C(a)(4)(B), which authorizes the Board to prescribe the
types of records that can be used to quickly and effectively verify a
consumer's income.
Proposed Sec. 226.43(c)(4) implements TILA Section 129C(a)(4) and
provides that a creditor must verify the amounts of income or assets it
relies on to determine a consumer's ability to repay a covered
transaction using third-party records that provide reasonably reliable
evidence of the consumer's income or assets. The proposed rule and
associated commentary provide the following examples of third-party
records creditors may use to verify the consumer's income or assets, in
addition to or instead of tax-return transcripts issued by the IRS: (1)
Copies of tax returns the consumer filed with the IRS or a state taxing
authority; (2) IRS Form W-2s or similar IRS forms for reporting wages
or tax withholding; (3) payroll statements, including military Leave
and Earnings Statements; (4) financial institution records; (5) records
from the consumer's employer or a third party that obtained consumer-
specific income information from the consumer's employer; (6) records
from a government agency stating the consumer's income from benefits or
entitlements, such as a ``proof of income'' letter issued by the Social
Security Administration; (7) check cashing receipts; and (8) receipts
from a consumer's use of funds transfer services. See proposed Sec.
226.43(c)(4)(i)-(viii); proposed comment 43(c)(4)(vi)-1. Those examples
are illustrative, not exhaustive, and creditors may determine that
other records provide reasonably reliable evidence of the income relied
upon in determining a consumer's repayment ability.
Creditors need consider only the income or assets relied upon to
determine the consumer's repayment ability, as discussed above in the
section-by-section analysis of proposed Sec. 226.43(c)(2)(i). See
proposed comment 43(c)(2)(i)-2. Accordingly, proposed comment 43(c)(4)-
1 clarifies that creditors need verify only the income or assets relied
upon to determine the consumer's repayment ability. Proposed comment
43(c)(4)-1 also provides an example where the creditor need not verify
a consumer's annual bonus because the creditor relies on only the
consumer's salary to determine the consumer's repayment ability.
Proposed comment 43(c)(4)-2 clarifies that, if multiple consumers apply
jointly for a loan and each lists income or assets on the application,
the creditor need verify only the income or assets the creditor relies
on to determine repayment ability. Proposed comment 43(c)(4)-3
clarifies that creditors may verify a consumer's income using an IRS
tax-return transcript that summarizes the information in the consumer's
filed tax return, another record that provides reasonably reliable
evidence of the consumer's income, or both. Proposed comment 43(c)(4)-3
also clarifies that creditors may obtain a copy of an IRS tax-return
transcript or filed tax return from a service provider or the consumer
and need not obtain the copy directly from the IRS or other taxing
authority, and cross-references guidance on obtaining records in
proposed comment 43(c)(3)-2. Proposed comments 43(c)(4)-1, -2, and -3
are consistent with current commentary adopted by the Board's 2008
HOEPA Final Rule. See comments 34(a)(4)-7, 34(a)(4)(ii)(A)-1 and -2.
Proposed comment 43(c)(4)(vi)-1 clarifies that an example of a record
from a Federal, state, or local government agency stating the
consumer's income from benefits or entitlements is a ``proof of income
letter'' (also known as a ``budget letter,'' ``benefits letter,'' or
``proof of award letter'') from the Social Security Administration.
The Board generally solicits comment on this approach. In addition,
the Board specifically solicits comment on whether, consistent with the
Board's 2008 HOEPA Final Rule, the Board should provide an affirmative
defense for a creditor that can show that the amounts of the consumer's
income or assets relied upon in determining the consumer's repayment
ability were not materially greater than the amounts the creditor could
have verified using third-party records at or before consummation. See
Sec. 226.34(a)(4)(ii)(B).
43(c)(5) Payment Calculation
Background
Requirements of TILA Sections 129C(a)(1), (3) and (6)
The Board proposes Sec. 226.43(c)(5) to implement the payment
calculation requirements of TILA Section 129C(a), as enacted by Section
1411 of the Dodd-Frank Act. TILA Section 129C(a) contains the general
requirement that a creditor determine the consumer's ``ability to repay
the loan, according to its terms, and all applicable taxes, insurance
(including mortgage
[[Page 27427]]
guarantee insurance), and assessments,'' based on several
considerations, including ``a payment schedule that fully amortizes the
loan over the term of the loan.'' TILA Sections 129C(a)(1) and (3). The
statutory requirement to consider mortgage-related obligations, as
defined under proposed Sec. 226.43(b)(8), is discussed above in the
section-by-section analysis for proposed Sec. 226.43(c)(2)(v).
TILA Sections 129C(a)(6)(A)-(D) also require creditors to make
uniform assumptions when calculating the payment obligation for
purposes of determining the consumer's repayment ability for the
covered transaction. Specifically, TILA Section 129C(a)(6)(D)(i)-(iii)
provides that when calculating the payment obligation that will be used
to determine whether the consumer can repay the covered transaction,
the creditor must use a fully amortizing payment schedule and assume
that--
(1) The loan proceeds are fully disbursed on the date the loan is
consummated;
(2) the loan is repaid in substantially equal, monthly amortizing
payments for principal and interest over the entire term of the loan
with no balloon payment; and
(3) the interest rate over the entire term of the loan is a fixed
rate equal to the fully-indexed rate at the time of the loan closing,
without considering the introductory rate.
The statute defines the term ``fully-indexed rate'' in TILA Section
129C(a)(7).
TILA Section 129C(a)(6)(D)(ii)(I) and (II), however, provides two
exceptions to the second assumption regarding ``substantially equal,
monthly payments over the entire term of the loan with no balloon
payment'' for loans that require ``more rapid repayment (including
balloon payment).'' First, this statutory provision authorizes the
Board to prescribe regulations for calculating the payment obligation
for loans that require more rapid repayment (including balloon
payment), and which have an annual percentage rate that does not exceed
a certain rate threshold. TILA Section 129C(a)(6)(D)(ii)(I). Second,
for loans that ``require more rapid repayment (including balloon
payment),'' and which exceed a certain rate threshold, the statute
requires that the creditor use the loan contract's repayment schedule.
TILA Section 129C(a)(6)(D)(ii)(II). The statute does not define the
term ``rapid repayment.''
The statute also provides three additional clarifications to the
assumptions stated above for loans that contain certain features.
First, for variable-rate loans that defer repayment of any principal or
interest, TILA Section 129C(a)(6)(A) states that for purposes of the
repayment ability determination a creditor must use ``a fully
amortizing repayment schedule.'' This provision generally reiterates
the requirement provided under TILA Section 129C(a)(3) to use a payment
schedule that fully amortizes the loan.
Second, for covered transactions that permit or require interest-
only payments, the statute requires that the creditor determine the
consumers' repayment ability using ``the payment amount required to
amortize the loan by its final maturity.'' TILA Section 129C(a)(6)(B).
Third, for covered transactions with negative amortization, the
statute requires the creditor to also take into account ``any balance
increase that may accrue from any negative amortization provision''
when making the repayment ability determination. TILA Section
129C(a)(6)(C). The statute does not define the terms ``variable-rate,''
``fully amortizing,'' ``interest-only,'' or ``negative amortization.''
Proposed Sec. 226.43(c)(5)(i) and (ii) implement these statutory
provisions, and are discussed in further detail below.
2008 HOEPA Final Rule
TILA Section 129C(a), as enacted by Section 1411 of the Dodd-Frank
Act, largely codifies many aspects of the repayment ability rule under
Sec. 226.34(a)(4) of the Board's 2008 HOEPA Final Rule, which the
Board is proposing to remove, and extends such requirements to the
entire mortgage market regardless of the loan's interest rate. Similar
to Sec. 226.34(a)(4), the statutory framework of TILA Section 129C(a)
focuses on prescribing the requirements that govern the underwriting
process and extension of credit to consumers, rather than dictating
which credit terms may or may not be permissible. However, there are
differences between TILA Section 129C(a) and the Board's 2008 HOEPA
Final Rule with respect to payment calculation requirements.
Current Sec. 226.34(a)(4) does not address how a creditor must
calculate the payment obligation for a loan that cannot meet the
presumption of compliance under Sec. 226.34(a)(4)(iii)(B). For
example, Sec. 226.34(a)(4) does not specify how to calculate the
periodic payment required for a negative amortization loan or balloon
loan with a term of less than seven years. In contrast, the Dodd-Frank
Act lays out a specific framework for underwriting any loan subject to
proposed Sec. 226.43(c). In taking this approach, the statutory
requirements in TILA Section 129C(a)(6)(D) addressing payment
calculation requirements differ from Sec. 226.34(a)(4)(iii) in the
following manner: (1) The statute generally premises repayment ability
on monthly payment obligations calculated using the fully indexed rate,
with no limit on the term of the loan that should be considered for
such purpose; (2) the statute permits underwriting loans with balloon
payments to differ depending on whether the loan's annual percentage
rate exceeds the applicable loan pricing metric, or meets or falls
below the applicable loan pricing metric; and (3) the statute expressly
addresses underwriting requirements for loans with interest-only
payments or negative amortization.
Interagency Supervisory Guidance
As discussed above in Part II.C, in 2006 and 2007 the Board and
other Federal banking agencies addressed concerns regarding the
increased risk to creditors and consumers presented by loans that
permit consumers to defer repayment of principal and sometimes
interest, and by adjustable-rate mortgages in the subprime market. The
Interagency Supervisory Guidance stated that creditors should determine
a consumer's repayment ability using a payment amount based on the
fully indexed rate, assuming a fully amortizing schedule. In addition,
the 2006 Nontraditional Mortgage Guidance addressed specific
considerations for negative amortization and interest-only loans. State
supervisors issued parallel statements to this guidance, which most
states have adopted. TILA Sections 129C(a)(3) and (6) are generally
consistent with this longstanding Interagency Supervisory Guidance, and
largely extend the guidance regarding payment calculation assumptions
to all loan types covered under TILA Section 129C(a), regardless of
loan's interest rate.
The Board's Proposal
The Board proposes Sec. 226.43(c)(5) to implement the payment
calculation requirements of TILA Sections 129C(a)(1), (3) and (6) for
purposes of the repayment ability determination required under proposed
Sec. 226.43(c). Consistent with these statutory provisions, proposed
Sec. 226.43(c)(5) does not prohibit the creditor from offering certain
credit terms or loan features, but rather focuses on the calculation
process the creditor must use to determine whether the consumer can
repay the loan according to its terms. Under the proposal, creditors
generally would be required to determine a consumer's
[[Page 27428]]
ability to repay a covered transaction using the fully indexed rate or
the introductory rate, whichever is greater, to calculate monthly,
fully amortizing payments that are substantially equal, unless a
special rule applies. See proposed Sec. 226.43(c)(5)(i). For clarity
and simplicity, proposed Sec. 226.43(c)(5)(i) would use the terms
``fully amortizing payment'' and ``fully indexed rate,'' as discussed
above under proposed Sec. 226.43(b)(2) and (3), respectively. Proposed
comment 43(c)(5)(i)-1 would clarify that the general rule would apply
whether the covered transaction is an adjustable-, step-, or fixed-rate
mortgage, as those terms are defined in Sec. 226.18(s)(7)(i), (ii),
and (iii), respectively.
Proposed Sec. 226.43(c)(5)(ii)(A)-(C) create exceptions to the
general rule and provide special rules for calculating the payment
obligation for balloon-payment loans, interest-only loans or negative
amortization loans, as follows:
Balloon-payment loans. Consistent with TILA Section
129C(a)(6)(D)(ii)(I) and (II) of the Dodd-Frank Act, proposed Sec.
226.43(c)(5)(ii)(A) provides special rules for covered transactions
with a balloon payment that would differ depending on the loan's rate.
Proposed Sec. 226.43(c)(5)(ii)(A)(1) states that for covered
transactions with a balloon payment that are not higher-priced covered
transactions, the creditor must determine a consumer's ability to repay
the loan using the maximum payment scheduled in the first five years
after consummation. Proposed Sec. 226.43(c)(5)(ii)(A)(2) further
states that for covered transactions with balloon payments that are
higher priced covered transactions, the creditor must determine the
consumer's ability to repay according to the loan's payment schedule,
including any balloon payment. For clarity, proposed Sec.
226.43(c)(5)(ii)(A) would use the term ``higher-priced covered
transaction'' to refer to a loan that exceeds the applicable loan rate
threshold, and is defined in proposed Sec. 226.43(b)(4), discussed
above. The term ``balloon payment'' has the same meaning as in current
Sec. 226.18(s)(5)(i).
Interest-only loans. Consistent with TILA Sections 129C(a)(6)(B)
and (D) of the Dodd-Frank Act, proposed Sec. 226.43(c)(5)(ii)(B)
provides special rules for interest-only loans. Proposed Sec.
226.43(c)(5)(ii)(B) requires that the creditor determine the consumer's
ability to repay the interest-only loan using (1) the fully indexed
rate or the introductory rate, whichever is greater; and (2)
substantially equal, monthly payments of principal and interest that
will repay the loan amount over the term of the loan remaining as of
the date the loan is recast. For clarity, proposed Sec.
226.43(c)(5)(ii)(B) would use the terms ``loan amount'' and ``recast,''
which are defined and discussed under proposed Sec. 226.43(b)(5) and
(11), respectively. The term ``interest-only loan'' has the same
meaning as in current Sec. 226.18(s)(7)(iv).
Negative amortization loans. Consistent with TILA Sections
129C(a)(6)(C) and (D) of the Dodd-Frank Act, proposed Sec.
226.43(c)(5)(ii)(C) provides special rules for negative amortization
loans. Proposed Sec. 226.43(c)(5)(ii)(C) requires that the creditor
determine the consumer's ability to repay the negative amortization
loan using (1) the fully indexed rate or the introductory rate,
whichever is greater; and (2) substantially equal, monthly payments of
principal and interest that will repay the maximum loan amount over the
term of the loan remaining as of the date the loan is recast. Proposed
comment 43(c)(5)(ii)(C)-1 clarifies that for purposes of this proposed
rule, the creditor must first determine the maximum loan amount and the
period of time that remains in the loan term after the loan is recast.
For clarity, proposed Sec. 226.43(c)(5)(ii)(C) would use the terms
``maximum loan amount'' and ``recast,'' which are defined and discussed
under proposed Sec. 226.43(b)(7) and (11), respectively. The term
``negative amortization loan'' has the same meaning as in current Sec.
226.18(s)(7)(v) and comment 18(s)(7)(v)-1.
Each of these proposed payment calculation provisions is discussed
in greater detail below.
43(c)(5)(i) General rule
Proposed Sec. 226.43(c)(5)(i) implements the payment calculation
requirements in TILA Sections 129C(a)(3) and (6)(D)(i)-(iii), and
states the general rule for calculating the payment obligation on a
covered transaction for purposes of the ability-to-repay provisions.
Consistent with the statute, proposed Sec. 226.43(c)(5)(i) provides
that unless an exception applies under proposed Sec. 226.43(c)(5)(ii),
a creditor must make the repayment ability determination required under
proposed Sec. 226.43(c)(2)(iii) by using the greater of the fully
indexed rate or any introductory interest rate, and monthly, fully
amortizing payments that are substantially equal. That is, under this
proposed general rule the creditor would calculate the consumer's
monthly payment amount based on the loan amount, and amortize that loan
amount in substantially equal payments over the loan term, using the
fully indexed rate.
Proposed comment 43(c)(5)(i)-1 would explain that the payment
calculation method set forth in Sec. 226.43(c)(5)(i) applies to any
covered transaction that does not have a balloon payment, or that is
not an interest-only loan or negative amortization loan, whether it is
a fixed-rate, adjustable-rate or step-rate mortgage. This comment would
further explain that the payment calculation method set forth in Sec.
226.43(c)(5)(ii) applies to any covered transaction that is a loan with
a balloon payment, interest-only loan, or negative amortization loan.
To facilitate compliance, this comment would list the defined terms
used in proposed Sec. 226.43(c)(5) and provide cross-references to
their definitions.
The fully indexed rate or introductory rate, whichever is greater.
Proposed Sec. 226.43(c)(5)(i)(A) implements the requirement in TILA
Section 129C(a)(6)(D)(iii) to use the fully indexed rate when
calculating the monthly, fully amortizing payment for purposes of the
repayment ability determination. Proposed Sec. 226.43(c)(5)(i)(A)
would also provide that when creditors calculate the monthly, fully
amortizing payment for adjustable-rate mortgages, they must use the
introductory interest rate if it is greater than the fully indexed rate
(i.e., a premium rate). In some adjustable-rate transactions, creditors
may set an initial interest rate that is not determined by the index or
formula used to make later interest rate adjustments. Typically, this
initial rate charged to consumers is lower than the rate would be if it
were determined by using the index plus margin, or formula (i.e., the
fully indexed rate). However, an initial rate that is a premium rate is
higher than the rate based on the index or formula. See proposed
comment 43(c)(5)(i)-2. Thus, requiring creditors to use only the fully
indexed rate would result in creditors underwriting loans that have a
``premium'' introductory rate at a rate lower than the rate on which
the consumer's initial payments would be based. The Board believes
requiring creditors to assess the consumer's ability to repay on the
initial higher payments better effectuates the statutory intent and
purpose.
The Board proposes to require creditors to underwrite the loan at
the premium rate if greater than the fully indexed rate for purposes of
the repayment ability determination using its authority under TILA
Section 105(a). 15 U.S.C. 1604(a). TILA Section 105(a), as amended by
Section 1100A of the Dodd-Frank Act, authorizes the Board to
[[Page 27429]]
prescribe regulations to carry out the purposes of TILA and Regulation
Z, to prevent circumvention or evasion, or to facilitate compliance. 15
U.S.C. 1604(a). This approach is further supported by the Board's
authority under TILA Section 129B(e) to condition terms, acts or
practices relating to residential mortgage loans that the Board finds
necessary or proper to effectuate the purposes of TILA. 15 U.S.C.
1639b(e). The stated purpose of TILA Section 129C is to assure that
consumers are offered and receive residential mortgage loans on terms
that reasonably reflect their ability to repay the loan. TILA Section
129B(b), 15 U.S.C. 1639b. For the reasons discussed above, the Board
believes requiring creditors to underwrite the loan to the premium rate
for purposes of the repayment ability determination will help to ensure
that the consumers are offered, and receive, loans on terms that
reasonably reflect their ability to repay, and to prevent circumvention
or evasion.
Monthly, fully amortizing payments. For simplicity, proposed Sec.
226.43(c)(5)(i) uses the term ``fully amortizing payment'' to refer to
the statutory requirements that a creditor use a payment schedule that
repays the loan assuming that (1) the loan proceeds are fully disbursed
on the date of consummation of the loan; and (2) the loan is repaid in
amortizing payments for principal and interest over the entire term of
the loan. See TILA Sections 129C(a)(3) and (6)(D)(i)-(ii). As discussed
above, proposed Sec. 226.43(b)(2) defines ``fully amortizing payment''
to mean a periodic payment of principal and interest that will fully
repay the loan amount over the loan term. The terms ``loan amount'' and
``loan term'' are defined in proposed Sec. 226.43(b)(5) and (b)(6),
respectively, and discussed above.
The statute also expressly requires that a creditor use ``monthly
amortizing payments'' for purposes of the repayment ability
determination. TILA Section 129C(6)(D)(ii). The Board recognizes that
some loan agreements require consumers to make periodic payments with
less frequency, for example quarterly or semi-annually. Proposed Sec.
226.43(c)(5)(i)(B) does not dictate the frequency of payment under the
terms of the loan agreement, but does require creditors to convert the
payment schedule to monthly payments to determine the consumer's
repayment ability. Proposed comment 43(c)(5)(i)-3 clarifies that the
general payment calculation rules do not prescribe the terms or loan
features that a creditor may choose to offer or extend to a consumer,
but establishes the calculation method a creditor must use to determine
the consumer's repayment ability for a covered transaction. This
comment explains, by way of example, that the terms of the loan
agreement may require that the consumer repay the loan in quarterly or
bi-weekly scheduled payments, but for purposes of the repayment ability
determination, the creditor must convert these scheduled payments to
monthly payments in accordance with Sec. 226.43(c)(5)(i)(B). This
comment would also explain that the loan agreement may not require the
consumer to make fully amortizing payments, but for purposes of the
repayment ability determination the creditor must convert any non-
amortizing payments to fully amortizing payments.
Substantially equal. Proposed comment 43(c)(5)(i)-4 provides
additional guidance to creditors for determining whether monthly, fully
amortizing payments are ``substantially equal.'' See TILA Section
129C(a)(6)(D)(ii). This comment would state that creditors should
disregard minor variations due to payment-schedule irregularities and
odd periods, such as a long or short first or last payment period. The
comment would explain that monthly payments of principal and interest
that repay the loan amount over the loan term need not be equal, but
that the monthly payments should be substantially the same without
significant variation in the monthly combined payments of both
principal and interest. Proposed comment 43(c)(5)(i)-4 further explains
that where, for example, no two monthly payments vary from each other
by more than 1% (excluding odd periods, such as a long or short first
or last payment period), such monthly payments would be considered
substantially equal for purposes of this proposal. The comment would
further provide that, in general, creditors should determine whether
the monthly, fully amortizing payments are substantially equal based on
guidance provided in Sec. 226.17(c)(3) (discussing minor variations),
and Sec. 226.17(c)(4)(i)-(iii) (discussing payment-schedule
irregularities and measuring odd periods due to a long or short first
period) and associated commentary. The Board solicits comment on
operational difficulties that arise by ensuring payment amounts meet
the ``substantially equal'' condition. The Board also solicits comment
on whether a 1% variance is an appropriate tolerance threshold.
Examples of payment calculations. Proposed comment Sec.
226.43(c)(5)(i)-5 provides illustrative examples of how to determine
the consumer's repayment ability based on substantially equal, monthly,
fully amortizing payments as required under proposed Sec.
226.43(c)(5)(i) for a fixed-rate, adjustable-rate and step-rate
mortgage. For example, proposed comment 43(c)(5)(i)-5.ii provides an
illustration of the payment calculation for an adjustable-rate mortgage
with a five-year discounted rate. The example first assumes a loan in
an amount of $200,000 has a 30-year loan term. The loan agreement
provides for a discounted interest rate of 6% that is fixed for an
initial period of five years, after which the interest rate will adjust
annually based on a specified index plus a margin of 3%, subject to a
2% annual periodic interest rate adjustment cap. The index value in
effect at consummation is 4.5%; the fully indexed rate is 7.5% (4.5%
plus 3%). See proposed comment 43(c)(5)(i)-5.ii. This proposed comment
explains that even though the scheduled monthly payment required for
the first five years is $1,199, for purposes of Sec. 226.43(c)(2)(iii)
the creditor must determine the consumer's ability to repay the loan
based on a payment of $1,398, which is the substantially equal,
monthly, fully amortizing payment that will repay $200,000 over 30
years using the fully indexed rate of 7.5%.
The Board recognizes that, although consistent with the statute,
the proposed framework would require creditors to underwrite certain
loans, such as hybrid ARMs with a discounted rate period of five or
more years (e.g., 5/1, 7/1, and 10/1 ARMs) to a more stringent standard
as compared to the underwriting standard set forth in proposed Sec.
226.43(e)(2)(v) for qualified mortgages. The Board believes this
approach is consistent with the statute's intent to ensure consumers
can reasonably repay their loan, and that in both cases consumers'
interests are properly protected. See TILA Section 129B(a)(2), 15
U.S.C. 1639b(a)(2). To meet the definition of a qualified mortgage, a
loan cannot have certain risky terms or features, such as provisions
that permit deferral of principal or a term that exceeds 30 years; no
similar restrictions apply to loans subject to the ability-to-repay
standard. See proposed Sec. 226.43(e)(2)(i) and (ii). As a result, the
risk of potential payment shock is diminished significantly for
qualified mortgages. For this reason, the Board believes maintaining
the more lenient statutory underwriting standard for loans that satisfy
the qualified mortgage criteria will help to ensure that responsible
and affordable credit
[[Page 27430]]
remains available to consumers. See TILA 129B(a)(2), 15 U.S.C.
1639b(a)(2).
Requests for Comment
Loan amount or outstanding principal balance. As noted above,
proposed Sec. 226.43(c)(5)(i) is consistent with the statutory
requirements regarding payment calculations for purposes of the
repayment ability determination. The Board believes the intent of these
statutory requirements is to prevent creditors from assessing the
consumer's repayment ability based on understated payment obligations,
especially when risky features can be present on the loan. However, the
Board is concerned that the statute, as implemented in proposed Sec.
226.43(c)(5)(i), would require creditors to determine, in some cases, a
consumer's repayment ability using overstated payment amounts because
the creditor must assume that the consumer repays the loan amount in
substantially equal payments based on the fully indexed rate,
regardless of when the fully indexed rate can take effect under the
terms of the loan. The Board is concerned that this approach may
restrict credit availability, even where consumers are able to
demonstrate that they can repay the payment obligation once the fully
indexed rate takes effect.
For this reason, the Board solicits comment on whether it should
exercise its authority under TILA Sections 105(a) and 129B(e) to
provide that the creditor may calculate the monthly payment using the
fully indexed rate based on the outstanding principal balance as of the
date the fully indexed rate takes effect under the loan's terms,
instead of the loan amount at consummation. 15 U.S.C. 1604(a). Under
this approach, the creditor would determine the consumer's repayment
ability using the largest payment that could occur under the loan's
terms based on the fully indexed rate, rather than using monthly, fully
amortizing payments that are substantially equal. For example, for
loans with a significant introductory rate period of 7 years or longer,
it may be reasonable for the creditor to underwrite the consumer by
applying the fully indexed rate to the outstanding principal balance at
the end of the 7 year introductory period. To illustrate this approach
(all amounts are rounded), assume an adjustable-rate mortgage in the
amount of $200,000 with a seven-year discounted rate of 6.5%, after
which the interest rate will adjust annually to the specified index
plus a margin of 3%. The index value at consummation is 4.5%; the fully
indexed rate is 7.5%. At the end of the seventh year (after the 84th
monthly payment is credited), when the fully indexed rate takes effect,
the outstanding principal balance is $180,832. Under this approach, the
creditor could underwrite the loan based on the monthly payment of
principal and interest of $1,377 to repay the outstanding principal
balance of $180,832, instead of the monthly payment of $1,398 to repay
the loan amount of $200,000. Such an approach would seem to be
consistent with the purpose of TILA Section 129B(a)(2), which is to
ensure the consumer can reasonably repay the loan according to its
terms. 15 U.S.C. 1639b(a)(2).
Step-rate mortgages. The Board also notes that for purposes of the
repayment ability determination, a step-rate mortgage would be subject
to the general payment calculation rule under proposed Sec.
226.43(c)(5)(i), or the special rules under proposed Sec.
226.43(c)(5)(ii), if it did not otherwise meet the definition of a
``qualified mortgage.'' See proposed comment 43(c)(5)(i)-1. As
discussed in proposed Sec. 226.43(b)(3), which defines the term
``fully indexed rate'' for purposes of the repayment ability
determination, the proposed payment calculation requirements would
require creditors to determine a consumer's ability to repay a step-
rate mortgage using the maximum rate that can occur at any time during
the loan term. The Board notes that this approach is consistent with
the requirement that the creditor give effect to the largest margin
that can apply at any time during the loan term when determining the
fully indexed rate. See TILA Section 129C(a)(6)(iii) and (7). However,
the Board notes that by requiring creditors to use the maximum rate in
a step-rate mortgage, the monthly payments used to determine the
consumer's repayment ability will be higher than the consumer's actual
maximum payment.
The Board is concerned that this approach could restrict credit
availability. The Board recognizes that this concern is also present
for adjustable-rate mortgages, but notes that a step-rate product
differs from an adjustable-rate mortgage in that future interest rate
adjustments are known in advance and do not fluctuate over time in
accordance with a market index. The Board believes this feature of a
step-rate product could mitigate the payment shock risk to the consumer
because the exact rate and payment increases would be disclosed to the
consumer in advance, with no potential for the payment amounts to be
greater depending on market conditions.
On the other hand, the Board recognizes that a step-rate mortgage
that does not have a balloon payment, and is not an interest-only or
negative amortization loan, can meet the definition of a qualified
mortgage if the other underwriting criteria required are also met. As a
result, step-rate mortgages that would need to comply with the payment
calculation rules under proposed Sec. 226.43(c)(5) may be more likely
to be loans that contain a risky feature. The Board solicits comment,
and supporting data for alternative approaches, on whether it should
exercise its authority under TILA Sections 105(a) and 129B(e) to
provide an exception for step-rate mortgages subject to the payment
calculation rules in proposed Sec. 226.43(c)(5). For example, should
the Board require that creditors underwrite the step-rate mortgage
using the maximum rate in the first seven years, ten years, or some
other appropriate time horizon? Should the Board similarly require that
creditors underwrite an adjustable-rate mortgage using the maximum
interest rate in the first seven years or some other appropriate time
horizon that reflects a significant introductory rate period?
Safe harbor to facilitate compliance. The Board recognizes that
under this proposal, creditors must comply with multiple assumptions
when calculating the particular payment for purposes of the repayment
ability determination. For example, creditors would need to ensure that
the monthly payment amounts are ``substantially equal.'' Creditors
would also need to follow different payment calculation rules depending
on the type of loan being underwritten (i.e., balloon-payment loan vs.
a negative amortization loan), as discussed below under proposed Sec.
226.43(c)(5)(ii). The Board is concerned that the complexity attendant
to the proposed payment calculation requirements may increase the
potential for unintentional errors to occur, making compliance
difficult, especially for small creditors that may be unable to invest
in advanced technology or software needed to ensure payment
calculations are compliant. At the same time, the Board notes that the
intent of the statutory framework and this proposal is to ensure
consumers are offered and receive loans on terms that they can
reasonably repay. Thus, the Board solicits comment on whether it should
exercise its authority under TILA Sections 105(a) and 129B(e) to
provide a safe harbor for creditors that use the largest scheduled
payment that can occur during the loan term to determine the consumer's
ability to repay to facilitate compliance with the requirements under
proposed
[[Page 27431]]
Sec. 226.43(c)(5)(i) and (ii). 15 U.S.C. 1604(a).
43(c)(5)(ii) Special Rules: Balloon, Interest-Only, and Negative
Amortization Loans
Proposed Sec. 226.43(c)(5)(ii) creates exceptions to the general
rule under proposed Sec. 226.43(c)(5)(i), and provides special rules
in proposed Sec. 226.43(c)(5)(ii)(A)-(C) for loans with a balloon
payment, interest-only loans, and negative amortization loans,
respectively, for purposes of the repayment ability determination
required under proposed Sec. 226.43(c)(2)(iii). In addition to TILA
Section 129C(a)(6)(D)(i)-(iii), proposed Sec. 226.43(c)(5)(ii)(A)-(C)
implement TILA Sections 129C(a)(6)(B) and (C), and TILA Section
129C(a)(6)(D)(ii)(I)-(II). Each of these proposed special rules is
discussed below.
43(c)(5)(i)(A) Balloon Loans
The statute provides an exception to the requirement that creditors
determine a consumer's repayment ability using substantially equal,
monthly payments for loans that require ``more rapid repayment
(including balloon payment).'' See TILA Section 129C(a)(6)(D)(ii)(I)
and (II). First, the statute authorizes the Board to prescribe
regulations for calculating the payment obligation for loans that
require more rapid repayment (including balloon payment), and which
have an annual percentage rate that does not exceed the average prime
offer rate for a comparable transaction by 1.5 or more percentage
points for a first-lien transaction, and by 3.5 or more percentage
points for a subordinate-lien transaction (i.e., a ``prime'' loan). See
TILA Section 129C(a)(6)(D)(ii)(I). Second, for loans that ``require
more rapid repayment (including balloon payment),'' and exceed the loan
pricing threshold set forth (i.e., a ``nonprime'' loan), the statute
requires that the creditor use the loan contract's repayment schedule.
See TILA Section 129C(a)(6)(D)(ii)(II). The Board interprets these
statutory provisions as authorizing the Board to prescribe special
payment calculation rules for ``prime'' balloon loans, as discussed
more fully below.
Scope. The scope of loans covered by the phrase ``more rapid
repayment (including balloon payment)'' in TILA Section
129C(a)(6)(D)(ii) is unclear, and the statute does not define the term
``rapid repayment.'' The Board interprets the use of the term
``including,'' which qualifies the phrase ``more rapid repayment,'' as
meaning that balloon loans are covered, but that other loan types are
also intended to be covered. The Board notes, however, that loans with
a balloon payment actually require less rapid payment of principal and
interest because the amortization period used is much longer than the
term, thereby causing the balloon payment of principal and interest at
maturity. Thus, the reference to the phrase ``including balloon
payment'' makes it unclear whether the scope of this provision is meant
to cover loans that permit, for example, consumers to make initial
payments that are not fully amortizing, such as loans with negative
amortization, but that later require larger payments of principal and
interest, or other loan types.
Outreach participants offered various interpretations of the phrase
``more rapid repayment (including balloon payment).'' Participants
suggested that the loan types that could be covered by the phrase
``more repaid repayment'' could range from graduated payment mortgages
and negative amortization loans (where initial payments do not cover
principal and only some interest, and therefore higher payments of
principal and interest are required once the loan recasts to require
fully amortizing payments), to niche-market balloon-payment loans
(where a series of balloon payments are required intermittently
throughout the loan), to growth-equity mortgages (where the loan is
paid in full earlier than the term used to calculate initial payments
required under the payment schedule).
The Board does not believe it is feasible for the phrase ``more
rapid repayment'' to cover all these loan types given that each one has
varying terms and features. Thus, the Board is proposing to use its
authority under TILA Section 129C(a)(6)(D)(i)(I) only with respect to
balloon loans. The Board solicits comment on the meaning of the phrase
``more rapid repayment'' and what loan products should be covered by
this phrase. For example, the Board solicits comment on whether the
phrase ``more rapid repayment'' should include any loan where the
payments of principal and interest are based on an amortization period
that is shorter than the term of the loan during which scheduled
payments are permitted. For example, a loan may amortize the loan
amount over a 30-year period to determine monthly payment of interest
during the first five years, but fully amortizing payments begin after
five years, and therefore are amortized over a period of time that is
shorter than the term of the loan (i.e., 25 years). The Board further
solicits comment on the specific terms and features of loans that would
result in ``more rapid repayment.''
Higher-priced covered transaction. The Board is proposing Sec.
226.43(c)(5)(i)(A)(1) and (2) to provide special payment calculation
rules for a covered transaction with a balloon payment that would
differ depending on whether the loan is or is not a higher-priced
covered transaction. For purposes of proposed Sec. 226.43(c)(5)(i)(A),
the Board would define ``higher-priced covered transaction'' to mean a
covered transaction 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 a first-
lien covered transaction, or by 3.5 or more percentage points for a
subordinate-lien covered transaction. See proposed Sec. 226.43(b)(4).
As noted above under the proposed definition of higher-priced
covered transaction, the Board recognizes that ``jumbo'' loans
typically carry a premium interest rate to reflect the increased credit
risk and cost associated with lending larger loan amounts to consumers.
Such loans are more likely to be considered ``higher-priced covered
transactions'' and as a result, creditors would need to underwrite such
loans using the loan's payment schedule, including any balloon payment.
See proposed Sec. 226.43(c)(5)(i)(A)(2), discussed below. The Board is
concerned that this would restrict credit availability for consumers in
the ``jumbo'' balloon market. Accordingly, the Board is soliciting
comment on whether it should use its authority under TILA Sections
105(a) and 129B(e) to incorporate the special, separate coverage
threshold of 2.5 percentage points for ``jumbo loans'' to permit more
jumbo loans to benefit from the special payment calculation rule under
proposed Sec. 226.43(c)(5)(ii)(A)(1), and also to be consistent with
proposed Sec. 226.45(a)(1), which implements rate thresholds for the
proposed escrow account requirement and certain appraisal-related
requirements. See 76 FR 11598, Mar. 2, 2011; 75 FR 66554, Oct. 28,
2010.
The Board further notes under proposed Sec. 226.43(b)(4) that
premium interest rates are typically required for loans secured by non-
principal dwellings, such as vacation homes, which are covered by this
proposal. Accordingly, the Board also solicits comment and supporting
data on whether it should exercise its authority under TILA Sections
105(a) and 129B(e) to incorporate a special, separate coverage
threshold to address loans secured by non-principal dwellings, and
[[Page 27432]]
what rate threshold would be appropriate for such loans.
Proposed comment 43(c)(5)(ii)(A)-1 clarifies that for higher-priced
covered transactions with a balloon payment, the creditor must consider
the consumer's ability to repay the loan based on the payment schedule
under the terms of the legal obligation, including any required balloon
payment. This comment would explain that for loans with a balloon
payment that are not higher-priced covered transactions, the creditor
should use the maximum payment scheduled during the first five years of
the loan following consummation. To facilitate compliance, the comment
would cross-reference to the definition of ``balloon payment'' in
current Sec. 226.18(s)(5)(i).
43(c)(5)(ii)(A)(1) ``Prime'' Balloon Loans
Proposed Sec. 226.43(c)(5)(ii)(A)(1) requires a creditor to
determine a consumer's ability to repay a loan with a balloon payment
using the maximum payment scheduled during the first five years after
consummation where the loan is not a higher-priced covered transaction
(i.e., a ``prime'' loan). This proposed rule would apply to ``prime''
loans with a balloon payment that have a term of five or more years.
Legal authority. The Board proposes this approach using its
authority under TILA Section 129C(a)(6)(D)(ii)(I), which authorizes the
Board to prescribe regulations for ``prime'' balloon loans. In
addition, TILA Sections 105(a) and 129B(e) authorize the Board to
prescribe regulations that are consistent with the purposes of TILA. 15
U.S.C. 1604(a); 15 U.S.C. 1639b(e). One of the purposes of TILA is to
``assure that consumers are offered and receive residential mortgage
loan on terms that reasonably reflect their ability to repay the
loans.'' TILA Section 129B(a)(2); 15 U.S.C. 1629b(a)(2). The Board
believes proposing to require the creditor to use the largest payment
that can occur during the first five years after consummation to
determine repayment ability helps to ensure that consumers are offered
and receive loans on terms that reasonably reflect their ability to
repay the loan, and also facilitates compliance.
First five years after consummation. For several reasons, the Board
believes that five years is the appropriate time horizon for purposes
of determining the consumer's ability to repay a balloon loan. First,
the Board believes this approach preserves credit choice for consumers
interested in financing options that are based on interest rates more
consistent with shorter-term maturities, and therefore typically less
expensive than 30-year fixed-rate loans, but that may offer more
stability than some adjustable-rate loans. Five-year balloon loans
generally offer consumers a fixed rate for the entire term that is
lower than the prevailing rate for a 30-year fixed. Consumers may
choose this type of loan as short-term financing with the intent to
refinance in the near future into a fully amortizing, longer term loan
once the consumer's personal finances, market rate conditions, or some
other set of facts and circumstances improves. The Board believes that
five years is a sufficient period of time for consumers to improve
personal finances, for example, and that there is an increased
likelihood that a consumer may refinance, move or relocate during such
time frame. In contrast, as discussed in proposed Sec.
226.43(f)(1)(iv), balloon loans with terms less than five years, but
with extended amortization periods, such as 30 or more years, may
prevent consumers from growing equity and therefore, likely present
greater credit risk.
Second, the Board notes that using the first five years after
consummation to determine the consumer's repayment ability on a
``prime'' balloon loan is consistent with other proposed repayment
ability provisions, and therefore facilitates compliance. For example,
proposed Sec. 226.43(d)(5)(ii) and (e)(2)(iv) require the creditor to
use the five-year period after consummation for purposes of the
determining whether an exception applies to the repayment ability rules
for certain refinancings, and when underwriting the loan to meet the
qualified mortgage standard, respectively. The Board further notes that
the five-year period under proposed Sec. 226.43(e)(2)(iv) implements
the statutory requirement that creditors underwrite a loan, for
purposes of the qualified mortgage standard, based on the maximum rate
permitted during the first five years after consummation, and
therefore, reflects the statutory intent that a five-year period is a
reasonable period of time to repay a loan. See TILA Section
129(b)(2)(A)(v).
Third, the Board also is proposing to require that balloon loans
made by creditors in rural or underserved areas have a minimum five-
year term to be considered qualified mortgages. See proposed Sec.
226.43(f)(1), discussed below. The Board believes it is appropriate for
all types of creditors to use the same loan term when determining a
consumer's ability to repay a balloon loan to create a more level
playing field. The Board recognizes this concern may be mitigated in
part by the proposed asset threshold requirement, see proposed Sec.
226.43(f)(1)(v)(D), but believes a consistent approach to underwriting
balloon loans helps to prevent unintended consequences. For these
reasons, the Board believes this approach preserves credit availability
and choice of loan products that may offer more favorable terms to
consumers, and also facilitates compliance.
In developing the proposed approach for ``prime'' balloon loans,
the Board considered several different alternatives. For example, the
Board considered requiring the creditor to determine whether the
consumer could refinance the loan before incurring the balloon payment,
using a fully amortizing payment based on the then prevailing interest
rate for a fixed-rate mortgage with a 30-year term. The Board also
considered requiring the creditor to use a fully amortizing payment
based on a rate that would be two times the contractual rate offered
during the first five years of the loan with the balloon payment. The
Board believes both approaches are speculative in nature, and that
neither can accurately predict the interest rate that would be
available to consumers at the time they may want to refinance.
Moreover, the Board believes both approaches would likely overstate the
consumer's actual payment obligation for purposes of the repayment
ability determination where, for example, the interest rate on a five-
year balloon loan is typically lower than the rate offered on a 30-year
fixed. For these reasons, the Board did not believe these approaches
were appropriate.
The Board notes that the proposed five-year horizon for purposes of
determining the consumers repayment ability for a ``prime'' balloon
loan does not parallel the time horizon used for balloon loans under
the Board's anti-steering provisions regarding loan originator
compensation. See 75 FR 58509, Sept. 24, 2010. The Board's anti-
steering rules prohibit a loan originator from steering or directing a
consumer to a loan to earn more compensation, unless the transaction is
in the consumer's interest. See current Sec. 226.36(e). The Board
provides a safe harbor for loan originators if certain conditions are
met, including offering certain loan options to the consumer. One such
loan option must be a loan with no risky features; a balloon payment
that occurs in the first 7 years of the life of the loan is deemed a
risky feature for this purpose. The Board believes the different
approaches are warranted by the different purposes served by the
respective rules. Although the anti-steering provisions help to
[[Page 27433]]
ensure consumers' are offered certain loan options for which they
likely qualify, they are primarily intended to prevent loan originators
from offering loan options with features that may not benefit the
consumer, or that the consumer may not want or need, but which yield
the loan originator greater compensation. In contrast, the proposed
repayment ability provisions are meant to help ensure that the loan
offered or chosen by the consumer has terms that the consumer can
reasonably repay.
The Board solicits comment on whether the five-year term is an
appropriate time horizon, with supporting data for any alternative
approaches.
Proposed comment Sec. 226.43(c)(5)(ii)(A)(1)-2 provides further
guidance to creditors on determining whether a balloon payment occurs
in the first five years after consummation. This comment would clarify
that in considering the consumer's repayment ability for a balloon loan
that is not a higher-priced covered transaction, the creditor must use
the maximum payment scheduled during the first five years, or first 60
months, of the loan after the date of consummation. This comment would
provide an illustrative example that assumes a loan with a balloon
payment due at the end of a five-year loan term is consummated on
August 15, 2011. The first monthly payment is due on October 1, 2011.
The first five years after consummation occurs on August 15, 2016, with
a balloon payment required on the due date of the 60th monthly payment,
which is September 1, 2016. This comment would conclude that in this
example, the creditor does not need to consider the balloon payment
when determining the consumer's ability to repay this loan.
Proposed comment 43(c)(5)(ii)(A)(1)-3 addresses renewable balloon
loans. This comment recognizes balloon loans that are not higher-priced
covered transactions which provide an unconditional obligation to renew
a balloon loan at the consumer's option or obligation to renew subject
to conditions within the consumer's control. This comment would clarify
that for purposes of the repayment ability determination, the loan term
does not include the period of time that could result from a renewal
provision. This comment would provide the following illustration to
provide further clarification: Assume a 3-year balloon loan that is not
a higher-priced covered transaction contains an unconditional
obligation to renew for another three years at the consumer's option.
In this example, the loan term for the balloon loan is 3 years, and not
the potential 6 years that could result if the consumer chooses to
renew the loan. Accordingly, the creditor must underwrite the loan
using the maximum payment scheduled in the first five years after
consummation, which includes the balloon payment due at the end of the
3-year loan term. This comment would cross-reference proposed comment
43(c)(5)(ii)(A).ii, which provides an example of how to determine the
consumer's repayment ability for a 3-year renewable balloon loan, and
comment 17(c)(1)-11 for a discussion of renewable balloon payment
loans.
The Board recognizes that proposed comment 43(c)(5)(ii)(A)(1)-3
does not take the same approach as guidance contained in comment
17(c)(1)-11 regarding treatment of renewable balloon loans for
disclosure purposes, or with guidance contained in current comment
34(a)(4)(iv)-2 of the Board's 2008 HOEPA Final Rule. Current comment
17(c)(1)-11 states that creditors may make the required TILA
disclosures based on a period of time that accounts for any
unconditional obligation to renew (i.e., the payment amortization
period), assuming the interest rate in effect at the time of
consummation. Comment 34(a)(4)(iv)-2, which the Board is proposing to
remove, provides that where the creditor is unconditionally obligated
to renew the balloon loan, the full term resulting from such renewal is
the relevant term for purposes of the exclusion of certain balloon-
payment loans from the ability-to-repay presumption of compliance.
Although the proposal differs from current guidance in Regulation
Z, the Board believes this approach is appropriate for several reasons.
First, the ability-to-repay provisions in the Dodd-Frank Act do not
address extending the term of a balloon loan with an unconditional
obligation to renew provision. Second, permitting short-term ``prime''
balloon loans to benefit from the special payment calculation rule when
a creditor includes an unconditional obligation to renew, but retains
the right to increase the interest rate at the time of renewal, would
create a significant loophole in the balloon payment rules. Such an
approach could frustrate the objective to ensure consumers obtain
mortgages on affordable terms for a reasonable period of time because
the interest rate could escalate within a short period of time,
increasing the potential risk of payment shock to the consumer. This is
particularly the case where no limits exist on the interest rate that
the creditor can choose to offer to the consumer at the time of
renewal. TILA Section 129B(a)(2), 15 U.S.C. 1639b(a)(2), and TILA
Section 129C(b)(2)(A)(v). Moreover, the Board believes it would be
speculative to posit the interest rate at the time of renewal for
purposes of the repayment ability determination. Third, the guidance
contained in comment 17(c)(1)-11 regarding treatment of renewable
balloon loans is to help ensure consumers are aware of their loan terms
and avoid the uninformed use of credit, which differs from the stated
purpose of this proposed provision which is to help ensure that
consumers receive loans on terms that reasonably reflect their
repayment ability. TILA Section 102(a), 15 U.S.C. 1601(a)(2), and TILA
Section 129B(a)(2), 15 U.S.C. 1639b(a)(2).
At the same time, the Board recognizes that small creditors with
limited capital and reserves may use these short-term balloon loans
with unconditional obligations to renew to hedge their market rate
risk. Not treating renewable balloon loans in the same manner as
comment 17(c)(1)-11 could restrict credit access to ``prime'' balloon
loans. Accordingly, the Board solicits comment on whether creditors
should be able to treat the loan term of a ``prime'' balloon loan with
an unconditional obligation to renew as extended by the renewal
provision for purposes of proposed Sec. 226.43(c)(5)(ii)(A), subject
to certain conditions. Specifically, the Board solicits comment on how
to ensure consumers can reasonably repay the loan on its terms at the
time of renewal. The Board further solicits comment on methods to
address the risk of circumvention and potential payment shock risk to
consumers where creditors are able to unilaterally increase the
interest rate at the time of renewal. For example, should the Board
permit loan terms to be extended by renewal provisions for purposes of
proposed Sec. 226.43(c)(5)(ii)(A) when the creditor underwrites the
``prime'' balloon loan based on an average fully indexed rate for a
comparable transaction?
Proposed 226.43(c)(5)(ii)(A)(1)-4 would provide several
illustrative examples of how to determine the maximum payment scheduled
during the first five years after consummation for loans with a balloon
payment that are not higher-priced covered transactions. For example,
this comment would illustrate the payment calculation rule for a
balloon payment loan with a five-year loan term and fixed interest
rate. This comment would assume that a loan provides for a fixed
interest rate of 6%, which is below the APOR threshold for a comparable
transaction, and thus the loan is not a
[[Page 27434]]
higher-priced covered transaction. The comment would further assume
that the loan amount is $200,000, and that the loan has a five-year
loan term but is amortized over 30 years. The loan is consummated on
March 15, 2011, and the monthly payment scheduled for the first five
years following consummation is $1,199, with the first monthly payment
due on May 1, 2011. The first five years after consummation end on
March 15, 2016. The balloon payment of $187,308 is required on the due
date of the 60th monthly payment, which is April 1, 2016 (more than
five years after consummation). See proposed comment
226.43(c)(5)(ii)(A)(1)-4.iii. This comment explains that for purposes
of Sec. 226.43(c)(2)(iii), the creditor must determine the consumer's
ability to repay the loan based on the monthly payment of $1,199, and
need not consider the balloon payment of $187,308 due on April 1, 2016.
43(c)(5)(ii)(A)(2) ``Non-Prime'' Balloon Loans
Proposed Sec. 226.43(c)(5)(ii)(A)(2) implements TILA Section
129C(a)(6)(D)(ii)(II) and provides that for a higher-priced covered
transaction, the creditor must determine the consumer's ability to
repay a loan with a balloon payment using the scheduled payments
required under the terms of the loan, including any balloon payment.
TILA Section 129C(a)(6)(D)(ii)(II) states that for loans that require
more rapid repayment (including balloon payment), and which exceed the
loan pricing threshold set forth, the creditor must underwrite the loan
using the ``[loan] contract's repayment schedule.'' The Board
interprets the statutory requirement that the creditor use ``the loan
contract's payment schedule'' to mean that the creditor must use all
scheduled payments under the terms of the loan needed to fully amortize
the loan, consistent with the requirement under TILA Section
129C(a)(3). Payment of the balloon payment, either at maturity or
during at any intermittent period, is necessary to fully amortize the
loan. The proposed rule would apply to ``non-prime'' loans with a
balloon payment regardless of the length of the term or any contract
provision that provides for an unconditional guarantee to renew. The
Board is concerned that this approach could lessen credit choice for
non-prime borrowers, restrict credit availability and negatively impact
competition for this credit market. Accordingly, the Board solicits
comment, with supporting data, on the impact of this approach for low-
to-moderate income borrowers. In addition, under proposed Sec.
226.43(c)(2), the creditor would be required to determine that the
consumer has a reasonable ability to repay the loan, including the
balloon payment, from current or reasonably expected income or assets
other than the value of the dwelling. As a result, the creditor would
not be able to consider the consumer's ability to refinance the loan in
order to pay, or avoid, the balloon payment. The Board requests comment
on this approach.
Proposed comment Sec. 226.43(c)(5)(ii)(A)(2)-5 provides an
illustrative example of how to determine the consumer's repayment
ability based on the loan contract's payment schedule, including any
balloon payment, for higher-priced covered transactions with a balloon
payment. This comment would provide an illustrative example for a
balloon payment loan with a 10-year loan term; fixed interest rate.
This comment would assume that the loan is a higher-priced covered
transaction with a fixed interest rate of 7%. This comment would also
assume that the loan amount is $200,000 and the loan has a 10-year loan
term, but is amortized over 30 years. This comment would state that the
monthly payment scheduled for the first ten years is $1,331, with a
balloon payment of $172,956. This comment would explain that for
purposes of Sec. 226.43(c)(2)(iii), the creditor must consider the
consumer's ability to repay the loan based on the payment schedule that
repays the loan amount, including the balloon payment of $172,956.
43(c)(5)(i)(B) Interest-Only Loans
For interest-only loans (i.e., loans that permit interest only
payments for any part of the loan term), proposed Sec.
226.43(c)(5)(ii)(B) provides that the creditor must determine the
consumer's ability to repay the interest-only loan using (1) the fully
indexed rate or any introductory rate, whichever is greater; and (2)
substantially equal, monthly payments of principal and interest that
will repay the loan amount over the term of the loan remaining as of
the date the loan is recast. The proposed payment calculation rule for
interest-only loans parallels the general rule proposed in Sec.
226.43(c)(5)(i), except that proposed Sec. 226.43(c)(5)(ii)(B)(2)
requires a creditor to determine the consumer's ability to repay the
loan amount over the term that remains after the loan is recast, rather
than requiring the creditor to use fully amortizing payments, as
defined under proposed Sec. 226.43(b)(2).
Proposed Sec. 226.43(c)(5)(ii)(B)(2) implements TILA Section
129C(a)(6)(B), which requires that the creditor determine the
consumer's repayment ability using ``the payment amount required to
amortize the loan by its final maturity.'' For clarity, this proposed
rule uses the term ``recast,'' which is defined for interest-only loans
as the expiration of the period during which interest-only payments are
permitted under the terms of the legal obligation. See proposed Sec.
226.43(b)(11). The statute does not define the term ``interest-only.''
For purposes of this proposal, the terms ``interest-only loan'' and
``interest-only'' have the same meaning as in Sec.
226.18(s)(7)(iv).\43\
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\43\ See 12 CFR 226.18(s)(7)(iv), defining ``interest only'' to
mean that under the terms of the legal obligation, one or more of
the periodic payments may be applied solely to accrued interest and
not to loan principal, and ``interest-only loan'' to mean a loan
that permits interest-only payments.
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Interest-only loans typically provide a fixed introductory payment
period, such as five or ten years, during which the consumer may make
payments that pay only accrued interest, but no principal. When the
interest-only period expires, the payment amount required under the
terms of the loan is the principal and interest payment that will repay
the loan amount over the remainder of the loan term. The Board
interprets the statutory text in TILA Section 129C(a)(6)(B) as
requiring the creditor to determine the consumer's ability to repay an
interest-only loan using the monthly principal and interest payment
amount needed to repay the loan amount once the interest-only payment
period expires, rather than using, for example, an understated monthly
principal and interest payment that would amortize the loan over its
entire term, similar to a 30-year fixed mortgage. The proposed rule
would apply to all interest-only loans, regardless of the length of the
interest-only period. The Board believes this approach most accurately
assesses the consumer's ability to repay the loan once it begins to
amortize; this is consistent with the approach taken for interest-only
loans in the Interagency Supervisory Guidance.
Proposed comment 43(c)(5)(ii)(B)-1 would clarify that for loans
that permit interest-only payments, the creditor must use the fully
indexed rate or introductory rate, whichever is greater, to calculate
the substantially equal, monthly payment of principal and interest that
will repay the loan amount over the term of the loan remaining as of
the date the loan is recast for purposes of the repayment ability
determination. This comment would also clarify that under proposed
Sec. 226.43(c)(5)(ii)(B), the relevant term of the loan is the period
of time that remains after the loan is recast to
[[Page 27435]]
require payments that will repay the loan amount. This comment would
also explain that for a loan on which only interest and no principal
has been paid, the loan amount will be the outstanding principal
balance at the time of the recast. To facilitate compliance, this
comment would cross-reference to proposed comments 43(b)(3)-1 through -
5, which provide further guidance on determining the fully indexed rate
on the transaction, and proposed comment 43(c)(5)(i)-4, which provides
further guidance on the meaning of ``substantially equal.'' This
comment would also provide cross-references to defined terms.
Proposed comment 43(c)(5)(ii)(B)-2 would provide illustrative
examples for how to determine the consumer's repayment ability based on
substantially equal, monthly payments of principal and interest for
interest-only loans. This comment would provide the following
illustration of the payment calculation rule for a fixed-rate mortgage
with interest-only payments for five years: A loan in an amount of
$200,000 has a 30-year loan term. The loan agreement provides for a
fixed interest rate of 7%, and permits interest-only payments for the
first five years. The monthly payment of $1167 scheduled for the first
five years would cover only the interest due. The loan is recast on the
due date of the 60th monthly payment, after which the scheduled monthly
payments increase to $1414, a monthly payment that repays the loan
amount of $200,000 over the 25 years remaining as of the date the loan
is recast (300 months). For purposes of Sec. 226.43(c)(2)(iii), the
creditor must determine the consumer's ability to repay the loan based
on a payment of $1414, which is the substantially equal, monthly, fully
amortizing payment that would repay $200,000 over the 25 years
remaining as of the date the loan is recast using the fixed interest
rate of 7%.
43(c)(5)(i)(C) Negative Amortization Loans
For negative amortization loans, proposed Sec. 226.43(c)(5)(ii)(C)
provides that a creditor must determine the consumer's repayment
ability using (1) the fully indexed rate or any introductory interest
rate, whichever is greater; and (2) substantially equal, monthly
payments of principal and interest that will repay the maximum loan
amount over the term of the loan remaining as of the date the loan is
recast. This proposed payment calculation rule for negative
amortization loans parallels the general rule in proposed Sec.
226.43(c)(5)(i), except that proposed Sec. 226.43(c)(5)(ii)(C)(2)
requires the creditor to use the monthly payment amount that repays the
maximum loan amount over the term of the loan that remains after the
loan is recast, rather than requiring the creditor to use fully
amortizing payments, as defined under proposed Sec. 226.43(b)(2). This
proposed rule uses the terms ``maximum loan amount'' and ``recast,''
which are defined and discussed under proposed Sec. 226.43(b)(7) and
(b)(11), respectively. Proposed Sec. 226.43(c)(5)(ii)(C)(2) implements
the statutory requirement in TILA Section 129C(a)(6)(C) that the
creditor consider ``any balance increase that may accrue from any
negative amortization provision when making the repayment ability
determination.'' The statute does not define the term ``negative
amortization.''
Scope. The Board proposes that the term ``negative amortization
loan'' have the same meaning as set forth in current Sec.
226.18(s)(7)(v) for purposes of the repayment ability determination.
The Board recently amended Sec. 226.18(s)(7)(v) to clarify that the
term ``negative amortization loan'' covers a loan, other than a reverse
mortgage subject to current Sec. 226.33, that provides for a minimum
periodic payment that covers only a portion of the accrued interest,
resulting in negative amortization. As defined, the term ``negative
amortization loan'' does not cover other loan types that may have a
negative amortization feature, but which do not permit the consumer
multiple payment options, such as seasonal income loans.\44\
Accordingly, proposed Sec. 226.43(c)(5)(ii)(C) covers only loan
products that permit or require minimum periodic payments, such as pay
option loans and graduated payment mortgages with negative
amortization.
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\44\ See the 2010 MDIA Interim Final Rule, 75 FR 58470, Sept.
24, 2010, revised by 75 FR 81836, 81840, Dec. 29, 2010, which
defines the terms ``negative amortization'' and ``negative
amortization loan.'' The term ``negative amortization'' means
payment of periodic payments that will result in an increase in the
principal balance under the terms of the legal obligation. See Sec.
226.18(s)(7)(v).
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Negative amortization loans typically permit borrowers to defer
principal and interest repayment for a fixed period of time, such as
five years, or until the principal balance increases to the maximum
amount allowed under the terms of the loan (i.e., the negative
amortization cap). When the introductory period permitting such minimum
periodic payments expires or the negative amortization cap is reached,
whichever is earlier, the payment amount required under the terms of
the loan is the monthly principal and interest payment that will repay
the loan amount, plus any balance increase, over the remaining term of
the loan. These loans are also often referred to as ``pay option''
loans because they offer multiple payment options to the consumer.
Similarly, graduated payment mortgages that have negative amortization
and fall within the definition of ``negative amortization loans''
provide for step payments that may be less than the interest accrued
for a fixed period of time. The unpaid interest is added to the
principal balance of the loan. When the introductory payment period
expires, the payment amount required under the terms of the loan is the
monthly principal and interest payment that will repay the loan amount,
plus any principal balance increase, over the remaining term of the
loan. The Board believes covering both types of loans in proposed Sec.
226.43(c)(5)(ii)(C) is consistent with statutory intent to account for
the negative equity that can occur when a consumer makes payments that
defer some or all principal or interest for a period of time, and to
address the impact any potential payment shock may have on the
consumer's ability to repay the loan. See TILA Section 129C(a)(6)(C).
In contrast, in a transaction that has a negative amortization
feature, but which does not provide for minimum periodic payments that
permit deferral of some or all principal, the consumer repays the loan
with fully amortizing payments in accordance with the payment schedule
and therefore, the same potential for payment shock or negative equity
does not exist. For example, certain loans are designed to permit
borrowers with seasonal income to make periodic payments that repay the
loan amount for part of the year, and then to skip payments during
certain months. During those months when no payments are made, accrued
interest results in an increase in the principal balance. However, when
the monthly required payments resume, they are fully amortizing
payments that repay the principal and interest accrued during that
year. See comment 18(s)(7)-1 discussing negative amortization loans,
and providing an example of a seasonal income loan that is not covered
by the term. Loans not covered by the term ``negative amortization
loan,'' but which may have a negative amortization feature, would be
subject to the payment calculation requirements under the proposed
general rule for purposes of determining the consumer's repayment
ability. See proposed Sec. 226.43(c)(5)(i). Thus, seasonal income
loans and
[[Page 27436]]
graduated payment mortgages that do not fall within the definition of a
``negative amortization loan'' would be covered by the general payment
calculation rule in proposed Sec. 226.43(c)(5)(i).
For purposes of determining the consumer's ability to repay a
negative amortization loan under proposed Sec. 226.43(c)(5)(ii)(C),
creditors must make a two-step payment calculation.
Step one: maximum loan amount. Proposed Sec. 226.43(c)(5)(ii)(C)
requires that the creditor first determine the maximum loan amount and
period of time that remains in the loan term after the loan is recast
before determining the consumer's repayment ability on the loan. See
proposed comment 43(c)(5)(ii)(C)-1; see also proposed Sec.
226.43(b)(11), which defines the term ``recast'' to mean the expiration
of the period during which negatively amortizing payments are permitted
under the terms of the legal obligation. Proposed comment
43(c)(5)(ii)(C)-2 would further clarify that recast for a negative
amortization loan occurs after the maximum loan amount is reached
(i.e., the negative amortization cap) or the introductory minimum
periodic payment period expires. See proposed comment 43(c)(5)(ii)(C)-
2.
As discussed above, proposed Sec. 226.43(b)(7) defines ``maximum
loan amount'' as the loan amount plus any increase in principal balance
that results from negative amortization, as defined in Sec.
226.18(s)(7)(v), based on the terms of the legal obligation. Under the
proposal, creditors would make the following two assumptions when
determining the maximum loan amount: (1) The consumer makes only the
minimum periodic payments for the maximum possible time, until the
consumer must begin making fully amortizing payments; and (2) the
maximum interest rate is reached at the earliest possible time.
As discussed above under the proposed definition of ``maximum loan
amount,'' the Board interprets the statutory language in TILA Section
129C(a)(6)(C) as requiring creditors to fully account for any potential
increase in the loan amount that may result under the loan's terms
where the consumer makes only the minimum periodic payments required.
The Board believes the intent of this statutory provision is to help
ensure that the creditor consider the consumer's capacity to absorb the
increased payment amounts that would be needed to amortize the larger
loan amount once the loan is recast. The Board recognizes that the
approach taken towards calculating the maximum loan amount requires
creditors to assume a ``worst-case scenario,'' but believes this
approach is consistent with statutory intent to take into account the
greatest potential increase in the principal balance.
Moreover, the Board believes that where negative equity occurs in
the loan, it can be more difficult for the consumer to refinance out of
the loan because no principal has been reduced; a dropping home value
market can further aggravate this situation. In these cases, the
consumer is more likely to incur the increased payment obligation once
the loan is recast. Accordingly, the Board believes it is appropriate
to ensure that the consumer can make these increased payment amounts
assuming the maximum loan amount, consistent with the statute. The
Board also notes that calculating the maximum loan amount based on
these assumptions is consistent with the approach in the 2010 MDIA
Interim Final Rule,\45\ which addresses disclosure requirements for
negative amortization loans, and also the 2006 Nontraditional Mortgage
Guidance, which provides guidance to creditors regarding underwriting
negative amortization loans.\46\ Both the 2010 MDIA Interim Final Rule
and the 2006 Nontraditional Mortgage Guidance provide that the loan
amount plus any balance increase should be taken into account when
disclosing terms or calculating the monthly principal and interest
payment obligation, respectively.
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\45\ See 12 CFR 226.18(s)(2)(ii) and comment 18(s)(2)(ii)-2.
\46\ See 2006 Nontraditional Mortgage Guidance at 58614, n.7.
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As discussed above, comment proposed 43(b)-1 would clarify that in
determining the maximum loan amount, the creditor must assume that the
consumer makes the minimum periodic payment until any negative
amortization cap is reached or until the period permitting minimum
periodic payments expires, whichever occurs first. Comment 43(b)-2
would provide further guidance to creditors regarding the assumed
interest rate. Comment 43(b)-3 would provide examples illustrating how
to calculate the maximum loan amount for negative amortization loans
for purposes of proposed Sec. 226.43(c)(5)(ii)(C).
Step two: payment calculation. Once the creditor knows the maximum
loan amount and period of time that remains after the loan is recast,
the proposed payment calculation rule for negative amortization loans
requires the creditor to use the fully indexed rate or introductory
rate, whichever is greater, to calculate the substantially equal,
monthly payment amount that will repay the maximum loan amount over the
term of the loan that remains as of the date the loan is recast. See
proposed Sec. 226.43(c)(5)(ii)(C)(1) and (2).
Proposed comment 43(c)(5)(ii)(C)-1 would clarify that creditors
must follow this two-step approach when determining the consumer's
repayment ability on a negative amortization loan, and would also
cross-reference to the following defined terms: ``maximum loan
amount,'' ``negative amortization loan,'' ``fully indexed rate,'' and
``recast.'' To facilitate compliance, this comment would also cross-
reference to proposed comment 43(c)(5)(i)-4 for further guidance on the
``substantially equal'' requirement.
Proposed comment 43(c)(5)(ii)(C)-2 would provide further guidance
to creditors regarding the relevant term of the loan that must be used
for purposes of the repayment ability determination. This comment would
explain that the relevant term of the loan is the period of time that
remains as of the date the terms of the legal obligation recast. This
comment would further explain that the creditor must determine
substantially equal, monthly payments of principal and interest that
will repay the maximum loan amount based on the period of time that
remains after any negative amortization cap is triggered or any period
permitting minimum periodic payments expires, whichever occurs first.
Proposed comment 43(c)(5)(ii)(C)-3 would provide illustrative
examples of how to determine the consumer's repayment ability based on
substantially equal, monthly payments of principal and interest as
required under proposed Sec. 226.43(c)(5)(ii)(C) for a negative
amortization loan. For example, proposed comment 43(c)(5)(ii)(C)-3.ii
would illustrate the payment calculation rule for a graduated payment
mortgage with a fixed-interest rate that is a negative amortization
loan. This comment would first assume a loan in the amount of $200,000
has a 30-year loan term. Second, the comment assumes that the loan
agreement provides for a fixed-interest rate of 7.5%, and requires the
consumer to make minimum monthly payments during the first year, with
payments increasing 12.5% every year (the annual payment cap) for four
years. This comment would state that the payment schedule provides for
payments of $943 in the first year, $1061 in the second year, $1194 in
the third year, $1343 in the fourth year, and then requires $1511 for
the remaining term of the loan. This
[[Page 27437]]
comment would then explain that during the first three years of the
loan, the payments are less than the interest accrued each month,
resulting in negative amortization. Assuming the minimum payments
increase year-to-year up to the 12.5% payment cap, the consumer will
begin making payments that cover at least all of the interest accrued
at the end of the third year. Thus, the loan is recast on the due date
of the 36th monthly payment. The maximum loan amount on that date is
$207,659, and the remaining loan term is 27 years (324 months). See
proposed comment 43(c)(5)(ii)(C)-3.ii.
This comment would conclude that for purposes of the repayment
ability determination required in Sec. 226.43(c)(2)(iii), the creditor
must determine the consumer's ability- to repay the loan based on a
monthly payment of $1497, which is the substantially equal, monthly
payment of principal and interest that will repay the maximum loan
amount of $207,659 over the remaining loan term of 27 years using the
fixed interest rate of 7.5%.
The Board recognizes that the payment calculation requirements,
which are consistent with statutory requirements, will sometimes
require the creditor to underwrite a graduated payment mortgage using a
monthly payment that is lower than the largest payment the consumer
would be required to pay. For example, as illustrated in proposed
comment 43(c)(5)(ii)(C)-3.ii, the creditor would underwrite the loan
using a monthly payment of $1497 for purposes of the repayment ability
determination, even though the consumer will need to begin making
monthly payments of $1511 beginning in the fifth year of the loan. This
anomaly occurs because the creditor must assume substantially equal
payments over the term of the loan remaining as of the date the loan is
recast. As discussed above in relation to step-rate mortgages, the
Board solicits comment on whether it should exercise its authority
under TILA Sections 105(a) and 129B(e) to require the creditor to use
the largest payment scheduled when determining the consumer's ability
to repay the loan. 15 U.S.C. 1604(a).
43(c)(6) Payment Calculation for Simultaneous Loans
As discussed above, proposed Sec. 226.43(c)(2)(iv) implements TILA
Section 129C(a)(2) and requires that when determining the consumer's
repayment ability on a covered transaction, the creditor must consider
the consumer's monthly payment on any simultaneous loan that the
creditor knows or has reason to know will be made, calculated in
accordance with proposed Sec. 226.43(c)(6). Furthermore, as discussed
under proposed Sec. 226.43(b)(12), the Board is proposing to use its
authority under TILA Sections 105(a) and 129B(e) to broaden the scope
of TILA Section 129C(a)(2) to include HELOCs, and define the term
``simultaneous loan'' accordingly, for purposes of the requirements
under proposed Sec. 226.43(c)(2)(iv) and (c)(6). 15 U.S.C. 1604(a).
Proposed Sec. 226.43(c)(6) provides the payment calculation for a
simultaneous loan that is a closed-end covered transaction or a HELOC.
Specifically, proposed Sec. 226.43(c)(6) requires that the creditor
consider the consumer's payment on a simultaneous loan that is: (1) A
covered transaction, by following proposed Sec. 226.43(c)(5)(i)-(ii);
or (2) a HELOC, by using the periodic payment required under the terms
of the plan using the amount of credit that will be drawn at
consummation of the covered transaction. That is, with respect to
simultaneous loans that are covered transactions (i.e., closed-end
loans subject to proposed Sec. 226.43(c)), proposed Sec.
226.43(c)(6)(i) requires the creditor to calculate the payment
obligation consistent with the rules that apply to covered transactions
under proposed Sec. 226.43(c)(5). Under those proposed rules, the
creditor must make the repayment ability determination using the
greater of the fully indexed rate or any introductory rate, to
calculate monthly, fully amortizing payments that are substantially
equal. Under proposed Sec. 226.43(b)(2), a ``fully amortizing
payment'' is defined as a periodic payment of principal and interest
that will repay the loan amount over the loan term. Thus, in the case
of a simultaneous loan that is a closed-end credit transaction, the
payment is based on the loan amount. Typically, in closed-end
transactions the consumer is committed to using the entire loan amount
because there is full disbursement of funds at consummation. See
proposed comment 43(b)(5)-1, which discusses the definition of loan
amount and clarifies that the amount disbursed at consummation is not
determinative for purposes of the payment calculation rules. See
proposed Sec. 226.43(c)(5) for further discussion of the payment
calculation requirements for covered transactions.
By contrast, for a simultaneous loan that is a HELOC, the consumer
is generally not committed to using the entire credit line at
consummation. The amount of funds drawn on a simultaneous HELOC may
differ greatly depending, for example, on whether the HELOC is used as
a ``piggyback loan'' to help towards payment on a home purchase
transaction or if the HELOC is opened for convenience to be drawn down
at a future time. The Board is concerned that requiring the creditor to
underwrite a simultaneous HELOC assuming a full draw on the credit line
may unduly restrict credit access, especially in connection with non-
purchase transactions (i.e., refinancings), because it would require
creditors to assess the consumer's repayment ability using potentially
overstated payment amounts. Thus, the Board is proposing under Sec.
226.43(c)(6)(ii) that the creditor calculate the payment for the
simultaneous HELOC based on the amount of funds to be drawn by the
consumer at consummation of the covered transaction. As discussed in
further detail below under proposed comment 43(c)(6)-3, the Board
solicits comment on whether this approach is appropriate.
Proposed comment 43(c)(6)-1 states that in determining the
consumer's repayment ability for a covered transaction, the creditor
must include consideration of any simultaneous loan which it knows or
has reason to know will be made at or before consummation of the
covered transaction. To facilitate compliance, the comment would cross-
reference to proposed comment 43(c)(2)(iv)-2 for further discussion on
the standard ``knows or has reason to know,'' and proposed Sec.
226.43(b)(12) for the meaning of the term ``simultaneous loan.''
Proposed comment 43(c)(6)-2 explains that for a simultaneous loan
that is a covered transaction, as that term is defined in proposed
Sec. 226.43(b)(1), the creditor must determine a consumer's ability to
repay the monthly payment obligation for a simultaneous loan as set
forth in Sec. 226.43(c)(5), taking into account any mortgage-related
obligations. The comment would provide a cross-reference to proposed
Sec. 226.43(b)(8) for the meaning of the term ``mortgage-related
obligations.''
Proposed comment 43(c)(6)-3 clarifies that for a simultaneous loan
that is a HELOC, the creditor must consider the periodic payment
required under the terms of the plan when assessing the consumer's
ability to repay the covered transaction secured by the same dwelling
as the simultaneous loan. This comment would explain that under
proposed Sec. 226.43(c)(6)(ii), the creditor must determine the
periodic payment required under the terms of the plan by considering
the actual amount of credit to be drawn by the consumer at or
[[Page 27438]]
before consummation of the covered transaction. This comment would
clarify that the amount to be drawn is the amount requested by the
consumer; when the amount requested will be disbursed, or actual
receipt of funds, is not determinative. This comment would provide the
following example: Where the creditor's policies and procedures require
the source of downpayment to be verified, and the creditor verifies
that a simultaneous loan that is a HELOC will provide the source of
downpayment for the first-lien covered transaction, the creditor must
consider the periodic payment on the HELOC by assuming the amount to be
drawn at consummation is the downpayment amount. The Board recognizes
that determining the actual amount to be drawn by the consumer may
depend on a number of variables, and may not be readily determined
prior to consummation. As discussed more fully below, the Board is
soliciting comment on the appropriateness of this approach. Proposed
comment 43(c)(6)-3 would further clarify that, in general, the creditor
should determine the periodic payment based on guidance in staff
commentary to Sec. 226.5b(d)(5), which discusses disclosure of payment
terms for HELOCs.
The Board recognizes that consumers may fully draw on available
credit immediately after closing on the first-lien loan, which could
significantly impact their repayment ability on both the first-lien and
second-lien mortgage obligations. Although this risk is present with
respect to any credit line available to a consumer post-consummation,
unlike credit cards, HELOCs are secured by a consumer's dwelling.
Inability to repay the first- or second-lien loan could result in
foreclosure and loss of the home. In addition, outreach revealed that
creditors take varied approaches to determining the periodic payment
they consider when underwriting a simultaneous HELOC, with some
participants indicating they assume a full draw and calculate the
periodic payment based on the fully indexed rate, and other
participants indicating that a 50% draw is assumed and only the minimum
periodic payment is considered.
For these reasons, the Board solicits comment on the
appropriateness of the approach provided under proposed Sec.
226.43(c)(6)(ii) and comment 43(c)(6)-3 regarding the payment
calculation for simultaneous HELOCs, with supporting data for any
alternative approaches. Specifically, the Board solicits comment on
what amount of credit should be assumed as drawn by the consumer for
purposes of the payment calculation for simultaneous HELOCs. For
example, should the Board require creditors to assume a full draw
(i.e., requested amount to be used) of the credit line, a 50% draw, or
some other amount instead of the actual amount to be drawn by the
consumer? The Board also solicits comment on whether it would
facilitate compliance to provide a safe harbor where creditors assume
the full credit line is drawn at consummation.
In addition, as noted above, proposed Sec. 226.43(c)(2)(iv) and
(c)(6) do not distinguish between purchase and non-purchase covered
transactions when requiring creditors to consider a periodic payment
required on a simultaneous loan that is a HELOC for purposes of the
repayment ability determination. The Board recognizes, however, that
concerns regarding ``piggyback loans'' may not be as acute with non-
purchase transactions (i.e., refinancings) where HELOCs generally are
taken against established equity in the home, and are opened
concurrently with the refinancing of the first-lien loan for
convenience and savings in closing costs. In addition, the Board notes
that with respect to simultaneous HELOCs originated in connection with
a refinancing, proposed Sec. 226.43(c)(2)(iv) and (c)(6) could be
circumvented, or its value diminished significantly, where consumers do
not draw on the credit line until after the covered transaction is
consummated. Moreover, the Board is concerned that the proposal could
encourage creditors and consumers to simply originate HELOCs
immediately subsequent to the consummation of a covered transaction
that is a refinancing, resulting in lost savings and convenience to
consumers. For these reasons, the Board solicits comment, and
supporting data, on whether the Board should narrow the requirement
under proposed Sec. 226.43(c)(2)(iv) and (c)(6) to require creditors
to consider simultaneous HELOCs only in connection with purchase
transactions.
43(c)(7) Monthly Debt-to-Income Ratio or Residual Income
As discussed above, proposed Sec. 226.43(c)(2)(vii) implements
TILA Section 129C(a)(3) and requires creditors, as part of the
repayment ability determination, to consider the consumer's monthly
debt-to-income ratio or residual income. Proposed Sec. 226.43(c)(7)
provides the definitions and calculations for the monthly debt-to-
income ratio and residual income. With respect to the definitions,
proposed Sec. 226.43(c)(7)(i)(A) defines the term ``total monthly debt
obligations'' to mean the sum of: The payment on the covered
transaction, as required to be calculated by Sec. 226.43(c)(2)(iii)
and (c)(5); the monthly payment on any simultaneous loans, as required
to be calculated by Sec. 226.43(c)(2)(iv) and (c)(6); the monthly
payment amount of any mortgage-related obligations, as required to be
considered by Sec. 226.43(c)(2)(v); and the monthly payment amount of
any current debt obligations, as required to be considered by Sec.
226.43(c)(2)(vi). Proposed Sec. 226.43(c)(7)(i)(B) defines the term
``total monthly income'' to mean the sum of the consumer's current or
reasonably expected income, including any income from assets, as
required to be considered by Sec. 226.43(c)(2)(i) and (c)(4).
With respect to the calculations, proposed Sec.
226.43(c)(7)(ii)(A) requires the creditor to consider the consumer's
monthly debt-to-income ratio for purposes of Sec. 226.43(c)(2)(vii)
using the ratio of the consumer's total monthly debt obligations to
total monthly income. Proposed Sec. 226.43(c)(7)(ii)(B) requires the
creditor to consider the consumer's remaining income after subtracting
the consumer's total monthly debt obligations from the total monthly
income.
Proposed comment 43(c)(7)-1 states that creditors must calculate
the consumer's total monthly debt obligations and total monthly income
in accordance with the requirements in proposed Sec. 226.43(c)(7). The
commentary explains that creditors may look to widely accepted
governmental and non-governmental underwriting standards to determine
the appropriate thresholds for the debt-to-income ratio or residual
income.
Proposed comment 43(c)(7)-2 explains that if a creditor considers
both the consumer's debt-to-income ratio and residual income, the
creditor may base its repayment ability determination on either the
consumer's debt-to-income ratio or residual income, even if the
ability-to-repay determination would differ with the basis used.
Indeed, the Board does not wish to create an incentive for creditors to
consider and verify as few factors as possible in the repayment ability
determination.
Proposed comment 43(c)(7)-3 clarifies that creditors may consider
compensating factors to mitigate a higher debt-to-income ratio or lower
residual income. For example, creditors may consider the consumer's
assets other than the dwelling securing the covered transaction, or the
consumer's residual income as compensating factors for a higher debt-
to-income ratio. The proposed commentary permits creditors to look to
widely accepted governmental and non-governmental underwriting
[[Page 27439]]
standards in determining whether and in what manner to include the
compensating factors. The Board solicits comment on whether it should
provide more guidance on what compensating factors creditors may
consider, and on how creditors may include compensating factors in the
repayment ability determination.
Residual income. Except for one small creditor and the U.S.
Department of Veterans' Affairs (VA), the Board is not aware of any
creditors that routinely use residual income in underwriting, other
than as a compensating factor.\47\ The VA underwrites its loans to
veterans based on a residual income table developed in 1997. The table
shows the residual income required for the borrower based on the loan
amount, region of the country, and family size. The residual income is
calculated by deducting obligations, including Federal and state taxes,
from effective income. The Board solicits comment on whether
consideration of residual income should account for loan amount, region
of the country, and family size. The Board also solicits comment on
whether creditors should be required to include Federal and state taxes
in the consumer's obligations for purposes of calculating residual
income.
---------------------------------------------------------------------------
\47\ See also, 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'').
---------------------------------------------------------------------------
Automated underwriting systems. The Board understands that
creditors routinely rely on automated underwriting systems. Many of
those systems are proprietary and thus lack transparency to the
individual creditors using the systems. The Board solicits comment on
providing a safe harbor for creditors relying on automated underwriting
systems that use monthly debt-to-income ratios, if the system developer
certifies that the system's use of monthly debt-to-income ratios in
determining repayment ability is empirically derived and statistically
sound. The Board also solicits comment on other methods to facilitate
creditor reliance on automated underwriting systems, while ensuring
that creditors can demonstrate compliance with the rule.
43(d) Refinancing of Non-Standard Mortgages
Introduction
Proposed Sec. 226.43(d) exempts creditors of refinancings under
certain limited circumstances from the requirement to verify income and
assets in determining whether a consumer has the ability to repay a
covered transaction. See proposed Sec. 226.43(c)(2)(ii). It also
applies a different payment calculation requirement to creditors
determining whether a consumer has the ability to repay these special
types of refinanced loans. See proposed Sec. 226.43(c)(2)(iii), and
(c)(5). Proposed Sec. 226.43(d) implements TILA Section 129C(a)(6)(E),
which was added to TILA under Sec. 1411 of the Dodd-Frank Act. 15
U.S.C. 1639c(a)(6)(E). As previously noted, Section 1411 of the Dodd-
Frank Act amends TILA by adding new Section 129C(a), which requires
creditors to determine whether a consumer has a reasonable ability to
repay a home mortgage loan before making the loan and sets the
parameters for that determination (detailed above in the section-by-
section analysis of Sec. 226.43(c)). 15 U.S.C. 1639c(a). TILA Section
129C(a)(6)(E) applies special ability-to-repay provisions to
transactions in which a ``hybrid loan'' is refinanced into a ``standard
loan'' and the following additional conditions are met:
The ``creditor'' for the hybrid loan and the standard loan
is the ``same'';
There is a ``reduction'' in the consumer's monthly payment
from the hybrid loan to the standard loan; and
The consumer ``has not been delinquent on any payment on
the existing hybrid mortgage.''
15 U.S.C. 1639c(a)(6)(E).
Specifically, ``in considering any application for a refinancing,''
the creditor may--
Consider the consumer's ``good standing on the existing
mortgage.''
Consider whether the extension of new credit would prevent
a likely default should the original mortgage reset and may give this
concern a ``higher priority as an acceptable underwriting practice.''
Offer rate discounts and other favorable terms to the
consumer that would be available to ``new customers with high credit
ratings based on [the creditor's] underwriting practice.''
TILA Section 129C(a)(6)(E)(i)-(iii); 15 U.S.C. 1639c(a)(6)(E)(i)-(iii).
The Dodd-Frank Act does not define the terms ``hybrid loan'' or
``standard loan.'' The statute also does not expressly state that a
creditor is exempt from the statutory ability to repay requirements in
refinancings for which the above conditions are met. To determine the
meaning of these provisions, the Board reviewed the Dodd-Frank Act's
legislative history; consulted with consumer advocates and
representatives of both industry and government-sponsored housing
finance enterprises (GSEs); and examined underwriting rules and
guidelines for the streamlined refinance programs of private creditors,
GSEs and government agencies, as well as for the Home Affordable
Modification Program (HAMP). For additional guidance, the Board also
considered the Dodd-Frank Act provisions exempting streamlined
refinancings under Federal government agency programs. See TILA Section
129C(a)(5); 15 U.S.C. 1639c(a)(5).
In the Board's view, both the statutory text and additional
research support interpreting TILA Section 129C(a)(6)(E) to mean that
creditors of refinancings meeting certain conditions should have
greater flexibility to comply with the general ability-to-repay
provisions in TILA Section 129C(a) (proposed to be implemented by Sec.
226.43(c)). Accordingly, the proposal: (1) Clarifies the conditions
that must be met in home mortgage refinancings to which greater
flexibility applies; and (2) provides an exemption for creditors of
these refinancings from certain limited criteria required to be
considered as part of the general repayment ability determination under
TILA Section 129C(a) (see proposed Sec. 226.43(c)).
Under the proposal, loans that can result in ``payment shock'' may
be refinanced without the creditor having to verify the borrower's
income and assets with written documentation as prescribed in the
general ability-to-repay requirements (see the section-by-section
analysis of Sec. 226.43(c)(2)(ii) and (c)(4)), as long as a number of
additional conditions are met. In addition, the creditor is permitted
to calculate the monthly payment used for determining the consumer's
ability to repay the new loan based on assumptions that would typically
result in a lower monthly payment than those required to be used under
the general ability-to-repay requirements (see the section-by-section
analysis of Sec. 226.43(c)(2)(iii) and (c)(5)). As a result, when all
of the special refinancing conditions are met, creditors may be better
able to qualify a consumer for a new loan than under the general
ability-to-repay requirements.
A central provision of TILA Section 129C(a)(6)(E) permits creditors
to give prevention of a ``likely default should the original mortgage
reset a higher priority as an acceptable underwriting practice.'' TILA
Section 129C(a)(6)(E)(ii); 15 U.S.C. 1639c(a)(6)(E)(ii). The Board
believes that the structure of the statute supports interpreting this
provision to mean that certain ability-to-repay criteria under TILA
Section 129C(a) should not apply to refinances that meet
[[Page 27440]]
the requisite conditions. The special refinancing provisions of TILA
Section 129C(a)(6)(E) are part of TILA Section 129C(a), entitled
``Ability to Repay,'' the paragraph that specifically prescribes the
requirements that creditors must meet to satisfy the obligation to
determine a consumer's ability to repay a home mortgage. In the Board's
view, the term ``underwriting practice'' is reasonably interpreted to
refer to the underwriting rules prescribed in earlier portions of TILA
Section 129C(a)--namely, those concerning the general ability to repay
underwriting requirements.
Overall, the Board interprets the special refinancing provisions of
TILA Section 129C(a)(6)(E) as intended to allow for the greater
flexibility in underwriting that is characteristic of so-called
``streamlined refinances.'' The Board notes in particular that typical
streamlined refinance programs do not require documentation of income
and assets, although a verbal verification of employment may be
required.\48\ The Board's interpretation is based both on the statutory
text and on the Board's research and outreach with concerned parties.
---------------------------------------------------------------------------
\48\ See id. at 4. See also, e.g., Freddie Mac Single-Family
Seller/Servicer Guide, Vol. 1, Ch. 24: Refinance Mortgages/24.4:
Requirements for Freddie Mac-owned streamlined refinance mortgages
(Sept. 1, 2010). As of May 1, 2011, Freddie Mac will no longer
purchase Freddie Mac-owned streamlined refinance mortgages. See
Freddie Mac Bulletin 2011-2 (Jan. 18, 2011).
---------------------------------------------------------------------------
Regarding the Board's research and outreach, the Board understands
that streamlined refinances have been an important resource for
consumers, particularly in recent years, who faced impending payment
shock, could not qualify for a typical refinance because of property
value declines, or both. To address these problems, many lenders as
well as the GSEs and government agencies developed lending programs to
allow borrowers of loans held by them to refinance despite high loan-
to-value ratios or other characteristics that might otherwise impede
refinancing. Representatives of creditors and GSEs in particular
informed the Board that their streamlined refinance programs are a
significant proportion of their portfolios and that they view their
programs as valuable to both consumers and loan holders. Consumers are
able to take advantage of lower rates to obtain a more affordable loan
(and lower payments) and, in some cases, to avoid default or even
foreclosure. At the same time, loan holders strengthen their portfolios
by replacing potentially unaffordable and unstable loans with
affordable, stable products.
Regarding the statutory text, the Board notes that the refinancing
provisions under TILA Section 129C(a)(6)(E) include three central
elements of typical streamlined refinance programs.\49\ First, the
creditor for both the existing mortgage and the new mortgage must be
the same (see the section-by-section analysis of Sec. 226.43(d)(1)(i)
discussing the Board's interpretation of ``same creditor'' to mean the
current holder of the loan or the servicer acting on behalf of the
current holder). 15 U.S.C. 1639C(a)(6)(E). Second, the borrower must
have a positive payment history on the existing mortgage (see the
section-by-section analysis of Sec. 226.43(d)(1)(iv) and (d)(1)(v) for
further discussion). Third, TILA's special refinancing provisions
require that the payment on the new mortgage be lower than the payment
on the existing mortgage--a common objective of typical streamlined
refinance programs.\50\
---------------------------------------------------------------------------
\49\ During outreach, Fannie Mae provided data to the Board
indicating that for 2010, Fannie Mae, Freddie Mac and Ginnie Mae
refinancings totaled $925 billion, while non-GSE refinancings
totaled $73 billion. Of the combined GSE refinancings, $288.6
billion were ``streamlined refinances''--approximately one-third of
all GSE refinancings.
\50\ See, e.g., Fannie Mae, ``Home Affordable Refinance Refi
PlusTM Options,'' p. 1 (Mar. 29, 2010).
---------------------------------------------------------------------------
Finally, as noted, TILA Section 129C(a) includes a provision that
specifically addresses how the general ability-to-repay requirements
apply to streamlined refinances under programs of government agencies
such as the Federal Housing Administration and U.S. Department of
Veterans' Affairs. See TILA Section 129C(a)(5), 15 U.S.C. 1639c(a)(5).
In the Board's view, the most reasonable interpretation of the
additional section on refinancings under TILA Section 129C(a)(6)(E) is
that it is intended to cover the remaining market for streamlined
refinances--namely, those offered under programs of private creditors
and the GSEs.
One difference between the statute and typical streamlined
refinance programs, however, is that the statute targets consumers
facing ``likely default'' if the existing mortgage ``reset[s].'' The
Board understands that, by contrast, streamlined refinance programs are
not normally limited to borrowers at risk in this way. For example,
they often assist consumers who are not facing potential default but
who simply wish to take advantage of lower rates despite a drop in
their home value or wish to switch from a less stable variable-rate
product to a fixed-rate product.\51\ However, the focus of TILA's new
refinancing provisions is similar to the focus of HAMP, a government
program specifically aimed at providing modifications for borrowers at
risk of ``imminent default,'' or in default or foreclosure.\52\
Underwriting criteria for a HAMP modification are considerably more
stringent than for a typical streamlined refinance; for example, income
verification documentation is required, in addition to documented
verification of expenses.\53\ Concerns about the potential risks posed
by loans to troubled borrowers may explain the robust underwriting
standards for HAMP modifications.
---------------------------------------------------------------------------
\51\ See, e.g., Fannie Mae, ``Home Affordable Refinance Refi
PlusTM Options,'' p. 1 (Mar. 29, 2010); Freddie Mac,
``Freddie Mac-owned Streamlined Refinance Mortgage,'' Pub. No. 387,
pp. 1-2 (Aug. 2010).
\52\ See, e.g., Fannie Mae, ``Home Affordable Modification
Program,'' p. 1, FM 0509 (2009).
\53\ See, Fannie Mae, ``Making Home Affordable\SM\ Program,
Handbook for Servicers of Non-GSE Mortgages,'' Ch. II, Sec. 5, pp.
59-62 (Dec. 2, 2010).
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On balance, the Board believes that the statutory language is most
appropriately interpreted to be modeled on the underwriting standards
of typical streamlined refinance programs rather than the tighter
standards of HAMP. The plain language of the Dodd-Frank Act indicates
that Congress intended to facilitate opportunities to refinance loans
on which their payments could become significantly higher and thus
unaffordable. Applying the strict underwriting standards that are too
stringent could impede refinances that Congress intended to encourage.
In particular, the statutory language permitting creditors to give
``likely default'' a ``higher priority as an acceptable underwriting
practice'' indicates that flexibility in these special refinances
should be permitted. In addition, underwriting standards that go
significantly beyond those used in existing streamlined refinance
programs could create a risk that these programs would be unable to
meet the TILA ability-to-repay requirements; thus, an important
refinancing resource for at-risk borrowers would be compromised and the
overall mortgage market potentially disrupted at a vulnerable time.
At the same time, the Board recognizes that borrowers at risk of
default when higher payments are required might present greater credit
risks to the institutions holding their loans when those loans are
refinanced without verifying the consumer's income and assets. For
example, a consumer may be paying $525 per month as an interest-only
payment on an existing adjustable-rate loan. When refinanced at a
lower, fixed rate with fully amortizing payments, however, the
[[Page 27441]]
payment may go up somewhat from the previous interest-only level--for
example, to $650--because the new payments now cover both principal and
interest. (For further discussion of how this scenario is possible
under the proposal, see the section-by-section analysis of proposed
Sec. 226.43(d)(5).) The new payment of $650 is likely to be lower than
the ``reset'' payment at the fully-indexed rate on the existing
mortgage; nonetheless, the creditor incurs some risk that the consumer
may not be able to afford the new payments.
For this reason, to qualify for the ability to repay exemptions
under proposed Sec. 226.43(d), a consumer must meet some requirements
that are more stringent than those of typical streamlined refinance
programs. Under the proposal, for example, a consumer may have had only
one delinquency of more than 30 days in the 24 months immediately
preceding the consumer's application for a refinance. See proposed
Sec. 226.43(d)(1)(iv). By contrast, streamlined refinance programs of
which the Board is aware tend to consider the consumer's payment
history for only the last 12 months.\54\ As another safeguard against
risk, the Board defines the type of loan into which a consumer may
refinance under TILA's new refinancing provisions to include several
characteristics designed to ensure that those loans are stable and
affordable. These include a requirement that the interest rate be fixed
for the first five years after consummation (see proposed Sec.
226.43(d)(2)(ii)(D)) and that the points and fees be capped at three
percent of the total loan amount, subject to a limited exemption for
smaller loans (see proposed Sec. 226.43(d)(2)(ii)(B))).
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\54\ See, e.g., Fannie Mae, ``Home Affordable Refinance Refi
PlusTM Options,'' p. 2 (Mar. 29, 2010); Freddie Mac,
``Freddie Mac-owned Streamlined Refinance Mortgage,'' Pub. No. 387,
p. 2 (Aug. 2010).
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The Board's Proposal
43(d)(1) Scope
Proposed Sec. 226.43(d)(1) defines the scope of the provisions
regarding the refinancing of non-standard mortgages under proposed
Sec. 226.43(d). Specifically, this provision states that Sec.
226.43(d) applies to the refinancing of a ``non-standard mortgage''
(defined in proposed Sec. 226.43(d)(2)(i)) into a ``standard
mortgage'' (defined in proposed Sec. 226.43(d)(2)(ii)) when the
following conditions are met--
The creditor of the standard mortgage is the current
holder of the existing non-standard mortgage or the servicer acting on
behalf of the current holder.
The monthly payment for the standard mortgage is
significantly lower than the monthly payment for the non-standard
mortgage, as calculated under proposed Sec. 226.43(d)(5).
The creditor receives the consumer's written application
for the standard mortgage before the non-standard mortgage is
``recast'' (defined in proposed Sec. 226.43(b)(11)).
The consumer has made no more than one payment more than
30 days late on the non-standard mortgage during the 24 months
immediately preceding the creditor's receipt of the consumer's written
application for the standard mortgage.
The consumer has made no payments more than 30 days late
during the six months immediately preceding the creditor's receipt of
the consumer's written application for the standard mortgage.
As discussed further below, proposed Sec. 226.43(d)(2)(iii) defines
the term ``refinancing'' to have the same meaning as in Sec.
226.20(a).
Proposed comment 43(d)(1)-1 clarifies that the requirements for a
``written application,'' a term that appears in Sec.
226.43(d)(1)(iii), (d)(1)(iv) and (d)(1)(v), discussed in detail below,
are found in comment 19(a)(1)(i)-3. Comment 19(a)(1)(i)-3 states that
creditors may rely on the Real Estate Settlement Procedures Act (RESPA)
and Regulation X (including any interpretations issued by HUD) in
deciding whether a ``written application'' has been received. This
comment further states that, in general, Regulation X defines
``application'' to mean the submission of a borrower's financial
information in anticipation of a credit decision relating to a
Federally related mortgage loan. See 24 CFR 3500.2(b). The comment
clarifies that an application is received when it reaches the creditor
in any of the ways applications are normally transmitted--by mail, hand
delivery, or through an intermediary agent or broker. The comment
further clarifies that, if an application reaches the creditor through
an intermediary agent or broker, the application is received when it
reaches the creditor, rather than when it reaches the agent or broker.
This comment also cross-references comment 19(b)-3 for guidance in
determining whether or not the transaction involves an intermediary
agent or broker.
43(d)(1)(i) Creditor is the Current Holder or Servicer Acting on Behalf
of Current Holder
Proposed Sec. 226.43(d)(1)(i) requires that the creditor for the
new mortgage (the ``standard mortgage'') also be either the current
holder of the existing ``non-standard mortgage'' or the servicer acting
on behalf of the current holder. This provision implements the
statutory requirement that the existing loan must be refinanced by
``the creditor into a standard loan to be made by the same creditor.''
TILA Section 129C(a)(6)(E); 15 U.S.C. 1639c(a)(6)(E). The Board
believes that this statutory provision requires the entity refinancing
the loan to have an existing relationship with the consumer. The
existing relationship is important because the creditor must be able to
easily access the consumer's payment history and potentially other
information about the consumer in lieu of documenting the consumer's
income and assets. In addition, the Board reads the statute to be
intended in part to ensure the safety and soundness of financial
institutions by giving them greater flexibility to improve the quality
of their loan portfolios through streamlined refinances.
The Board also believes that this statutory provision is intended
to ensure that the creditor of the refinancing have an interest in
placing the consumer into new loan that is affordable and beneficial.
In the Board's view, the creditor of the new loan will in most cases
retain an interest in the consumer's well-being when the creditor is
also the current holder of the loan or the servicer acting on the
current holder's behalf. In cases where a creditor holds a loan and
will hold the loan after it is refinanced, the creditor has a direct
interest in refinancing the consumer into a more stable and affordable
product. In addition, the Board understands that the existing servicer
often will be the entity conducting the refinance, particularly for
refinances held by GSEs. By also permitting the creditor on the
refinanced loan to be the servicer acting on behalf of the holder of
the existing mortgage, the proposal is intended clearly to cover
instances where a loan that has been sold to a GSE is refinanced by the
existing servicer and continues to be held by the same GSE.
At the same time, the Board recognizes that the creditor on the new
mortgage may not necessarily retain an interest in the new loan if the
creditor immediately sells the loan to a new holder. The Board requests
comment on whether the proposed rule could be structured differently to
better ensure that the creditor on a refinancing under Sec. 226.43(d)
retains an interest in the performance of the new loan and whether
additional guidance is needed.
[[Page 27442]]
43(d)(1)(ii) Monthly Payment for the Standard Mortgage is Materially
Lower Than the Monthly Payment for the Non-Standard Mortgage
Proposed Sec. 226.43(d)(1)(ii) requires that the monthly payment
on the new loan (the ``standard mortgage'') be ``materially lower''
than the monthly payment for the existing loan (the ``non-standard
mortgage''). This provision implements the statutory requirement that
there be ``a reduction in monthly payment on the existing hybrid loan''
in order for the special provisions to apply to a refinancing. TILA
Section 129C(a)(6)(E); 15 U.S.C. 1639c(a)(6)(E). Proposed comment
43(d)(1)(ii)-1 provides that the exemptions afforded under Sec.
226.43(d)(3) (discussed below) apply to a refinancing only if the
monthly payment for the new loan is ``materially lower'' than the
monthly payment for an existing non-standard mortgage and clarifies
that the payments that must be compared must be calculated based on the
requirements under Sec. 226.43(d)(5) (discussed below). This comment
also explains that whether the new loan payment is ``materially lower''
than the non-standard mortgage payment depends on the facts and
circumstances, but that, in all cases, a payment reduction of 10
percent or greater would meet the ``materially lower'' standard.
For several reasons, the Board interprets the statutory requirement
for a ``reduction in monthly payment'' to mean that the new payment
must be ``materially lower'' than the payment under the existing
mortgage and that a 10 percent or greater reduction is a reasonable
safe harbor. First, if the required reduction could be merely de
minimis--such as a reduction of a few cents or dollars--the statutory
purpose would not be met. In such cases, the consumer would not obtain
a meaningful benefit that would prevent default--in other words, the
reduction would not be ``material.'' Second, based on outreach, the
Board understands that a 10 percent reduction in the payment is a
reasonable minimum reduction that can provide a meaningful benefit to
the consumer.
The Board requests comment on whether a requirement that the
payment on the standard mortgage must be ``materially lower'' than the
payment on the non-standard mortgage (as calculated under Sec.
226.43(d)(5)(ii) and (d)(5)(i), respectively) and whether a 10 percent
reduction or some other percentage or dollar amount would be a more
appropriate safe harbor for compliance with this requirement. The Board
also requests comment on whether a percentage or dollar amount
reduction would be more appropriate a rule rather than a safe harbor.
43(d)(1)(iii) Creditor Receives the Consumer's Written Application for
the Standard Mortgage Before the Non-Standard Mortgage is Recast
Proposed Sec. 226.43(d)(1)(iii) requires that the creditor for the
refinancing receive the consumer's written application for the
refinancing before the existing non-standard mortgage is ``recast.'' As
discussed in the section-by-section analysis of Sec. 226.43(b)(11),
the Board defines the term ``recast'' to mean, for an adjustable-rate
mortgage, the expiration of the period during which payments based on
the introductory fixed rate are permitted; for an interest-only loan,
the expiration of the period during which the interest-only payments
are permitted; and, for a negative amortization loan, the expiration of
the period during which negatively amortizing payments are permitted.
The Board believes that proposed Sec. 226.43(d)(1)(iii) is
necessary to implement TILA Section 129C(a)(6)(E)(ii), which permits
creditors of certain refinances to ``consider if the extension of new
credit would prevent a likely default should the original mortgage
reset.'' 15 U.S.C. 1639c(a)(6)(E)(ii). This statutory language implies
that the special refinancing provisions apply only where the original
mortgage has not yet ``reset.'' Congress's concern appears to be
prevention of default in the event of a ``reset,'' not loss mitigation
on a mortgage for which a default on the ``reset'' payment has already
occurred.
The Board recognizes that a consumer may not realize that a loan
will be recast until the recast occurs and that, at that point, the
consumer could not refinance the loan under the special streamlined
refinancing provisions of proposed Sec. 226.43(d). The Board requests
comment on whether to use its legal authority to make adjustments to
TILA to permit streamlined refinancings even after a loan is recast.
43(d)(1)(iv) One Payment More Than 30 Days Late During the 24 Months
Immediately Preceding the Creditor's Receipt of the Consumer's Written
Application
Proposed Sec. 226.43(d)(1)(iv) requires that, during the 24 months
immediately preceding the creditor's receipt of the consumer's written
application for the standard mortgage, the consumer has made no more
than one payment on the non-standard mortgage more than 30 days late.
Together with Sec. 226.43(d)(1)(v) (discussed below), Sec.
226.43(d)(1)(iv) implements the portion of TILA Section 129C(a)(6)(E)
that requires that the borrower not have been ``delinquent on any
payment on the existing hybrid loan.'' 15 U.S.C. 1639c(a)(6)(E).
The Board believes that the proposal is consistent with the
statutory prohibition on ``any'' delinquencies on the existing non-
standard (``hybrid'') mortgage, in addition to being consistent with
the consumer protection purpose of TILA and industry practices under
many current streamlined refinance programs. Further, the proposal is
supported by the Board's authority under TILA Sections 105(a) and
129B(e) to adjust provisions of TILA and condition practices ``to
assure that consumers are offered and receive residential mortgage loan
on terms that reasonably reflect their ability to repay the loans and
that are understandable and not unfair, deceptive, or abusive.'' 15
U.S.C. 1604(a); 15 U.S.C. 1639b(e); TILA Section 129B(a)(2), 15 U.S.C.
1639b(a)(2). The proposal is designed to further this purpose by
facilitating transactions that help consumers refinance out of
unaffordable loans.
During outreach, the Board learned that a delinquency of more than
30 days often can occur at the time of loan set-up due to errors in the
set-up process outside of the consumer's control. The Board also noted,
as discussed above, that all of the streamlined refinance programs
reviewed by the Board permit at least one 30- or 31-day delinquency,
although usually during the last 12 months rather than the last 24
months prior to application for a refinancing.\55\ Thus the proposal is
more stringent than typical streamlined refinance programs, but does
not prohibit all delinquencies.
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\55\ See, e.g., Fannie Mae, ``Home Affordable Refinance Refi
PlusTM Options,'' p. 2 (Mar. 29, 2010); Freddie Mac,
``Freddie Mac-owned Streamlined Refinance Mortgage,'' Pub. No. 387,
p. 2 (Aug. 2010).
---------------------------------------------------------------------------
24-Month Look-Back Period. The Board proposes to require a look-
back period for payment history of 24 months, rather than a 12-month
period, for several reasons. First, as noted earlier, typical
streamlined refinance programs are often aimed at helping borrowers
with no risk of default. The Board recognizes that borrowers at risk of
default when higher payments are required might present greater credit
risks to the institutions holding their loans, even if the institutions
refinance those loans. In the Board's view, when income and assets are
not required to be verified, as proposed, the borrower's payment
history takes on greater
[[Page 27443]]
importance, especially in dealing with at-risk borrowers.
Second, the Board sees some merit in the views expressed during
outreach by GSE and creditor representatives that borrowers with
positive payment histories tend to be less likely than other borrowers
to sign up for a new loan for which they cannot afford the monthly
payments. At the same time, the Board acknowledges that a positive
payment history on payments at low levels due to temporarily favorable
loan terms is no guaranty that the consumer can afford the payments on
a new loan. The Board solicits comment on the proposal to require that
the consumer have only one delinquency during the 24 months prior to
applying for a refinancing, particularly on whether a longer or shorter
look-back period should be required.
Delinquency of 30 days or fewer permitted. Under the proposal, late
payments of 30 days or fewer on the existing, non-standard mortgage
would not disqualify a consumer from refinancing the non-standard
mortgage under the streamlined refinance provisions of proposed Sec.
226.43(d). The Board believes that allowing delinquencies of 30 or
fewer days is consistent with the statutory prohibition on ``any''
delinquency for several reasons. First, delinquencies of this length
may occur for many reasons outside of the consumer's control, such as
mailing delays, miscommunication about where the payment should be
sent, or payment crediting errors. Second, many creditors incorporate a
late fee ``grace period'' into their payment arrangements, which
permits consumers to make their monthly payments for a certain number
of days after the contractual due date without incurring a late fee.
Thus, many consumers regularly make their payments after the
contractual due date and may even set up automated withdrawals for
their payments to be made after the contractual due date in order to
coincide with the consumer's pay periods. The Board does not believe
that the statute is reasonably interpreted to prohibit consumers from
obtaining needed refinances due to payments that are late but within a
late fee grace period.
In addition, as discussed above, the Board interprets TILA Section
129C(a)(6)(E) to be intended as a mechanism for allowing existing
streamlined refinance programs to continue should the entities offering
them wish to maintain these programs. The predominant streamlined
refinance programs of which the Board is aware uniformly measure
whether a consumer has a positive payment history based on whether the
consumer has made any payments late by 30 days or more (or, as in the
proposal, more than 30 days).\56\
---------------------------------------------------------------------------
\56\ See, e.g., Freddie Mac Single-Family Seller/Servicer Guide,
Vol. 1, Ch. 24: Refinance Mortgages/24.4: Requirements for Freddie
Mac-owned streamlined refinance mortgages (Sept. 1, 2010) (requiring
that the consumer has been current on the existing mortgage ``for
the most recent 90 days and has not been 30 days delinquent more
than once in the most recent 21 months, or if the Mortgage being
refinanced is seasoned for less than 12 months, since the Mortgage
Note Date'').
---------------------------------------------------------------------------
Proposed comment 43(d)(1)(iv)-1 provides the following illustration
of the rule under Sec. 226.43(d)(1)(iv): Assume a consumer applies for
a refinancing on May 1, 2011. Assume also that the consumer made a non-
standard mortgage payment on August 15, 2009, that was 45 days late,
but made no other late payments on the non-standard mortgage between
May 1, 2009, and May 1, 2011. In this example, the requirement under
Sec. 226.43(d)(1)(iv) is met because the consumer made only one
payment that was over 30 days late within the 24 months prior to
applying for the refinancing (i.e., 20 and one-half months prior to
application).
Payment due date. Proposed comment 43(d)(1)(iv)-2 clarifies that
whether a payment is more than 30 days late depends on the contractual
due date not accounting for any grace period. The comment provides the
following example: The contractual due date for a non-standard mortgage
payment is the first day of every month, but no late fee will be
charged as long as the payment is received by the 16th day of the
month. Here, the ``payment due date'' is the first day of the month
rather than the 16th day of the month. Thus, a payment due under the
contract on September 1st that is paid on October 1st is made more than
30 days after the payment due date.
The Board believes that using the contractual due date for
determining whether a payment has been made more than 30 days after the
due date will facilitate compliance and enforcement by providing
clarity. Whereas late fee ``grace periods'' are often not stated in
writing, the contractual due date is unambiguous. In addition, using
the contractual due date for determining whether a loan payment is made
on time is consistent with standard home mortgage loan contracts.\57\
---------------------------------------------------------------------------
\57\ See Fannie Mae/Freddie Mac Uniform Instrument, Multistate
Fixed Rate Note--Single Family, Form 3200, Sec. Sec. 3, 6.
---------------------------------------------------------------------------
The Board requests comment on whether the delinquencies that
creditors are required to consider under Sec. 226.43(d)(1) should be
late payments of more than 30 days as proposed, 30 days or more, or
some other time period.
43(d)(1)(v) No Payments More Than 30 Days Late During the Six Months
Immediately Preceding the Creditor's Receipt of the Consumer's Written
Application
Proposed Sec. 226.43(d)(1)(v) requires that the consumer have made
no payments on the non-standard mortgage more than 30 days late during
the six months immediately preceding the creditor's receipt of the
consumer's written application for the standard mortgage. This
provision is intended to complement proposed Sec. 226.43(d)(1)(iv),
discussed above, in implementing the portion of TILA Section
129C(a)(6)(E) that requires that the borrower not have been
``delinquent on any payment on the existing hybrid loan.'' 15 U.S.C.
1639C(a)(6)(E). The Board believes that, together with proposed Sec.
226.43(d)(1)(iv), this aspect of the proposal is a reasonable
interpretation of the prohibition on ``any'' delinquencies on the non-
standard mortgage and is supported by the Board's authority under TILA
Sections 105(a) and 129B(e) to adjust provisions of TILA and condition
practices ``to assure that consumers are offered and receive
residential mortgage loan on terms that reasonably reflect their
ability to repay the loans and that are understandable and not unfair,
deceptive, or abusive.'' 15 U.S.C. 1604(a); TILA Section 129B(a)(2), 15
U.S.C. 1639b(a)(2).
The Board believes that a six-month ``clean'' payment record
indicates a reasonable level of financial stability on the part of the
consumer applying for a refinancing. This measure of financial
stability is especially important where income and assets are not
required to be verified. In addition, some outreach participants
indicated that a prohibition on delinquencies of more than 30 days for
the six months prior to application for the refinancing was generally
consistent with common industry practice and would not be unduly
disruptive to existing streamlined refinance programs with well-
performing loans.
Proposed comment 43(d)(1)(v)-1 provides the following examples of
the proposed rule: Assume a consumer in a non-standard mortgage applies
for a refinancing on May 1, 2011. If the consumer made a 45-day late
payment on March 15, 2011, the requirement under Sec. 226.43(d)(1)(v)
is not met because the consumer made a payment more than 30 days late
just one and one-half months prior to application.
[[Page 27444]]
The comment further clarifies that if the number of months between
consummation of the non-standard mortgage and the consumer's
application for the standard mortgage is six or fewer, the consumer may
not have made any payment more than 30 days late on the non-standard
mortgage. The comment cross-references proposed comments 43(d)(1)-2 and
43(d)(1)(iv)-2 for an explanation of ``written application'' and how to
determine the payment due date, respectively.
43(d)(2) Definitions
Proposed Section 226.43(d)(2) defines the terms ``non-standard
mortgage'' and ``standard mortgage'' in proposed Sec. 226.43(d). As
noted earlier, the statute does not define the terms ``hybrid loan''
and ``standard loan'' used in the special refinancing provisions of
TILA Section 129C(a)(6)(E). Therefore, the Board proposes definitions
that in its view are consistent with the policy objective underlying
these special provisions: Facilitating the refinancing of home
mortgages on which consumers risk a likely default due to impending
payment shock into more stable and affordable products.
43(d)(2)(i) Non-Standard Mortgage
Proposed Sec. 226.43(d)(2)(i) substitutes the term ``non-standard
mortgage'' for the statutory term ``hybrid loan'' and defines this term
to mean a covered transaction on which the loan has a fixed ``teaser''
rate for a period of one year or longer after consummation, which then
adjusts to a variable rate plus a margin for the remaining term of the
loan; or the minimum periodic payments (whether required or optional)
are either interest-only or negatively amortizing. Specifically, a
``non-standard mortgage'' is any ``covered transaction'' (defined in
proposed Sec. 226.43(b)(1)) that is:
An adjustable-rate mortgage, as defined in Sec.
226.18(s)(7)(i), with an introductory fixed interest rate for a period
of one year or longer; \58\
---------------------------------------------------------------------------
\58\ ``The term `adjustable-rate mortgage' means a transaction
secured by real property or a dwelling for which the annual
percentage rate may increase after consummation.'' 12 CFR
226.18(s)(7)(i).
---------------------------------------------------------------------------
An interest-only loan, as defined in Sec.
226.18(s)(7)(iv); \59\ or
---------------------------------------------------------------------------
\59\ ``The term `interest-only' means that, under the terms of
the legal obligation, one or more of the periodic payments may be
applied solely to accrued interest and not to loan principal; an
`interest-only loan' is a loan that permits interest-only
payments.'' 12 CFR 226.18(s)(7)(iv).
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A negative amortization loan, as defined in Sec.
226.18(s)(7)(v).\60\
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\60\ ``[T]he term `negative amortization' means payment of
periodic payments that will result in an increase in the principal
balance under the terms of the legal obligation; the term `negative
amortization loan' means a loan that permits payments resulting in
negative amortization, other than a reverse mortgage subject to
section 226.33.'' 12 CFR 226.18(s)(7)(v).
---------------------------------------------------------------------------
Proposed comment 43(d)(2)(i)(A)-1 explains what it means that a
``non-standard mortgage'' includes an adjustable-rate mortgage with an
introductory fixed interest rate for one or more years. This comment
clarifies that, for example, a covered transaction with a fixed
introductory rate for the first two, three or five years and then
converts to a variable rate for the remaining 28, 27 or 25 years,
respectively, is a ``non-standard mortgage.'' By contrast, a covered
transaction with an introductory rate for six months that then converts
to a variable rate for the remaining 29 and \1/2\ years is not a ``non-
standard mortgage.''
The Board believes that the proposed definition of a ``non-standard
mortgage'' is consistent with congressional intent. First, the
legislative history of the Dodd-Frank Act describes ``hybrid''
mortgages as mortgages with a ``blend'' of fixed-rate and adjustable-
rate characteristics--generally loans with an initial fixed period and
adjustment periods, such as ``2/23s and 3/27s.'' \61\ The legislative
history also indicates that Congress was concerned about borrowers
being trapped in mortgages likely to result in payments that would
suddenly become significantly higher--often referred to as ``payment
shock''--because their home values had dropped, thereby ``making
refinancing difficult.'' \62\
---------------------------------------------------------------------------
\61\ See U.S. House of Reps., Comm. on Fin. Services, Report on
H.R. 1728, Mortgage Reform and Anti-Predatory Lending Act, No. 111-
94, 51 (May 4, 2009).
\62\ Id. at 51-52.
---------------------------------------------------------------------------
The Board believes that Congress's overriding concern about
consumers being at risk due to payment shock supports an interpretation
of the term ``hybrid loan'' to encompass both loans that are ``hybrid''
in that they start with a fixed interest rate and convert to a variable
rate, but also loans that are ``hybrid'' in that borrowers can make
payments that do not pay down principal for a period of time that then
convert to higher payments covering all or a portion of principal. By
defining ``non-standard mortgage'' in this way, the proposal is
intended to increase refinancing options for a wide range of at-risk
consumers while remaining true to the statutory language and
legislative intent.
The proposed definition of ``non-standard mortgage'' does not
include adjustable-rate mortgages whose rate is fixed for an initial
period of less than one year. In those instances, a consumer arguably
does not face ``payment shock'' because the consumer has paid the fixed
rate for such a short period of time. Another concern is that allowing
streamlined refinancings under this provision where the interest rate
is fixed for less than one year could result in ``loan flipping.'' A
creditor, for example, could make a covered transaction and then only a
few months later refinance that loan under Sec. 226.43(d) to take
advantage of the exemption from certain ability-to-repay requirements
while still profiting from the refinancing fees.
The Board recognizes that under this definition, a consumer could
refinance out of a relatively stable product, such as an adjustable-
rate mortgage with a fixed interest rate for a period of 10 years,
which then adjusts to a variable rate for the remaining loan term (a
``10/1 ARM''). Whether this is the type of product that the special
refinancing provisions were meant to accommodate is unclear. The Board
solicits comment on whether adjustable-rate mortgages with an initial
fixed rate should be considered ``non-standard mortgages'' regardless
of how long the initial fixed rate applies, or if the proposed initial
fixed-rate period of at least one year should otherwise be revised.
The proposed definition of ``non-standard mortgage'' also does not
include balloon mortgages. As discussed above, the Board understands
Congress's intent to be to cover ``hybrid'' loans, meaning loans on
which the monthly payment will jump because new monthly payment terms
take effect, making the loan unaffordable for the remaining loan term.
Balloon mortgages are not clearly ``hybrid'' in this sense. The monthly
payments on a balloon mortgage do not necessarily increase or change
from the time of consummation; rather, the entire outstanding principal
balance becomes due on a particular, predetermined date. Consumers of
balloon mortgages typically expect that the entire loan balance will be
due at once at a certain point in time and are generally aware well in
advance that they will need to repay the loan or refinance.
However, the Board recognizes that consumers of balloon mortgages
may be at risk of being unable to pay the outstanding principal balance
when due and may need refinancing assistance. Thus the Board solicits
comment on whether to use its legal authority to include balloon
mortgages in the definition of ``non-standard mortgage'' for purposes
of the special refinancing provisions of TILA Section 129C(a)(6)(E).
The Board also requests comment generally on the
[[Page 27445]]
appropriateness of the proposed definition of ``non-standard
mortgage.''
43(d)(2)(ii) Standard Mortgage
Proposed Sec. 226.43(d)(2)(ii) substitutes the term ``standard
mortgage'' for the statutory term ``standard loan'' and defines this
term to mean a covered transaction (see proposed Sec. 226.43(b)(1))
that has the following five characteristics, each of which will be
discussed in more detail further below:
First, the regular periodic payments may not (1) cause the
principal balance to increase; (2) allow the consumer to defer
repayment of principal; or (3) result in a balloon payment. In other
words, to qualify as a standard mortgage, a covered transaction may not
provide for negative amortization payments, payments of interest only
or of only a portion of the principal required to pay off the loan
amount over the loan term, or a balloon payment.
Second, the total points and fees payable in connection
with the transaction may not exceed three percent of the total loan
amount, with exceptions for smaller loans specified in proposed Sec.
226.43(e)(3), discussed in detail below.
Third, the loan term may not exceed 40 years.
Fourth, the interest rate must be fixed for the first five
years after consummation.
Fifth, the proceeds from the loan may be used solely to
pay--(1) the outstanding principal balance on the non-standard
mortgage; and (2) closing or settlement charges required to be
disclosed under RESPA. In other words, the refinance must be what is
commonly referred to as a ``no-cash-out'' refinancing, in which the
consumer receives no funds from the loan proceeds for discretionary
spending.
In general, the criteria for a ``standard mortgage'' is designed to be
similar to the criteria for a ``qualified mortgage'' under proposed
Sec. 226.43(e)(2), which places certain limits on loan features and
fees. The Board believes that this approach is appropriate to ensure
that standard mortgages provide product stability and affordability for
consumers.
Limitations on regular periodic payments. Under proposed Sec.
226.43(d)(2)(ii)(A), to qualify as a standard mortgage, a covered
transaction must provide for regular periodic payments that do not
result in negative amortization, deferral of principal repayment, or a
balloon payment. The Board believes that these limitations promote the
statutory purpose of facilitating refinances that place at-risk
consumers in more sustainable mortgages. These provisions are also
consistent with the definition of a ``qualified mortgage'' under
proposed Sec. 226.43(e)(2)(i). See section-by-section analysis of
Sec. 226.43(e)(2), below.
Proposed comment 43(d)(2)(ii)(A)-1 explains the meaning of
``regular periodic payments'' that do not result in an increase of the
principal balance (negative amortization) or allow the consumer to
defer repayment of principal (see proposed comment 43(e)(2)(i)-2,
discussed below). The comment explains that the requirement for
``regular periodic payments'' means that the contractual terms of the
standard mortgage must obligate the consumer to make payments of
principal and interest on a monthly or other periodic basis that will
repay the loan amount over the loan term. The comment further explains
that, with the exception of payments resulting from any interest rate
changes after consummation in an adjustable-rate or step-rate mortgage,
the periodic payments must be substantially equal. This comment notes
that meaning of ``substantially equal'' is explained in proposed
comment 43(c)(5)(i)-3 (discussed above in the section-by-section
analysis of proposed Sec. 226.43(c)(5)). In addition, the comment
clarifies that ``regular periodic payments'' do not include a single-
payment transaction and cross-references similar commentary on the
meaning of ``regular periodic payments'' for the purposes of a
``qualified mortgage'' (proposed comment 43(e)(2)(i)-1).
Proposed comment 43(d)(2)(ii)(A)-1 also cross-references proposed
comment 43(e)(2)(i)-2 to explain the prohibition on payments that
``allow the consumer to defer repayment of principal.'' Proposed
comment 43(e)(2)(i)-2 describes the meaning of this phrase in the
context of defining the term ``qualified mortgage'' under proposed
Sec. 226.43(e); however, the phrase has the same meaning in the
definition of ``standard mortgage'' under proposed Sec. 226.43(d).
Specifically, the comment states that deferral of principal repayment
includes interest-only terms, under which one or more of the periodic
payments may be applied solely to accrued interest and not to loan
principal. Deferral of principal repayment also includes terms under
which part of the periodic payment is applied to loan principal but is
insufficient to pay off the loan amount over the loan term, requiring
an increase in later periodic payments (or a balloon payment) to make
up the principal shortfall of earlier payments. Graduated payment
mortgages, for example, allow deferral of principal repayment in this
manner and therefore generally may not be standard mortgages or
qualified mortgages.
Three percent cap on points and fees. Proposed Sec.
226.43(d)(2)(ii)(B) prohibits creditors from charging points and fees
on the mortgage transaction of more than three percent of the total
loan amount, with certain exceptions for small loans. Specifically,
proposed Sec. 226.43(d)(2)(ii)(B) cross-references the points and fees
provisions under proposed Sec. 226.43(e)(3), thereby applying the
points and fees limitations for a ``qualified mortgage'' to a
``standard mortgage.'' The points and fees limitation for a ``qualified
mortgage'' is discussed in detail in the section-by-section analysis of
proposed Sec. 226.43(e)(3), below. In sum, under proposed Sec.
226.43(e)(3)(i), the total points and fees payable in connection with a
loan may not exceed--
Alternative 1:
For a loan amount of $75,000 or more, 3 percent of the total
loan amount;
For a loan amount of greater than or equal to $60,000 but less
than $75,000, 3.5 percent of the total loan amount;
For a loan amount of greater than or equal to $40,000 but less
than $60,000, 4 percent of the total loan amount;
For a loan amount of greater than or equal to $ 20,000 but
less than $40,000, 4.5 percent of the total loan amount; and
For a loan amount of less than $20,000, 5 percent of the total
loan amount.
Alternative 2:
For a loan amount of $75,000 or more, 3 percent of the total
loan amount;
For a loan amount of greater than or equal to $20,000 but less
than $75,000, a percent of the total loan amount not to exceed the
amount produced by the following formula--
[cir] Total loan amount - $20,000 = $Z
[cir] $Z x .0036 basis points = Y basis points
[cir] 500 basis points - Y basis points = X basis points
[cir] X basis points x .01 = Allowable points and fees as a
percentage of the total loan amount.
For a loan amount of less than $20,000, 5 percent of the total
loan amount.
For a detailed discussion of the alternative points and fees thresholds
for qualified mortgages, see the section-by-section analysis of
proposed Sec. 226.43(e)(3), below.
In the Board's view, the proposed limitation on the points and fees
that
[[Page 27446]]
may be charged on a ``standard mortgage'' is important for at least
three reasons. First, the limitation prevents creditors from
undermining the purpose of the provision--placing at-risk consumers
into more affordable loans--by charging excessive points and fees for
the refinance. Second, the points and fees cap helps ensure that
consumers attain a net benefit in refinancing their non-standard
mortgage. The higher a consumer's upfront costs to refinance a home
mortgage, the longer it will take for the consumer to recoup those
costs through lower payments on the new mortgage. By limiting the
amount of points and fees that can be charged in a refinance covered by
Sec. 226.43(d), the proposal reduces the amount of time it will take
for the consumer to recoup his transaction costs, thus increasing the
likelihood that the consumer will hold the loan long enough to in fact
recoup those costs. Third, this provision is consistent with the
exemption from income verification requirements for streamlined
refinances under Federal government programs. See TILA Section
129C(a)(5). The Board is not aware of any reason why points and fees
should be capped for government streamlined refinances but not for
private streamlined refinances.
The Board requests comment on the proposal to apply the same limit
on the points and fees that may be charged for a ``qualified mortgage''
under Sec. 226.43(e) to the points and fees that may be charged on a
``standard mortgage'' under Sec. 226.43(d).
Loan term of no more than 40 years. Proposed Sec.
226.43(d)(2)(ii)(C) provides that, to qualify as a standard mortgage
under proposed Sec. 226.43(d), a covered transaction may not have a
loan term of more than 40 years. The Board believes that allowing a
loan term of up to 40 years is consistent with the statutory goal of
promoting refinances for borrowers in potential crisis, as well as with
the statutory language that requires the monthly payment for the
standard mortgage to be lower than the payment for the non-standard
mortgage. The proposal is intended to ensure that creditors and
consumers have sufficient options to refinance a 30-year loan, for
example, which is unaffordable for the consumer in the near term, into
a loan with lower, more affordable payments over a longer term. This
flexibility may be especially important in higher cost areas where loan
amounts on average exceed loan amounts in other areas. At the same
time, the Board recognizes that loans of longer terms cost more over
time for the consumer.
During outreach, the Board heard concerns from consumer advocates
that allowing a loan term of 40 years on any mortgage is detrimental to
consumers and the market as a whole. Consumer advocates argued that 40-
year loans are expensive and do not save consumers sufficient money on
the monthly payment to offset this expense. Among other information,
consumer advocates provided an example of a $300,000 loan at an 8
percent fixed interest rate. The difference between the 20 and 30 year
payment is $308.03 a month ($2,509.32 reduced to $2,201.29). The
difference between the 30- and 40-year loan is $115.36 a month.
Consumer advocates question the advantages of a monthly payment
reduction of $115.36 per month when the loan costs an additional
$208,783 over the 40 years more than the 30-year loan.
A more appropriate comparison may be the total interest paid for
the two types of loans during an equal, shorter period rather than for
the life of each loan. A shorter period is relevant because most loans
are prepaid well before the stated end of the term. For instance,
during the first year, the total interest paid on the 30-year loan
would be $23,909, compared to $23,961 for the 40-year loan. Over the
first five years, total interest paid on the 30-year loan would be
$117,287, compared to $118,842 on the 40-year loan, which is a
difference of $1,555 more for the 40-year loan. Over the first 10
years, total interest paid on the 30-year loan would be $227,329,
compared to $234,591 on the 40-year loan, which is a difference of
$7,262 more for the 40-year loan.
While recognizing that a 40-year mortgage is more expensive than a
30-year mortgage over the long term, the Board is reluctant to
foreclose options for consumers for whom the lower payment of a 40-year
loan might make the difference between defaulting and not defaulting.
The Board also notes that prevalent streamlined refinance programs
permit loan terms of up to 40 years and is concerned about disrupting
the current mortgage market at a vulnerable time.\63\ The Board
requests comment on the proposal to allow a standard mortgage to have a
loan term of up to 40 years.
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\63\ See, e.g., Fannie Mae, ``Home Affordable Refinance--New
Refinance Options for Existing Fannie Mae Loans,'' Announcement 09-
04, p. 8 (Mar. 4, 2009) (permitting ``[f]ully-amortizing fixed-rate
mortgage loans with a term up to 40 years'').
---------------------------------------------------------------------------
Interest rate is fixed for the first five years. Proposed Sec.
226.43(d)(2)(ii)(D) requires that a standard mortgage have a fixed
interest rate for the first five years (60 months) after consummation.
Proposed comment 43(d)(2)(ii)(D)-1 illustrates this rule for an
adjustable-rate mortgage with an initial fixed interest rate for the
first five years after consummation. In the example provided, the
adjustable-rate mortgage consummates on August 15, 2011, and the first
monthly payment is due on October 1, 2011. The first five years after
consummation occurs on August 15, 2016. The first interest rate
adjustment occurs on the due date of the 60th monthly payment, which is
September 1, 2016. As explained in the comment, this loan meets the
requirement that the rate be fixed for the first five years after
consummation because the interest rate is fixed until September 1,
2016--more than five years after consummation. This comment also cross-
references proposed comment 43(e)(2)(iv)-3.iii for guidance regarding
step-rate mortgages. Step-rate mortgages may have a ``fixed'' interest
rate for five years that is not the same rate for the entire five-year
period.
The Board proposes a minimum five-year fixed-rate period for
standard mortgages for several reasons. First, requiring a fixed rate
for five years is consistent with the statutory requirement for a
qualified mortgage, which requires the creditor to underwrite the
mortgage based on the maximum interest rate that may apply during the
first five years after consummation. See TILA Section 129C(b)(2)(A)(v);
see also proposed Sec. 226.43(e)(2)(iv)(A). The Board understands that
Congress intended both qualified mortgages and standard mortgages to be
stable loan products, and therefore believes that the required five-
year fixed-rate period for qualified mortgages is an appropriate
benchmark for standard mortgages as well. As a matter of policy, the
Board believes that the safeguard of a fixed rate for five years after
consummation is necessary to ensure that consumers refinance into
products that are stable for a substantial period of time. In the
Board's view, a fixed payment for five years after consummation is a
significant improvement in the circumstances of a consumer who may have
defaulted absent the refinance. In effect, the proposal permits so-
called ``5/1 ARMs,'' where the interest rate is fixed for the first
five years, after which time the rate becomes variable. In this regard,
the proposal is intended to be generally consistent with existing
streamlined refinance programs.\64\ The Board's understanding based on
outreach is that 5/1 ARMs in existing streamlined refinance programs
have performed well.
---------------------------------------------------------------------------
\64\ See, e.g., id. (permitting ``[f]ully-amortizing ARM loans
with an initial fixed period of five years or greater with a term up
to 40 years'').
---------------------------------------------------------------------------
[[Page 27447]]
Consumer advocates have expressed the view that a longer fixed-rate
period for standard mortgages is necessary, preferably at least seven
years, arguing that consumers may hold their loans longer than five
years and be faced with payment shock sooner than they can afford. The
Board requests comment on the proposal to require that a standard
mortgage under proposed Sec. 226.43(d) have an interest rate that is
fixed for at least the first five years after consummation, including
on whether the rate should be required to be fixed for a shorter or
longer period and data to support any alternative time period.
In addition, the Board requests comment on whether a balloon
mortgage of at least five years should be considered a ``standard
mortgage'' under the streamlined refinancing provisions of Sec.
226.43(d). Arguably, a balloon mortgage with a fixed, monthly payment
for five years would benefit a consumer who otherwise would have
defaulted. Also, a five-year balloon mortgage may not be appreciably
less risky for the consumer than a ``5/1 ARM,'' which is permitted
under the proposal, depending on the terms of the rate adjustment
scheduled to occur in year five.
Loan proceeds used for limited purposes. Proposed Sec.
226.43(d)(2)(ii)(E) restricts the use of the proceeds of a standard
mortgage to two purposes:
To pay off the outstanding principal balance on the non-
standard mortgage; and
To pay closing or settlement charges required to be
disclosed under the Real Estate Settlement Procedures Act, 12 U.S.C.
2601 et seq., which includes amounts required to be deposited in an
escrow account at or before consummation.
Proposed comment 43(d)(2)(ii)(E)-1 clarifies that if the proceeds of a
covered transaction are used for other purposes, such as to pay off
other liens or to provide additional cash to the consumer for
discretionary spending, the transaction does not meet the definition of
a ``standard mortgage.''
This proposal is intended to ensure that the consumer does not
incur additional home mortgage debt as part of a refinance designed to
prevent the consumer from defaulting on an existing home mortgage. The
Board believes that permitting the consumer to lose additional equity
in his or her home under TILA's special refinancing provisions would
undermine the financial stability of the consumer, thus contravening
the purposes of the statute. The Board requests comment, however, on
whether some de minimis amount of cash to the consumer should be
permitted, either because this allowance would be operationally
necessary to cover transaction costs or for other reasons, such as to
reimburse a consumer for closing costs that were over-estimated but
financed.
43(d)(2)(iii) Refinancing
Proposed Sec. 226.43(d)(2)(iii) defines the term ``refinancing''
to have the same meaning as in Sec. 226.20(a). Section 226.20(a)
defines the term ``refinancing'' generally to mean a transaction in
which an existing obligation is ``satisfied and replaced by a new
obligation undertaken by the same consumer.'' Official staff commentary
explains that ``[w]hether a refinancing has occurred is determined by
reference to whether the original obligation has been satisfied or
extinguished and replaced by a new obligation, based on the parties'
contract and applicable law.'' See comment 20(a)-1. However, the
following, among other transaction events, are not considered
``refinancings'': (1) A renewal of a payment obligation with no change
in the original terms; and (2) a reduction in the annual percentage
rate with a corresponding change in the payment schedule. See Sec.
226.20(a)(1) and (a)(2), and comment 20(a)-2.
In the Board's 2010 Mortgage Proposal, the Board proposed to revise
the meaning of ``refinancing'' in Sec. 226.20 to include a broader
range of transactions for which creditors would be required to give
consumers new TILA disclosures.\65\ The Board requests comment on
whether the meaning of ``refinancing'' in Sec. 226.43(d) should be
expanded to include a broader range of transactions, similar to those
covered under the proposed revisions to Sec. 226.20, or otherwise
should be defined differently or explained more fully than proposed.
---------------------------------------------------------------------------
\65\ 75 FR 58539, 58594-58604, 58697-58699, 58761-58764, Sept.
24, 2010.
---------------------------------------------------------------------------
43(d)(3) Exemption From Certain Repayment Ability Requirements
Under specific conditions, proposed Sec. 226.43(d)(3) exempts a
creditor in a refinancing from two of the requirements under proposed
Sec. 226.43(c) for determining a consumer's ability to repay a home
mortgage. First, the creditor is not required to comply with the income
and asset verification requirements of proposed Sec. 226.43(c)(2)(i)
and (c)(4). Second, the creditor is not required to comply with the
payment calculation requirements of proposed Sec. 226.43(c)(2)(iii)
and (c)(5); the creditor may instead use payment calculations
prescribed in proposed Sec. 226.43(d)(5)(ii), discussed in more detail
in the section-by-section analysis of that provision.
For these exemptions to apply, all of the conditions in proposed
Sec. 226.43(d)(1)(i)-(v) described above must be met. See proposed
Sec. 226.43(d)(3)(i). In addition, the creditor must consider whether
the standard mortgage will prevent a likely default by the consumer on
the non-standard mortgage when the non-standard mortgage is recast. See
proposed Sec. 226.43(d)(3)(ii). This proposed provision implements
TILA Section 129C(a)(6)(E)(ii), which permits a creditor to ``consider
if the extension of new credit would prevent a likely default should
the original mortgage reset and give such concerns a higher priority as
an acceptable underwriting practice.'' 15 U.S.C. 1639c(a)(6)(E)(ii). As
clarified in proposed comment 43(d)(3)(i)-1, the Board believes that
this statutory provision requires a creditor consider whether:
the consumer is likely to default on the existing mortgage
once new, higher payments are required; and
the new mortgage will prevent the consumer's default.
Likely default. Proposed comment 43(d)(3)(i)-2 clarifies that, in
considering whether the consumer's default on the non-standard mortgage
is ``likely,'' the creditor may look to widely accepted governmental
and non-governmental standards for analyzing a consumer's likelihood of
default. The Board does not intend to constrain servicers and other
relevant parties from using other methods to determine a consumer's
likelihood of default, including those tailored specifically to that
servicer. Outreach participants informed the Board that servicers and
others use a variety of methods for determining a consumer's likelihood
of default, some of which are based on the particular servicer's
historical experience with the loans it has serviced.
The Board has also considered the meaning of ``imminent default''
in HAMP, which, as noted, is a government program designed to assist
consumers facing ``imminent default'' or who are in default or
foreclosure. The Board's understanding, based on research and
discussions with outreach participants, is that the requirements for
determining what constitutes ``imminent default'' were not precisely
defined in the HAMP rules due to the legitimate differences in servicer
assessments of a consumer's likelihood of default. In addition, a
servicer may use more than one method. For example, Freddie Mac
representatives informed the Board that
[[Page 27448]]
its tool for calculating ``imminent default''--the Imminent Default
Indicator or IDI--is one factor among several that Freddie Mac Seller/
Servicers review in determining a consumer's likelihood of default and
that these additional factors may vary depending on the type of loan
and other characteristics of a particular transaction or borrower.
The Board heard from consumer advocates that ``imminent default,''
as it has been interpreted by some to date, may be a standard that is
too high for the refinancing provisions in TILA Section 129C(a)(6)(E)
and could prevent many consumers from obtaining needed streamlined
refinances. The proposal therefore uses the exact statutory wording--
``likely default''--in implementing the provision permitting a creditor
to prioritize prevention of default in underwriting a refinancing. See
TILA Section 129C(a)(6)(E)(ii); 15 U.S.C. 1639c(a)(6)(E)(ii). In this
way, the proposal is intended to distinguish the required standard for
a consumer's potential default under TILA's new refinancing provisions
from any particular meaning that may have been ascribed to the term
``imminent default'' in connection with HAMP.
The Board solicits comment on the proposal to use the term ``likely
default'' in implementing TILA Section 129C(a)(6)(E)(ii) and on whether
additional guidance is needed on how to meet the requirement that a
creditor must reasonably and in good faith determine that a standard
mortgage will prevent a likely default should the non-standard mortgage
be recast.
Payment calculation for repayment ability determination. Proposed
comment 43(d)(3)(ii)-1 explains that, if the conditions in Sec.
226.43(d)(1) are met (discussed above), the creditor may satisfy the
payment calculation requirements for determining a consumer's ability
to repay the new loan by applying the calculation prescribed under
Sec. 226.43(d)(5)(ii), rather than the calculation prescribed under
Sec. 226.43(c)(2)(iii) and (c)(5). Specifically, as discussed in more
detail under proposed Sec. 226.43(d)(5)(ii) below, the creditor must
calculate the standard mortgage payment based on the rate at
consummation of the standard mortgage. This is the rate that will apply
for the first five years after consummation; to qualify as a ``standard
mortgage,'' a mortgage must have an interest rate that is fixed for at
least the first five years after consummation of the loan (see proposed
Sec. 226.43(d)(2)(ii)(D), discussed below). The comment explains that,
as a result, if the standard mortgage is a ``5/1 ARM'' with a fixed
rate for the first five years of payments (60 payments) followed by a
variable rate, the creditor would not be required to determine the
consumer's ability to repay the loan based on a payment that would
result once the variable rate applies. If the loan consummates on
August 15, 2011, and the first monthly payment is due on October 1,
2011, five years after consummation occurs on August 15, 2016, and the
first interest rate adjustment occurs on the due date of the 60th
monthly payment, which is September 1, 2016. Thus, under proposed Sec.
226.43(d)(3)(ii), to calculate the payment required for the ability to
repay rule under proposed Sec. 226.43(c)(2)(iii), the creditor should
use the payment based on the interest rate that is fixed for the first
five years after consummation (from August 15, 2011, until August 15,
2016) and is not required to account for the payment resulting after
the first interest rate adjustment on September 1, 2016.
The Board proposes this exemption from the general ability to repay
payment calculation requirements for three reasons. First, in the
Board's view, TILA Section 129C(a)(6)(E) is clearly intended to
encourage creditors to refinance loans on which consumers are likely to
default due to impending ``payment shock.'' The proposal is consistent
with this policy objective because underwriting a refinance based on
the payment due prior to the recast means that more consumers can
qualify for loans to ensure sustained homeownership. Second, the
safeguards built into the definition of a ``standard mortgage,''
discussed under the section-by-section analysis of proposed Sec.
226.43(d)(3)(ii), mitigate risks of not accounting for the payment due
after the recast in determining a consumer's ability to repay. A
standard mortgage, for example, may never have negative amortization
payments, interest-only payments, or a balloon payment.
Third, the statute in general seeks to ensure that consumers obtain
mortgages for which the payments are affordable for a reasonable period
of time. Based on the definition of a ``qualified mortgage,'' the Board
believes that Congress considered a reasonable amount of time to be the
first five years after consummation of a loan. Specifically, as
discussed in more detail below in the section-by-section analysis of
proposed Sec. 226.43(e)(2)(iv), an adjustable-rate mortgage is deemed
to be a qualified mortgage only if, among other factors, the
underwriting is based on the maximum rate permitted under the loan
during the first five years. TILA Section 129C(b)(2)(A)(v), 15 U.S.C.
1639c(b)(2)(A)(v). The Board believes that the same standard is
appropriately applied to determining a consumer's ability to repay a
``standard mortgage'' under Sec. 226.43(d). The statute is structured
to encourage creditors to make both ``qualified mortgages'' and
``standard mortgages,'' consistent with congressional findings on the
importance of ``ensuring that responsible, affordable mortgage credit
remains available to consumers.'' TILA Section 129B(a)(1). In
particular, the statute affords creditors of both qualified mortgages
and standard mortgages additional flexibility in complying with the
general ability to repay underwriting requirements of TILA Section
129C(a). See TILA Section 129C(a)(6)(E) (for standard mortgages) and
129C(b) (for qualified mortgages), 15 U.S.C. 1639c(a)(6)(E), (b).
Accordingly, the proposal requires that standard mortgages have most of
the product features and restrictions assigned by Congress to qualified
mortgages to ensure product stability and affordability for consumers.
Finally, the Board believes that this aspect of the proposal will
facilitate compliance by allowing creditors to use a single payment
calculation for determining whether: (1) The payment on the standard
mortgage is ``materially lower'' than the payment on the non-standard
mortgage; and (2) the consumer has a reasonable ability to repay the
standard mortgage.
The Board requests comment on the proposal to exempt creditors of
refinances that meet the conditions under proposed Sec. 226.43(d)(1)
from the income and asset verification requirements and the payment
calculation requirements of the general ability-to-repay rules in
proposed Sec. 226.43(c). The Board solicits comment on whether an
exemption from other ability to repay requirements under proposed Sec.
226.43(c), such as consideration of credit history under proposed Sec.
226.43(c)(2)(viii), may also be appropriate.
43(d)(4) Offer of Rate Discounts and Other Favorable Terms
Proposed Sec. 226.43(d)(4) provides that a creditor making a loan
under the special refinancing provisions of Sec. 226.43(d) may offer
to the consumer the same or better rate discounts and other terms that
the creditor offers to any new consumer, consistent with the creditor's
documented underwriting practices and to the extent not prohibited by
applicable state or Federal law. This provision implements TILA Section
129C(a)(6)(E)(iii), which permits creditors of refinancings under the
[[Page 27449]]
special conditions of TILA Section 129C(a)(6)(E) to ``offer rate
discounts and other favorable terms'' to the borrower ``that would be
available to new customers with high credit ratings based on such
underwriting practice.'' 15 U.S.C. 1639c(a)(6)(E)(iii).
The statutory provision is consistent with the congressional goal
of facilitating beneficial refinancings for borrowers facing potential
payment shock; the provision allows creditors to give their refinancing
customers rate discounts and favorable terms they might offer to new
customers with high credit ratings. The Board recognizes that the
meaning of ``high credit ratings'' may vary by creditor and that the
underwriting practices for these types of customers may vary also,
including the terms that are offered. Thus the proposal does not use
the term ``high credit ratings'' but simply states that the rate
discounts and terms offered to a consumer of a Sec. 226.43(d) loan may
be the same or better than those offered to any other consumer.
The proposal does require, however, that a creditor have
``documented underwriting practices'' to support the creditor's offer
of rate discounts and loan terms. In this way, the proposal is intended
to promote transparency for examiners and consumers in understanding
the basis for any special discounts or terms that the creditor offers
to borrowers refinancing their home mortgages under proposed Sec.
226.43(d). In addition, the Board recognizes that state or Federal laws
may regulate the rates and terms offered to consumers depending on
various consumer characteristics or other factors. For this reason, the
Board proposes that the rates and terms offered to consumers under
Sec. 226.43(d) not be prohibited by other applicable state or Federal
law.
The Board requests comment on the proposed interpretation of TILA
Section 129C(a)(6)(E)(iii) and whether additional guidance on the
meaning of proposed Sec. 226.43(d)(4) is needed.
43(d)(5) Payment Calculations
Proposed Sec. 226.43(d)(5) prescribes the payment calculations
that must be used to determine whether the consumer's monthly payment
for a standard mortgage will be ``materially lower'' than the monthly
payment for the non-standard mortgage, as required under proposed Sec.
226.43(d)(1)(ii), discussed above. Proposed Sec. 226.43(d)(5) thus
complements proposed Sec. 226.43(d)(1)(ii) in implementing the
statutory provision that requires a ``reduction'' in the monthly
payment for the existing non-standard (``hybrid'') mortgage when
refinanced into a standard mortgage. TILA Section 129C(a)(6)(E), 15
U.S.C. 1639c(a)(6)(E). As noted above, the payment calculation for a
standard mortgage required under proposed Sec. 226.43(d)(5)(ii) is
also the payment calculation that a creditor must use to calculate the
monthly payment on the standard loan in determining whether the
consumer is reasonably able to repay the mortgage. See proposed Sec.
226.43(c)(2)(iii).
43(d)(5)(i) Non-Standard Mortgage Payment Calculation
Proposed Sec. 226.43(d)(5)(i) requires that the monthly payment
for a non-standard mortgage be based on substantially equal, monthly,
fully amortizing payments of principal and interest that would result
once the mortgage is ``recast,'' as that term is defined in Sec.
226.43(b)(11) and discussed in the section-by-section analysis of that
provision. The Board believes that comparing the payment on the
standard mortgage to the payment amount on which the consumer likely
would have defaulted (i.e., the payment resulting on the existing non-
standard mortgage once the favorable terms cease and a higher payment
results) promotes needed refinances consistent with congressional
intent.
In the Board's view, the payment that the consumer is currently
making on the existing non-standard mortgage may be an inappropriately
low payment to compare to the standard mortgage payment. The existing
payments may be interest-only or negatively amortizing; these
temporarily lower payment amounts would be difficult for creditors to
``reduce'' with a refinanced loan that has a comparable term length and
principal amount. Indeed, the payment on a new loan with a fixed-rate
rate and fully-amortizing payment, as is required for the payment
calculation of a standard mortgage under proposed Sec.
226.43(d)(5)(ii), for example, is likely to be higher than the
interest-only or negative amortization payment. As a result, few
refinancings would yield a lower monthly payment, so many consumers
could not receive the benefits of refinancing into a more stable loan
product. In addition, streamlined refinances by GSEs and private
creditors might be severely hampered, with potentially detrimental
effects on the market.
Thus the proposal requires a creditor to calculate the monthly
payment for a non-standard mortgage using--
The fully indexed rate as of a reasonable period of time
before or after the date on which the creditor receives the consumer's
written application for the standard mortgage;
The term of the loan remaining as of the date of the
recast, assuming all scheduled payments have been made up to the recast
date and the payment due on the recast date is made and credited as of
that date; and
A remaining loan amount that is--
[cir] For an adjustable-rate mortgage under Sec.
226.43(d)(2)(i)(A), the outstanding principal balance as of the date
the mortgage is recast, assuming all scheduled payments have been made
up to the recast date and the payment due on the recast date is made
and credited as of that date;
[cir] For an interest-only loan under Sec. 226.43(d)(2)(i)(B), the
loan amount, assuming all scheduled payments have been made up to the
recast date and the payment due on the recast date is made and credited
as of that date;
[cir] For a negative amortization loan under Sec.
226.43(d)(2)(i)(C), the maximum loan amount.
Proposed comment 43(d)(5)(i)-1 explains that, to determine whether
the monthly periodic payment for a standard mortgage is materially
lower than the monthly periodic payment for the non-standard mortgage
under Sec. 226.43(d)(1)(ii), the creditor must consider the monthly
payment for the non-standard mortgage that will result after the loan
is ``recast,'' as defined in Sec. 226.43(b)(11), assuming
substantially equal payments of principal and interest that amortize
the remaining loan amount over the remaining term as of the date the
mortgage is recast. This comment notes that guidance regarding the
meaning of ``substantially equal'' and ``recast'' is provided comment
43(c)(5)(i)-4 and Sec. 226.43(b)(11), respectively (discussed above).
Proposed comment 43(d)(5)(i)-2 explains that the term ``fully
indexed rate'' used in Sec. 226.43(d)(5)(i)(A) for calculating the
payment for a non-standard mortgage is generally defined in Sec.
226.43(b)(3) and associated commentary. The comment explains an
important difference between the ``fully indexed rate'' as defined in
Sec. 226.43(b)(3), however, and the meaning of ``fully indexed rate''
in Sec. 226.43(d)(5)(i). Specifically, under Sec. 226.43(b)(3), the
fully indexed rate is calculated at the time of consummation. Under
Sec. 226.43(d)(5)(i), the fully indexed rate is calculated within
reasonable period of time before or after the date on which the
creditor receives the consumer's written application for the standard
mortgage. Comment 43(d)(5)(i)-2 clarifies that 30 days would generally
be considered a ``reasonable period of time.''
[[Page 27450]]
Proposed comment 43(d)(5)(i)-3 clarifies that the term ``written
application'' is explained in comment 19(a)(1)(i)-3. Comment
19(a)(1)(i)-3 states that creditors may rely on RESPA and Regulation X
(including any interpretations issued by HUD) in deciding whether a
``written application'' has been received. In general, Regulation X
defines ``application'' to mean the submission of a borrower's
financial information in anticipation of a credit decision relating to
a Federally related mortgage loan. See 24 CFR 3500.2(b). As explained
in comment 19(a)(1)(i)-3, an application is received when it reaches
the creditor in any of the ways applications are normally transmitted--
by mail, hand delivery, or through an intermediary agent or broker. If
an application reaches the creditor through an intermediary agent or
broker, the application is received when it reaches the creditor,
rather than when it reaches the agent or broker. This comment also
cross-references comment 19(b)-3 for guidance in determining whether
the transaction involves an intermediary agent or broker.
Payment calculation for an adjustable-rate mortgage with an
introductory fixed rate. Proposed comments 43(d)(5)(i)-4 and -5 explain
the payment calculation for an adjustable-rate mortgage with an
introductory fixed rate under proposed Sec. 226.43(d)(5)(i). Proposed
comment 43(d)(5)(i)-4 clarifies that the monthly periodic payment for
an adjustable-rate mortgage with an introductory fixed interest rate
for a period of one or more years must be calculated based on several
assumptions. First, the payment must be based on the outstanding
principal balance as of the date on which the mortgage is recast,
assuming all scheduled payments have been made up to that date and the
last payment due under those terms is made and credited on that date.
For example, assume an adjustable-rate mortgage with a 30-year loan
term. The loan agreement provides that the payments for the first 24
months are based on a fixed rate, after which the interest rate will
adjust annually based on a specified index and margin. The loan is
recast on the due date of the 24th payment. If the 24th payment is due
on September 1, 2013, the creditor must calculate the outstanding
principal balance as of September 1, 2013, assuming that all 24
payments under the fixed rate terms have been made and credited on
time. See comment 43(d)(5)(i)-4.i.
Second, the payment calculation must be based on substantially
equal monthly payments of principal and interest that will fully repay
the outstanding principal balance over the term of the loan remaining
as of the date the loan is recast. Thus, the comment states, in the
example above, the creditor must assume a loan term of 28 years (336
payments). See comment 43(d)(5)(i)-4.ii. Third, the payment must be
based on the fully indexed rate, as defined in Sec. 226.43(b)(3), as
of the date of the written application for the standard mortgage. See
comment 43(d)(5)(i)-4.iii.
Proposed comment 43(d)(5)(i)-5 provides an illustration of the
payment calculation for an adjustable-rate mortgage with an
introductory fixed rate. The example first assumes a loan in an amount
of $200,000 has a 30-year loan term. The loan agreement provides for a
discounted introductory interest rate of 5% that is fixed for an
initial period of two years, after which the interest rate will adjust
annually based on a specified index plus a margin of 3 percentage
points. See comment 43(d)(5)(i)-5.i. Second, the example states that
the non-standard mortgage is consummated on February 15, 2011, and the
first monthly payment is due on April 1, 2011. The loan is recast on
the due date of the 24th monthly payment, which is March 1, 2013. See
comment 43(d)(5)(i)-5.ii. Finally, the example assumes that on March
15, 2012, the creditor receives the consumer's written application for
a refinancing after the consumer has made 12 monthly on-time payments
and that, on this date, the index value is 4.5%. See comment
43(d)(5)(i)-5.iii.
Proposed comment 43(d)(5)(i)-5 then states that, to calculate the
non-standard mortgage payment that must be compared to the standard
mortgage payment under Sec. 226.43(d)(1)(ii), the creditor must use--
The outstanding principal balance as of March 1, 2013,
assuming all scheduled payments have been made up to March 1, 2013, and
the last payment due under the fixed rate terms is made and credited on
March 1, 2013. In this example, the outstanding principal balance is
$193,948.
The fully indexed rate of 7.5%, which is the index value
of 4.5% as of March 15, 2012 (the date on which the application for a
refinancing is received) plus the margin of 3%.
The remaining loan term as of March 1, 2013, the date of
the recast, which is 28 years (336 payments).
See comment 43(d)(5)(i)-5.iv.
The comment concludes by stating that, based on the assumptions
above, the monthly payment for the non-standard mortgage for purposes
of determining whether the standard mortgage monthly payment is lower
than the non-standard mortgage monthly payment (see proposed Sec.
226.43(d)(1)(ii)) is $1,383. This is the substantially equal, monthly
payment of principal and interest required to repay the outstanding
principal balance at the fully-indexed rate over the remaining term.
See comment 43(d)(5)(i)-5.v.
Payment calculation for an interest-only loan. Proposed comments
43(d)(5)(i)-6 and -7 explain the payment calculation for an interest-
only loan under proposed Sec. 226.43(d)(5)(i). Proposed comment
43(d)(5)(i)-6 clarifies that the monthly periodic payment for an
interest-only loan must be calculated based on several assumptions.
First, the payment must be based on the loan amount, as defined in
Sec. 226.43(b)(5) (for a loan on which only interest and no principal
has been paid, the ``loan amount'' will be the outstanding principal
balance at the time of the recast), assuming all scheduled payments are
made under the terms of the legal obligation in effect before the
mortgage is recast. The comment provides an example of a mortgage with
a 30-year loan term for which the first 24 months of payments are
interest-only. The comment then explains that, if the 24th payment is
due on September 1, 2013, the creditor must calculate the outstanding
principal balance as of September 1, 2013, assuming that all 24
payments under the interest-only payment terms have been made and
credited. See comment 43(d)(5)(i)-6.i.
Second, the payment calculation must be based on substantially
equal monthly payments of principal and interest that will fully repay
the loan amount over the term of the loan remaining as of the date the
loan is recast. Thus, in the example above, the creditor must assume a
loan term of 28 years (336 payments). See comment 43(d)(5)(i)-6.ii.
Third, the payment must be based on the fully indexed rate, as defined
in Sec. 226.43(b)(3), as of the date of the written application for
the standard mortgage. See comment 43(d)(5)(i)-6.iii.
Proposed comment 43(d)(5)(i)-7 provides an illustration of the
payment calculation for an interest-only loan. The example assumes a
loan in an amount of $200,000 that has a 30-year loan term. The loan
agreement provides for a fixed interest rate of 7%, and permits
interest-only payments for the first two years (the first 24 payments),
after which time amortizing payments of principal and interest are
required. See comment 43(d)(5)(i)-7.i. Second, the example states that
the non-standard mortgage is consummated on February 15, 2011, and the
first monthly payment is due on April 1, 2011. The loan is
[[Page 27451]]
recast on the due date of the 24th monthly payment, which is March 1,
2013. See comment 43(d)(5)(i)-7.ii. Finally, the example assumes that
on March 15, 2012, the creditor receives the consumer's written
application for a refinancing, after the consumer has made 12 monthly
on-time payments. See comment 43(d)(5)(i)-7.iii.
Proposed comment 43(d)(5)(i)-7 then states that, to calculate the
non-standard mortgage payment that must be compared to the standard
mortgage payment under Sec. 226.43(d)(1)(ii), the creditor must use--
The loan amount, which is the outstanding principal
balance as of March 1, 2013, assuming all scheduled interest-only
payments have been made and credited up to that date. In this example,
the loan amount is $200,000.
An interest rate of 7%, which is the interest rate in
effect at the time of consummation of this fixed-rate non-standard
mortgage.
The remaining loan term as of March 1, 2013, the date of
the recast, which is 28 years (336 payments).
The comment concludes by stating that, based on the assumptions
above, the monthly payment for the non-standard mortgage for purposes
of determining whether the standard mortgage monthly payment is lower
than the non-standard mortgage monthly payment (see Sec.
226.43(d)(1)(ii)) is $1,359. This is the substantially equal, monthly
payment of principal and interest required to repay the loan amount at
the fully-indexed rate over the remaining term. See comment
43(d)(5)(i)-7.v.
Payment calculation for a negative amortization loan. Proposed
comments 43(d)(5)(i)-8 and -9 explain the payment calculation for a
negative amortization loan under proposed Sec. 226.43(d)(5)(i)(C).
Proposed comment 43(d)(5)(i)-8 clarifies that the monthly periodic
payment for a negative amortization loan must be calculated based on
several assumptions. First, the calculation must be based on the
maximum loan amount, as defined in proposed Sec. 226.43(b)(7); The
comment further states that examples of how to calculate the maximum
loan amount are provided in proposed comment 43(b)(7)-3 (see the
section-by-section analysis of Sec. 226.43(b)(7), above). See comment
43(d)(5)(i)-8.i.
Second, the payment calculation must be based on substantially
equal monthly payments of principal and interest that will fully repay
the maximum loan amount over the term of the loan remaining as of the
date the loan is recast. For example, the comment states, if the loan
term is 30 years and the loan is recast on the due date of the 60th
monthly payment, the creditor must assume a loan term of 25 years (300
payments). See comment 43(d)(5)(i)-8.ii. Third, the payment must be
based on the fully-indexed rate as of the date of the written
application for the standard mortgage. See comment 43(d)(5)(i)-8.iii.
Proposed comment 43(d)(5)(i)-9 provides an illustration of the
payment calculation for a negative amortization loan. The example
assumes loan in an amount of $200,000 that has a 30-year loan term. The
loan agreement provides that the consumer can make minimum monthly
payments that cover only part of the interest accrued each month until
the date on which the principal balance increases to the negative
amortization cap of 115% of the loan amount, or for the first five
years of monthly payments (60 payments), whichever occurs first. The
loan is an adjustable-rate mortgage that adjusts monthly according to a
specified index plus a margin of 3.5%. See comment 43(d)(5)(i)-9.i.
The example also states that the non-standard mortgage is
consummated on February 15, 2011, and the first monthly payment is due
on April 1, 2011. Further, the example assumes that, based on the
calculation of the maximum loan amount required under Sec.
226.43(b)(7) and associated commentary, the negative amortization cap
of 115% is reached on July 1, 2013, the due date of the 28th monthly
payment (i.e., before the 60th payment is due). See comment
43(d)(5)(i)-9.ii. Finally, the example assumes that on March 15, 2012,
the creditor receives the consumer's written application for a
refinancing, after the consumer has made 12 monthly on-time payments.
On this date, the index value is 4.5%. See comment 43(d)(5)(i)-9.iii.
Proposed comment 43(d)(5)(i)-9 then states that, to calculate the
non-standard mortgage payment that must be compared to the standard
mortgage payment under Sec. 226.43(d)(1)(ii), the creditor must use--
The maximum loan amount of $229,243 as of July 1, 2013.
The fully indexed rate of 8%, which is the index value of
4.5% as of March 15, 2012 (the date on which the creditor receives the
application for a refinancing) plus the margin of 3.5%.
The remaining loan term as of July 1, 2013, the date of
the recast, which is 27 years and 8 months (332 monthly payments).
See comment 43(d)(5)(i)-9.iv.
The comment concludes by stating that, based on the assumptions
above, the monthly payment for the non-standard mortgage for purposes
of determining whether the standard mortgage monthly payment is lower
than the non-standard mortgage monthly payment (see Sec.
226.43(d)(1)(ii)) is $1,717. This is the substantially equal, monthly
payment of principal and interest required to repay the maximum loan
amount at the fully-indexed rate over the remaining term. See comment
43(d)(5)(i)-9.v.
The Board requests comment on the proposed payment calculation for
a non-standard mortgage and on the appropriateness and usefulness of
the proposed payment calculation examples.
43(d)(5)(ii) Standard Mortgage Payment Calculation
Proposed Sec. 226.43(d)(5)(ii) prescribes the required calculation
for the monthly payment on a standard mortgage that must be compared to
the monthly payment on a non-standard mortgage under proposed Sec.
226.43(d)(1)(ii). The same payment calculation must also be used by
creditors of refinances under proposed Sec. 226.43(d) in determining
whether the consumer has a reasonable ability to repay the standard
mortgage, as required under proposed Sec. 226.43(c)(2)(ii).
Specifically, the monthly payment for a standard mortgage must be
based on substantially equal, monthly, fully amortizing payments using
the maximum interest rate that may apply to the standard mortgage
within the first five years after consummation. Proposed comment
43(d)(5)(ii)-1 clarifies that the meaning of ``fully amortizing
payment'' is defined in Sec. 226.43(b)(2), discussed above, and that
guidance regarding the meaning of ``substantially equal'' may be found
in proposed comment 43(c)(5)(i)-4, also discussed above. Proposed
comment 43(d)(5)(ii)-1 also explains that, for a mortgage with a
single, fixed rate for the first five years, the maximum rate that will
apply during the first five years after consummation will be the rate
at consummation. For a step-rate mortgage, however, which is a type of
fixed-rate mortgage, the rate that must be used is the highest rate
that will apply during the first five years after consummation. For
example, if the rate for the first two years is 4%, the rate for the
second two years is 5%, and the rate for the next two years is 6%, the
rate that must be used is 6%.
Proposed comment 43(d)(5)(ii)-2 provides an illustration of the
payment calculation for a standard mortgage. The example assumes a loan
in an amount of $200,000 with a 30-year loan term. The loan agreement
provides for a discounted interest rate of 6% that is fixed for an
initial period of five years,
[[Page 27452]]
after which time the interest rate will adjust annually based on a
specified index plus a margin of 3%, subject to a 2% annual interest
rate adjustment cap. The comment states that, based on the above
assumptions, the creditor must determine whether the standard mortgage
payment is materially lower than the non-standard mortgage payment
based on a standard mortgage payment of $1,199. This is the
substantially equal, monthly payment of principal and interest required
to repay $200,000 over 30 years at an interest rate of 6%.
The Board requests comment on the proposed payment calculation for
a standard mortgage.
43(e) Qualified Mortgages
Background
The Dodd-Frank Act. TILA Section 129C(a)(1) prohibits a creditor
from making a residential mortgage loan unless the creditor makes a
reasonable and good faith determination, based on verified and
documented information, that the consumer has a reasonable ability to
repay the loan. TILA Section 129C(a)(1)-(4) and (6)-(9) provides that
the ability-to-repay determination must be based on consideration of
the following underwriting factors:
The consumer's current income, expected income the
consumer is reasonably ensured of receiving, and other financial
resources other than the consumer's equity in the dwelling or real
property that secures repayment of the loan;
The consumer's employment status;
The payment of the residential mortgage loan based on a
fully amortizing payment schedule and the fully-indexed rate;
The payment of any simultaneous liens of which the
creditor knows or has reason to know;
The payment of all applicable taxes, insurance (including
mortgage guarantee insurance), and assessments;
The consumer's current obligations;
The consumer's debt-to-income ratio or the residual income
the consumer will have after paying mortgage related obligations and
current debt obligations; and
The consumer's credit history.
The ability-to-repay requirements do not contain any limits on the
features, term, or costs of the loan.
TILA Section 129C(b) provides a presumption of compliance with the
ability-to-repay requirements if the loan is a ``qualified mortgage.''
Specifically, TILA Section 129C(b)(1) provides that ``[a]ny creditor
with respect to any residential mortgage loan, and any assignee of such
loan subject to liability under this title, may presume that the loan
has met the requirements of subsection (a).'' With respect to
underwriting requirements, TILA Section 129C(b)(2) defines a
``qualified mortgage'' as any residential mortgage loan--
For which the income and financial resources relied upon
to qualify the obligors on the loan are verified and documented;
For which the underwriting of the residential mortgage
loan is based on a fully amortizing payment schedule and the maximum
interest rate during the first 5 years, and takes into account all
applicable taxes, insurance, and assessments; and
That complies with any guidelines or regulations
established by the Board relating to ratios of total monthly debt to
monthly income or alternative measures of ability to pay regular
expenses after payment of total monthly debt, taking into account the
income levels of the borrower and such other factors as the Board may
determine relevant and consistent with the purposes of TILA Section
129C(b)(3)(B)(i).
In addition, the term ``qualified mortgage'' contains certain
limits on the features, term, and costs of the loan. Specifically, TILA
Section 129C(b) provides that a ``qualified mortgage'' is any
residential mortgage loan--
For which the regular periodic payments may not result in
an increase of the principal balance (negative amortization) or allow
the consumer to defer repayment of principal (interest-only payments);
The terms of which do not result in a balloon payment;
For which the loan term does not exceed 30 years; and
For which the points and fees do not exceed 3 percent of
the total loan amount.
Accordingly, a qualified mortgage cannot have an increase of the
principal balance, interest-only payments, balloon payments, a term
greater than 30 years, or points and fees that exceed the threshold set
forth in Sec. 226.43(e)(4). However, while the term ``qualified
mortgage'' limits the terms of loans in ways that the general ability-
to-repay requirements do not, the term ``qualified mortgage'' omits
certain underwriting factors. Specifically, the term ``qualified
mortgage'' does not include the following underwriting factors that are
part of the ability-to-repay requirements:
The consumer's employment status;
The payment of any simultaneous liens of which the
creditor knows or has reason to know;
The consumer's current obligations; and
The consumer's credit history.
2008 HOEPA Final Rule. Sections 226.34(a)(4) and 226.35(b)(1)
prohibit a creditor from extending credit that is a high-cost loan or
higher-priced mortgage loan without regard to the consumer's ability to
repay. Specifically, for higher-priced mortgage loans and high-cost
mortgages, the creditor must follow required procedures, such as
verifying the consumer's income or assets. Section 226.34(a)(4) and
comments 34(a)(4)-2 and -3. The 2008 HOEPA Final Rule further provides
a presumption of compliance with the ability-to-repay requirements if
the creditor follows additional optional procedures regarding
underwriting the loan payment, assessing the debt-to-income ratio or
residual income, and limiting the features of the loan. Section
226.34(a)(4)(iii)-(iv) and comment 34(a)(4)(iii)-1. However, the 2008
HOEPA Final Rule makes clear that even if the creditor follows the
required and optional criteria, the creditor has merely obtained a
presumption of compliance with the repayment ability requirement.
Comment 34(a)(4)(iii)-1. The consumer can still rebut or overcome that
presumption by showing that, despite following the required and
optional procedures, the creditor nonetheless disregarded the
consumer's ability to repay the loan. For example, the consumer could
present evidence that although the creditor assessed the creditor's
debt-to-income ratio, the debt-to-income ratio was very high with
little residual income. This evidence may be sufficient to overcome the
presumption of compliance and demonstrate that the creditor extended
credit without regard to the consumer's ability to repay the loan.
Qualified Mortgages and the Presumption of Compliance
With regard to the ability-to-repay requirement, the Dodd-Frank Act
provides special protection from liability for creditors who make
``qualified mortgages.'' However, it is unclear whether that protection
is intended to be a safe harbor or a presumption of compliance with the
ability-to-repay requirement. An analysis of the statutory construction
and policy implications demonstrate that there are sound reasons for
adopting either interpretation. For this reason, the Board is proposing
two alternative definitions of a ``qualified mortgage'': One that
operates as a safe harbor and one that operates as a presumption of
compliance.
[[Page 27453]]
With respect to statutory construction, on the one hand, the Dodd-
Frank Act states that a creditor or assignee ``may presume'' that a
loan has met the repayment ability requirement if the loan is a
qualified mortgage. TILA Section 129C(b)(1). This suggests that
originating a qualified mortgage provides a presumption of compliance,
which the consumer can rebut by providing evidence that the creditor
did not, in fact, make a good faith and reasonable determination of the
consumer's ability to repay the loan.
On the other hand, the statutory structure suggests that the
``qualified mortgage'' is an alternative to the general ability-to-
repay standard and thus would operate as a safe harbor. First, TILA
Section 129C(b)(1) states that a creditor or assignee may presume that
a loan has ``met the requirements of subsection (a), if the loan is a
qualified mortgage.'' TILA Section 129C(a) contains the ability-to-
repay requirement as well as all of the underwriting criteria for the
general ability-to-repay standard. Rather than stating that the
presumption of compliance applies only to TILA Section 129C(a)(1) for
the ability-to-repay requirement, it appears Congress intended
creditors who make qualified mortgages to be presumed to comply with
both the ability-to-repay requirement and the underwriting criteria for
the general ability-to-repay standard. Second, TILA Section 129C(b)(2)
does not define a ``qualified mortgage'' as requiring compliance with
all of the underwriting criteria of the general ability-to-repay
standard. Therefore, unlike the approach found in the 2008 HOEPA Final
Rule, it appears that the criteria for a ``qualified mortgage'' would
be an alternative to the general ability-to-repay standard, rather than
an addition to that standard.
With respect to the policy implications, there are sound reasons
for interpreting a qualified mortgage as providing either a safe harbor
or a presumption of compliance. On the one hand, interpreting a
``qualified mortgage'' as a safe harbor would provide creditors with an
incentive to make qualified mortgages. That is, in exchange for
limiting loan fees and features, the creditor's regulatory burden and
exposure to liability would be reduced. Consumers may benefit by being
provided with mortgage loans that do not have certain risky features or
high costs.
However, there are at least two drawbacks to the ``safe harbor''
approach. First, the definition of a ``qualified mortgage'' is not
necessarily consistent with ensuring the consumer's ability to repay
the loan. Some of the key elements in the statutory definition of a
qualified mortgage, while designed to ensure that qualified mortgages
do not contain risky features, do not directly address whether a
qualified mortgage is affordable for a particular borrower. Although
the qualified mortgage limits on loan terms and costs may, in general,
tend to make loans more affordable (in part because loan terms would be
more transparent to consumers thus enabling consumers to more easily
determine affordability for themselves), the limits on loan terms and
costs would not ensure that a given consumer could necessarily afford a
particular loan. Second, the ``safe harbor'' approach would limit the
consumer's ability to challenge a creditor's determination of repayment
ability. That is, creditors could not be challenged for failing to
underwrite the loan based on the consumer's employment status,
simultaneous loans, current debt obligations, or credit history, or for
generally not making a reasonable and good faith determination of the
consumer's ability to repay the loan.
On the other hand, interpreting a ``qualified mortgage'' as
providing a rebuttable presumption of compliance would better ensure
that creditors consider a consumer's ability to repay the loan.
Creditors would have to make individualized determinations that the
consumer has the ability to repay the loan based on all of the
underwriting factors listed in the general ability-to-repay standard.
This approach would require the creditor to comply with all of the
ability-to-repay standards, and preserve the consumer's ability to use
these standards in a defense to foreclosure or other legal action. In
addition, a consumer could assert that, despite complying with the
criteria for a qualified mortgage and the ability-to-repay standard,
the creditor did not make a reasonable and good faith determination of
the consumer's ability to repay the loan.
The drawback of treating a ``qualified mortgage'' as providing a
presumption of compliance is that it provides little legal certainty
for the creditor, and thus little incentive to make a ``qualified
mortgage,'' which limits loan fees and features. As stated above, the
underwriting requirements found in the general repayment ability rule
are based on individualized determinations that will vary from consumer
to consumer. As such, creditors or assignees may not be able to make
bright-line judgments as to whether or not a loan complies with these
underwriting requirements. In many cases sound underwriting practices
require judgment about the relative weight of various risk factors
(such as the tradeoff between a consumer's credit history and debt-to-
income ratio). These decisions are usually based on complex statistical
default models or lender judgments, which will differ across
originators and over time. While the Board's proposal would allow
creditors to look to widely accepted underwriting standards in
complying with the general ability-to-repay standard, those standards
may leave room for the exercise of discretion and judgment by creditors
and loan originators which could increase potential compliance and
litigation risk, thus weakening the incentive to make qualified
mortgages (even with a presumption of compliance for qualified
mortgages). As stated above, a violation of the ability-to-repay
requirement now provides a consumer with a defense to foreclosure for
an unlimited amount of time. Dodd-Frank Act Section 1413; TILA Section
130(k).
The Board's Proposal
Given the statutory ambiguity and competing concerns described
above, the Board proposes two alternative definitions for a qualified
mortgage. Under Alternative 1, a qualified mortgage would include only
the specific requirements listed in TILA Section 129C(b)(2), and would
provide creditors with a safe harbor to establish compliance with the
general repayment ability requirement in proposed Sec. 226.43(c)(1).
That is, a consumer would have to show that a loan was not a qualified
mortgage under Sec. 226.43(e) (e.g., that the loan permits negative
amortization) in order to assert that the loan violated the repayment
ability requirement under Sec. 226.43(c). Under Alternative 2, a
qualified mortgage would include the specific requirements listed in
the TILA Section 129C(b)(2), as well as additional requirements taken
from the proposed general ability-to-repay standard in Sec.
226.43(c)(2)-(7). Because Alternative 2 would require compliance with
the general ability-to-repay standard, it would provide a presumption
of compliance with the ability-to-repay requirement. However, as
discussed more fully below, a consumer would be able to rebut the
presumption of compliance (even if the loan was a qualified mortgage)
by demonstrating that the creditor did not adequately determine the
consumer's ability to repay the loan.
[[Page 27454]]
43(e)(1) In General
ALTERNATIVE 1
Proposed Sec. 226.43(e)(1) would implement TILA Section 129C(b)(1)
and state that the creditor or assignee complies with Sec.
226.43(c)(1) if the covered transaction is a qualified mortgage, as
defined in Sec. 226.43(e)(2). Proposed Sec. 226.43(e)(2) would
implement TILA Section 129C(b)(2), and state that a ``qualified
mortgage'' is a covered transaction--
That provides for regular periodic payments that do not--
[cir] Result in an increase of the principal balance (negative
amortization);
[cir] Allow the consumer to defer repayment of principal (i.e.,
interest-only payments); or
[cir] Result in a balloon payment;
For which the loan term does not exceed 30 years;
For which the total points and fees payable in connection
with the loan do not exceed the threshold set forth in Sec.
226.43(e)(3);
For which the creditor underwrites the loan using the
following method:
[cir] The creditor uses a periodic payment of principal and
interest based on the maximum interest rate that may apply during the
first 5 years after consummation;
[cir] The periodic payments of principal and interest would fully
repay either the loan amount over the loan term; or the outstanding
principal balance as of the date the interest rate adjusts to the
maximum interest rate;
[cir] The creditor takes into account any mortgage-related
obligations; and
For which the creditor considers and verifies the
consumer's current or reasonably expected income or assets.
Alternative 1 would construe the statutory text to provide
creditors with bright-line standards as an incentive to make loans
without certain risky features and high costs. The statutory definition
of a ``qualified mortgage'' includes only items which would allow
creditors and assignees to easily and efficiently verify whether or not
a loan is a ``qualified mortgage.'' By confining the qualified mortgage
definition to certain loan terms, features, and costs, and by requiring
only that the loan be underwritten based on certain straightforward
assumptions and using verified information about the consumer's income
or assets, creditors and assignees can obtain a high degree of
certainty that a loan is a qualified mortgage. Moreover, by clarifying
that a qualified mortgage is a safe harbor for compliance with the
general repayment ability rule, Alternative 1 would provide creditors
and assignees with the highest level of certainty about potential legal
and compliance risks and, concomitantly, the strongest incentive to
make qualified mortgages.
Accordingly, proposed comment 43(e)(1)-1-Alternative 1 would
clarify that a creditor assignee complies with Sec. 226.43(c)(1) if a
covered transaction meets the conditions for a ``qualified mortgage''
under Sec. 226.43(e)(2) (or Sec. 226.43(f), if applicable). That is,
a creditor or assignee need not demonstrate compliance with Sec.
226.43(c)(2)-(7) if the terms of the loan comply with Sec.
226.43(e)(2)(i)-(ii) (or Sec. 226.43(f), if applicable); the loan's
points and fees do not exceed the limits set forth in Sec.
226.43(e)(2)(iii); and the creditor has complied with the underwriting
criteria described in Sec. 226.43(e)(2)(iv)-(v) (or Sec. 226.43(f),
if applicable). The consumer may show the loan is not a qualified
mortgage with evidence that the terms, points and fees, or underwriting
not comply with Sec. 226.43(e)(2) (or Sec. 226.43(f), if applicable).
If a loan is not a qualified mortgage (for example because the loan
provides for negative amortization), then the creditor or assignee must
demonstrate that loan complies with all of the requirements in Sec.
226.43(c) (or Sec. 226.43(d), if applicable).
Debt-to-income ratio and residual income. While consideration of a
consumer's debt-to-income ratio is required under the general ability-
to-repay standard, TILA Section 129C(b)(2)(A)(vi) provides that
qualified mortgages must comply with any guidelines or regulations
established by the Board for the consumer's DTI ratio or residual
income. For several reasons, under Alternative 1 the Board is not
proposing to require creditors to consider the consumer's debt-to-
income ratio or residual income to make a qualified mortgage. First,
the debt-to-income ratio and residual income are based on widely
accepted standards, which, although flexible, do not provide certainty
that a loan is a qualified mortgage. Congress seems to have intended to
provide incentives to creditors to make qualified mortgages, since they
have less risky terms and features. Second, because the definition of a
qualified mortgage under Alternative 1 would not require consideration
of current debt obligations or simultaneous loans, it would be
impossible for a creditor to calculate the debt-to-income ratio or
residual income without adding those requirements as well. Third, data
show that the debt-to-income ratio generally does not have significant
predictive power of loan performance once the effects of credit
history, loan type, and loan-to-value ratio are considered.\66\ Fourth,
although consideration of the mortgage debt-to-income ratio, the so-
called ``front-end debt-to-income ratio,'' might help ensure that
consumers receive loans on terms that reasonably reflect their ability
to repay the loans, Board outreach indicated that creditors often do
not find that the ``front-end debt-to-income ratio'' is a strong
predictor of ability to repay.
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\66\ See Demyanyk Yuliya & Van Hemert, Otto Understanding the
Subprime Mortgage Crisis, The Review of Financial Studies (2009);
Berkovec, James A., Canner, Glenn B., Gabriel, Stuart A., and
Hannan, Timothy H., Race, Redlining, and Residential Mortgage Loan
Performance. The Journal of Real Estate Finance and Economics
(2004).
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Finally, the Board is concerned that the benefit of including the
debt-to-income ratio or residual income in the definition of
``qualified mortgage'' may not outweigh the cost to certain consumers.
In some cases, consumers may not meet widely accepted debt-to-income
ratio standards, but may have other compensating factors, such as
sufficient residual income or other resources, to be able to reasonably
to afford mortgage payments. A definition of ``qualified mortgage''
that required creditors to consider the consumer's debt-to-income ratio
or residual income could limit the availability of credit to those
consumers. While some creditors may be willing to take on the potential
compliance costs associated with considering compensating factors,
other creditors may choose not to extend qualified mortgages to
consumers who do not meet the creditor's specific thresholds.
ALTERNATIVE 2
Under Alternative 2, a qualified mortgage would include the
requirements in proposed Sec. 226.43(e)(2)-Alternative 1, as well as
additional ability-to-repay requirements. Specifically, proposed Sec.
226.43(e)(2)(v)-Alternative 2 would require the creditor (by a cross-
reference to the creditor's obligations in Sec. 226.43(c)) to consider
the following under the ability-to-repay requirements: (1) The
consumer's employment status, (2) any simultaneous loans, (3) the
consumer's current debt obligations, and (4) the consumer's credit
history. Proposed Sec. 226.43(e)(1)-Alternative 2 would implement TILA
Section 129C(b)(1), and state that a creditor or assignee of a covered
transaction is presumed to have complied with the repayment ability
requirement of Sec. 226.43(c)(1) if the covered transaction is a
qualified mortgage, as defined in Sec. 226.43(e)(2).
[[Page 27455]]
As discussed further below, the Board proposes these revisions to
the definition of a ``qualified mortgage'' under its authority under
TILA Section 129C(b)(3)B)(i). The Board believes this alternative
definition would further the purpose of TILA Section 129C by requiring
creditors to consider specific underwriting criteria to ensure a
consumer's ability to repay a qualified mortgage. In addition, proposed
Sec. 226.43(e)(2)(v)-Alternative 2 implements TILA Section
129C(b)(2)(vi) by requiring creditors to consider the consumer's
monthly debt-to-income ratio or residual income, as provided in
proposed Sec. 226.43(c)(2)(vii).
Proposed comment 43(e)(1)-1-Alternative 2 provides that a creditor
or assignee is presumed to have complied with the requirement of Sec.
226.43(c)(1) if the terms of the loan comply with Sec.
226.43(e)(2)(i)-(ii) (or Sec. 226.43(f), if applicable); the loan's
points and fees do not exceed the limit set forth in Sec.
226.43(e)(2)(iii); and the creditor has complied with the underwriting
criteria described in Sec. 226.43(e)(2)(iv)-(v) (or Sec. 226.43(f),
if applicable). If the loan is not a qualified mortgage (for example,
because the loan provides for negative amortization), then the creditor
or assignee must demonstrate that the loan complies with all of the
requirements of Sec. 226.43(c) (or Sec. 226.43(d), if applicable).
However, even if the loan is a qualified mortgage, the consumer may
rebut the presumption of compliance with evidence that the loan did not
comply with Sec. 226.43(c)(1). For example, evidence of a debt-to-
income ratio with no compensating factors, such as adequate residual
income, could be used to rebut the presumption. The Board solicits
comment on this approach.
The Board solicits comments on the two proposed alternative
definitions of a qualified mortgage, or other alternative definitions.
The Board specifically solicits comment, including supporting data, on
what criteria should be included in the definition of a qualified
mortgage to ensure that the definition provides an incentive to
creditors to make qualified mortgages, while also ensuring that
consumers have the ability to repay qualified mortgages.
43(e)(2) Qualified Mortgage Defined
Proposed Sec. 226.43(e)(2) implements TILA Section 129C(b)(2) and
states that a ``qualified mortgage'' is a covered transaction--
That provides for regular periodic payments that do not:
[cir] Result in an increase of the principal balance (i.e.,
negative amortization);
[cir] Allow the consumer to defer repayment of principal (i.e.,
interest-only payments); or
[cir] Result in a balloon payment;
For which the loan term does not exceed 30 years;
For which the total points and fees payable in connection
with the loan do not exceed the threshold set forth in Sec.
226.43(e)(3);
For which the creditor underwrites the loan using the
following method:
[cir] The creditor uses a periodic payment of principal and
interest based on the maximum interest rate that may apply during the
first 5 years after consummation;
[cir] The periodic payments of principal and interest would fully
repay either the loan amount over the loan term; or the outstanding
principal balance as of the date the interest adjusts to the maximum
interest rate;
[cir] The creditor takes into account any mortgage-related
obligations; and
For which the creditor considers and verifies the
consumer's current or reasonably expected income or assets.\67\
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\67\ As discussed below in this section-by-section analysis, in
certain limited situations, a creditor may comply with the
requirements of Sec. 226.43(f) instead of certain requirements
Sec. 226.43(e).
---------------------------------------------------------------------------
43(e)(2)(i) Limits on Periodic Payments
TILA Section 129C(b)(2)(A)(i) states that the regular periodic
payments of a qualified mortgage may not result in an increase of the
principal balance or allow the consumer to defer repayment of principal
(except for certain balloon-payment loans, discussed below in the
section-by-section analysis for Sec. 226.43(f)). TILA Section
129C(b)(2)(A)(ii) states that the terms of a qualified mortgage may not
include a balloon payment (except for certain balloon-payment loans,
discussed below in the section-by-section analysis for Sec.
226.43(f)). The statute defines ``balloon payment'' as ``a scheduled
payment that is more than twice as large as the average of earlier
scheduled payments.''
Proposed Sec. 226.43(e)(2)(i) implements TILA Sections
129C(b)(2)(A)(i) and (ii). First, the proposed provision requires that
a qualified mortgage provide for regular periodic payments. Proposed
comment 43(e)(2)(i)-1 clarifies that, for this reason, a single-payment
transaction, where no payment of principal or interest is required
until maturity, may not be a qualified mortgage. Second, proposed Sec.
226.43(e)(2)(i) provides that the regular periodic payments may not (1)
result in an increase of the principal balance; (2) allow the consumer
to defer repayment of principal, except as provided in Sec. 226.43(f),
discussed below; or (3) result in a balloon payment, as defined in
Sec. 226.18(s)(5)(i), except as provided in Sec. 226.43(f), discussed
below.
Proposed comment 43(e)(2)(i)-1 explains that, as a consequence of
the foregoing prerequisites, a qualified mortgage must require the
consumer to make payments of principal and interest, on a monthly or
other periodic basis, that will fully repay the loan amount over the
loan term. These periodic payments must be substantially equal except
for the effect that any interest rate change after consummation has on
the payment amount in the case of an adjustable-rate or step-rate
mortgage. The proposed comment also notes that, because Sec.
226.43(e)(2)(i) requires that a qualified mortgage provide for regular,
periodic payments, a single-payment transaction may not be a qualified
mortgage. This result would prevent potential evasion, as a creditor
otherwise could structure a transaction with a single payment due at
maturity (economically, a near equivalent to a balloon-payment loan)
that technically would not be a balloon payment as defined in Sec.
226.18(s)(5)(i) because it is not more than two times a regular
periodic payment.
Proposed comment 43(e)(2)(i)-2 provides additional guidance on the
requirement in proposed Sec. 226.43(e)(2)(i)(B) that a qualified
mortgage may not allow the consumer to defer repayment of principal.
The comment clarifies that, in addition to interest-only terms,
deferred principal repayment also occurs if the payment is applied to
both accrued interest and principal but the consumer makes periodic
payments that are less than the amount that would be required under a
payment schedule that has substantially equal payments that fully repay
the loan amount over the loan term. Graduated payment mortgages, for
example, allow deferral of principal repayment in this manner and
therefore may not be qualified mortgages.
As noted above, the statute defines ``balloon payment'' as ``a
scheduled payment that is more than twice as large as the average of
earlier scheduled payments.'' Proposed Sec. 226.43(e)(2)(i)(C) cross-
references Regulation Z's existing definition of ``balloon payment'' in
Sec. 226.18(s)(5)(i). That definition provides that a balloon payment
is ``a payment that is more than two times a regular periodic
payment.'' This definition is substantially similar to the statutory
one, except that it uses as its benchmark any regular periodic payment
rather than the average of earlier scheduled payments.
[[Page 27456]]
The Board believes that, because a qualified mortgage generally
must provide for substantially equal, fully amortizing payments of
principal and interest, a payment that is greater than twice any one of
a loan's regular periodic payments also generally will be greater than
twice the average of its earlier scheduled payments. Thus, the Board
believes that the difference in wording between the statutory
definition and the existing regulatory definition, as a practical
matter, does not yield a significant difference in what constitutes a
``balloon payment'' in the qualified mortgage context. Accordingly, in
the interest of facilitating compliance by affording creditors a single
definition within Regulation Z, the Board is proposing to cross-
reference Sec. 226.18(s)(5)(i)'s definition of ``balloon payment'' in
Sec. 226.43(e)(2)(i)(C). The Board proposes this adjustment to the
statutory definition pursuant to its authority under TILA Section
105(a) to make such adjustments for all or any class of transactions as
in the judgment of the Board are necessary or proper to facilitate
compliance with TILA. 15 U.S.C. 1604(a). The class of transactions for
which this adjustment is proposed is all covered transactions, i.e.,
closed-end consumer credit transactions that are secured by a dwelling.
The Board solicits comment on the appropriateness of this proposed
adjustment to the definition of ``balloon payment.'' This approach is
further supported by the Board's authority under TILA Section 129B(e)
to condition terms, acts or practices relating to residential mortgage
loans that the Board finds necessary or proper to facilitate
compliance. 15 U.S.C. 1639b(e).
The Board recognizes that some balloon-payment loans are renewable
at maturity. Such loans might appropriately be eligible to be qualified
mortgages, provided the terms for renewal eliminate the risk of the
consumer facing a large, unaffordable payment obligation, which
underlies the rationale for generally excluding balloon-payment loans
from the definition of qualified mortgages. If the consumer is
protected by the terms of the transaction from that risk, such a
transaction might appropriately be treated as though it effectively is
not a balloon-payment loan even if it is technically structured as one.
Accordingly, the Board solicits comment on whether it should
include an exception providing that, notwithstanding Sec.
226.43(e)(2)(i)(C), a qualified mortgage may provide for a balloon
payment if the creditor is unconditionally obligated to renew the loan
at the consumer's option (or is obligated to renew subject to
conditions within the consumer's control). The Board also seeks comment
on how such an exception should be structured to ensure that the large-
payment risk ordinarily accompanying a balloon-payment loan is fully
eliminated by the renewal terms. For example, the exception might
provide that the balloon-payment loan must be renewable on terms that
either (1) do not include a balloon payment; or (2) obligate the
creditor unconditionally (or subject to conditions within the
consumer's control) to renew the loan again upon expiration of each
renewed loan term, and the loan term resulting from such multiple
renewals is at least equal to the amortization period of the loan.
Finally, the Board recognizes that such an exception could enable a
creditor to circumvent the prohibition on qualified mortgages providing
for balloon payments by structuring a balloon-payment loan as
unconditionally renewable but with new terms that effectively render
the loan as renewed unaffordable for the consumer, such as a
substantially greater interest rate. The Board seeks comment on how
such an exception might be structured to avoid the potential for such
circumvention.
43(e)(2)(ii) Loan Term
TILA Section 129C(b)(2)(A)(viii) requires that a qualified mortgage
must not provide for a loan term that exceeds 30 years, ``except as
such term may be extended under paragraph (3), such as in high-cost
areas.'' Under TILA Section 129C(b)(3)(B)(i), the Board is authorized
``to revise, add to, or subtract from the criteria that define a
qualified mortgage upon a finding that such regulations are necessary
or proper to ensure that responsible, affordable mortgage credit
remains available to consumers in a manner consistent with the purposes
of this section, necessary and appropriate to effectuate the purposes
of this section and section 129B, to prevent circumvention or evasion
thereof, or to facilitate compliance with such sections.''
Proposed Sec. 226.43(e)(2)(ii) implements the 30-year maximum loan
term without any exception. Based on information available through
outreach and data analysis, the Board believes that mortgage loans with
terms greater than 30 years are rare and, when made, generally are for
the convenience of customers who could qualify for a loan with a 30-
year term but prefer to spread out their payments further. Therefore,
the Board believes such an exception generally is not necessary ``to
ensure that responsible, affordable mortgage credit remains available
to consumers'' in ``high-cost areas.'' This belief is in contrast with
the Board's proposal to implement TILA Section 129C(a)(6)(E) concerning
refinancing of an existing hybrid loan into a standard loan, in
proposed Sec. 226.43(d). As discussed in more detail above, proposed
Sec. 226.43(d)(2) provides an exemption from certain repayment ability
requirements when a creditor refinances a non-standard mortgage into a
standard mortgage. Proposed Sec. 226.43(d)(4)(ii)(C) permits a
standard mortgage to have a loan term of up to 40 years. The Board
believes that a 40-year loan term may be necessary to ensure affordable
mortgage credit remains available for a refinancing that is being
extended specifically to prevent a likely default, as provided in
proposed Sec. 226.43(d)(2)(i)(B).
The Board solicits comment on whether there are any ``high-cost
areas'' in which loan terms in excess of 30 years are necessary to
ensure that responsible, affordable credit is available and, if so, how
they should be identified for purposes of such an exception. The Board
also seeks comment on whether any other exceptions would be
appropriate, consistent with the Board's authority in TILA Section
129C(b)(3)(B)(i).
43(e)(2)(iii) Points and Fees
TILA Section 129C(b)(2)(A)(vii) defines a ``qualified mortgage'' as
a loan for which, among other things, the total points and fees payable
in connection with the loan do not exceed three percent of the total
loan amount. TILA Section 129C(b)(2)(D) requires the Board to prescribe
rules adjusting this threshold to ``permit lenders that extend smaller
loans to meet the requirements of the presumption of compliance.'' The
statute further requires the Board, in prescribing such rules, to
``consider the potential impact of such rules on rural areas and other
areas where home values are lower.'' Proposed Sec. 226.43(e)(2)(iii)
implements these provisions by providing that a qualified mortgage is a
loan for which the total points and fees payable in connection with the
loan do not exceed the amounts specified under Sec. 226.43(e)(3). As
discussed in detail in the section-by-section analysis for Sec.
226.43(e)(3), the Board proposes two alternatives for calculating the
allowable points and fees for a qualified mortgage. Proposed Sec.
226.43(b)(9) defines ``points and fees'' to have the same meaning as in
Sec. 226.32(b)(1), addressed above.
[[Page 27457]]
43(e)(2)(iv) Underwriting of the Loan
TILA Sections 129C(b)(2)(A)(iv) and (v) provide as a condition to
meeting the definition of a qualified mortgage, in addition to other
criteria, that the underwriting process for a fixed-rate or adjustable-
rate loan be based on ``a payment schedule that fully amortizes the
loan over the loan term and takes into account all applicable taxes,
insurance, and assessments.'' The statute further states that for an
adjustable-rate loan, the underwriting must be based on ``the maximum
rate permitted under the loan during the first 5 years.'' See TILA
Section 129C(b)(2)(A)(v). The statute does not define the terms ``fixed
rate,'' adjustable rate,'' or ``loan term,'' and provides no additional
set of assumptions regarding how to calculate the payment obligation.
These statutory requirements differ from the payment calculation
requirements set forth under Sec. 226.34(a)(4)(iii) of the Board's
2008 HOEPA Final Rule. Section 226.34(a)(4)(iii) states that a
presumption of compliance exists where the creditor underwrites the
loan using the largest payment of principal and interest scheduled in
the first seven years following consummation. The existing presumption
of compliance under Sec. 226.34(a)(4)(iii) is available for all loan
types, except for loans with negative amortization or balloon loans
with a term less than seven years. In contrast, TILA Section
129C(b)(2)(A) provides a five-year time horizon for purposes of
underwriting the loan to the maximum interest rate, and does not extend
the scope of qualified mortgages to any loan that contains certain
risky features or a loan term exceeding 30 years. For example, loans
that permit deferral of principal or that have a term greater than 30
years would not meet the definition of a qualified mortgage. See
proposed Sec. 226.43(e)(2)(i) and (ii). In addition, loans with a
balloon feature would not meet the definition of a qualified mortgage
regardless of term length, unless made by a creditor that satisfies the
conditions set forth under the proposed exception. See proposed Sec.
226.43(f)(1).
The Board's Proposal
The Board proposes Sec. 226.43(e)(2)(iv) to implement the
underwriting requirements of TILA Sections 129C(b)(2)(A)(iv) and (v),
as enacted by Section 1412 of the Dodd-Frank Act, for purposes of
determining whether a loan meets the definition of a qualified
mortgage. Under the proposal, creditors would be required to underwrite
the consumer for a loan that is a fixed-, adjustable-, or step-rate
mortgage using a periodic payment of principal and interest based on
the maximum interest rate permitted during the first five years after
consummation. The terms ``adjustable-rate mortgage,'' step-rate
mortgage,'' and ``fixed-rate mortgage'' have the meaning as in current
Sec. 226.18(s)(7)(i)-(iii), respectively.
Specifically, proposed Sec. 226.43(e)(2)(iv) provides that meeting
the definition of a qualified mortgage is contingent, in part, on
creditors underwriting the loan in the following manner:
(1) First, proposed Sec. 226.43(e)(2)(iv) requires that the
creditor take into account any mortgage-related obligations when
underwriting the consumer's loan.
(2) Second, proposed Sec. 226.43(e)(2)(iv)(A) requires creditors
to use the maximum interest rate that may apply during the first five
years after consummation;
(3) Third, proposed Sec. 226.43(e)(2)(iv)(B) requires that the
periodic payments of principal and interest repay either the
outstanding principal balance over the remaining term of the loan as of
the date the interest rate adjusts to the maximum interest rate that
can occur during the first five years after consummation, or the loan
amount over the loan term; and
These three underwriting conditions under proposed Sec.
226.43(e)(2)(iv) are discussed below.
43(e)(2)(iv) Mortgage-Related Obligations
Proposed Sec. 226.43(e)(2)(iv) implements TILA Section
129C(b)(2)(A)(iv) and (v), in part, and provides that the creditor
underwrite the loan taking into account any mortgage-related
obligations. As discussed in proposed Sec. 226.43(b)(8), the Board
proposes to use the term ``mortgage-related obligations'' to refer to
``all applicable taxes, insurance (including mortgage guarantee
insurance), and assessments.'' Proposed Sec. 226.43(b)(8) would define
the term ``mortgage-related obligations'' to mean property taxes;
mortgage-related insurance premiums required by the creditor as set
forth in proposed Sec. 226.45(b)(1); homeowner association,
condominium, and cooperative fees; ground rent or leasehold payments;
and special assessments. Unlike the requirement under proposed Sec.
226.43(c)(5)(v), however, creditors would not need to verify and
document mortgage-related obligations for purposes of satisfying this
underwriting condition. Proposed comment 43(e)(2)(iv)-6 provides cross-
references to proposed Sec. 226.43(b)(8) and associated commentary to
facilitate compliance.
43(e)(2)(iv)(A) Maximum Interest Rate During First Five Years
Proposed Sec. 226.43(e)(2)(iv)(A) implements TILA Sections
129C(b)(2)(A)(iv) and (v), in part, and provides as a condition to
meeting the definition of a qualified mortgage that the creditor
underwrite the loan using the maximum interest rate that may apply
during the first five years after consummation. The statute does not
define the term ``maximum rate.'' In addition, the statute does not
clarify whether the phrase ``the maximum rate permitted under the loan
during the first 5 years'' means the creditor should use the maximum
interest rate that occurs during the first five years of the loan
beginning with the first periodic payment due under the loan, or during
the first five years after consummation of the loan. The distinction
between these two approaches is that the former would capture the rate
reset for a \5/1\ hybrid ARM that occurs on the due date of the 60th
monthly payment, and the latter would not.
Maximum interest rate. The Board interprets the phrase ``maximum
rate permitted'' as requiring creditors to underwrite the loan based on
the maximum interest rate that could occur under the terms of the loan
during the first five years after consummation, assuming a rising index
value. See TILA Section 129C(b)(2)(A)(v). The plain meaning of
``maximum'' is to the greatest possible degree or amount. For this
reason, the Board believes it is reasonable to interpret the phrase as
requiring the creditor to use the maximum rate possible, assuming that
the index value is increasing. See proposed comment 43(e)(2)(iv)-1.
This interpretation is consistent with current guidance contained in
Regulation Z regarding disclosure of the maximum interest rate. See
MDIA Interim Rule, 75 FR 58471, Sept. 24, 2010. The Board further
believes this interpretation is consistent with Congressional intent to
encourage creditors to make loans to consumers that are less risky and
that afford the consumer a reasonable period of time to repay (i.e., 5
years) on less risky terms.
First five years after consummation. For several reasons, the Board
proposes to interpret the phrase ``during the first 5 years'' as
requiring creditors to underwrite the loan based on the maximum
interest rate that may apply during the first five years after
consummation. TILA Section 129C(b)(2)(A)(v). First, a plain reading
[[Page 27458]]
of the statutory language conveys that the ``first 5 years'' is the
first five years of the loan once it comes into existence (i.e., once
it is consummated). Interpreting the phrase to mean the first five
years beginning with the first periodic payment due under the loan
would require an expansive reading of the statutory text.
Second, the Board believes the intent of this underwriting
condition is to ensure that the consumer can afford the loan's payments
for a reasonable amount of time. The Board believes that Congress
intended for a reasonable amount of time to be the first five years
after consummation, and therefore interprets the statutory text
``maximum rate permitted during the first five years'' accordingly.
Third, the Board believes this approach is consistent with prior
iterations of this statutory text and the Board's 2008 HOEPA Final
Rule. As noted above, the Dodd-Frank Act codifies many aspects of the
repayment ability requirements contained in Sec. 226.34(a)(4) of the
Board's 2008 HOEPA Final Rule. Previous versions of this statutory text
provided that creditors underwrite the loan using the maximum interest
rate during the first seven years; \68\ this time horizon parallels
Sec. 226.34(a)(4)(iii), which requires creditors to determine a
consumers repayment ability using the largest payment in first seven
years ``following consummation.''
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\68\ See, e.g., Mortgage Reform and Anti-Predatory Lending Act,
H. Rep. 111-94, p. 39 (2009).
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Fourth, the Board believes that interpreting the phrase ``during
the first five years'' as including the rate adjustment at the end of
the fifth year would be of limited benefit to consumers because
creditors could easily structure their product offerings to avoid
application of the rule. For example, a creditor could move a rate
adjustment that typically occurs on the due date of the 60th monthly
payment to due date of the first month that falls outside the specified
time horizon, making any proposal to extend the time period in order to
include the rate adjustment of diminished value.
Finally, the Board recognizes that the proposed timing of the five-
year period differs slightly from the approach used under the 2010 MDIA
Interim Final Rule, but believes this is appropriate given the
different purposes of the rules. The Board recently amended the 2010
MDIA Interim Final Rule to require that creditors base their
disclosures on the first five years after the first regular periodic
payment due date rather than the first five years after consummation.
See 75 FR 81836, Dec. 29, 2010. The revision clarifies that the
disclosure requirements for 5/1 hybrid ARMs must include the rate
adjustment that occurs on the due date of the 60th monthly payment,
which typically occurs more than five years after consummation. The
disclosure requirements under the 2010 MDIA Interim Final Rule, as
revised, are intended to help make consumers aware of changes to their
loan terms that may occur if they choose to stay in the loan beyond
five years and therefore, helps to ensure consumers avoid the
uninformed use of credit.
By contrast, consistent with statutory intent, proposed Sec.
226.43(e)(2)(iv) seeks to ensure that the loan's payments are
affordable for a reasonable period of time. For the reasons stated
above, the Board believes that Congress intended the first five years
after consummation to be a reasonable period of time to ensure that the
consumer has the ability to repay the loan according to its terms. The
Board also notes that the 2010 MDIA Interim Final Rule and
226.43(e)(2)(iv) complement, rather than conflict, with each other.
That is, consistent with Congressional intent, proposed
226.43(e)(2)(iv) would ensure that a consumer could repay the loan for
the first five years after consummation. For those borrowers that want
to stay in the mortgage longer than five years, the disclosure required
under the 2010 MDIA Interim Final Rule provides information about any
potential increase in payments so that the consumer can decide whether
those payments are affordable.
For these reasons, the Board believes it is appropriate to
interpret the statutory text as requiring that the creditor underwrite
the loan using the maximum interest rate during the first five years
after consummation. The Board solicits comment on its interpretation of
the phrase ``first five years'' and the appropriateness of this
approach.
Proposed comment 43(e)(2)(iv)-1 would provide additional guidance
to creditors on how to determine the maximum interest rate during the
first five years after consummation. This comment would explain that
creditors must use the maximum rate that could apply at any time during
the first five years after consummation, regardless of whether the
maximum rate is reached at the first or subsequent adjustment during
such five year period. Proposed comment 43(e)(2)(iv)(A)-2 would clarify
that for a fixed-rate mortgage, creditors should use the interest rate
in effect at consummation, and provide a cross-reference to Sec.
226.18(s)(7)(iii) for the meaning of the term ``fixed-rate mortgage.''
Proposed comment 43(e)(2)(iv)-3 would provide further guidance to
creditors regarding treatment of periodic interest rate adjustment
caps. This comment would explain that for an adjustable-rate mortgage,
creditors should assume the interest rate increases after consummation
as rapidly as possible, taking into account the terms of the legal
obligation. This comment would further explain that creditors should
account for any periodic interest rate adjustment cap that may limit
how quickly the interest rate can increase under the terms of the legal
obligation. This comment would also state that where a range for the
maximum interest rate during the first five years is provided, the
highest rate in that range is the maximum interest rate for purposes of
this section. Finally, this comment would clarify that where the terms
of the legal obligation are not based on an index plus a margin, or
formula, the creditor must use the maximum interest rate that occurs
during the first five years after consummation.
Proposed comment 43(e)(2)(iv)-3 provides several illustrative
examples of how to determine the maximum interest rate. For example,
this comment would illustrate how to determine the maximum interest
rate in the first five years after consummation for an adjustable-rate
mortgage with a discounted rate for three years. The example first
assumes an adjustable-rate mortgage that has an initial discounted rate
of 5% that is fixed for the first three years of the loan, after which
the rate will adjust annually based on a specified index plus a margin
of 3%. This comment assumes the index value in effect at consummation
is 4.5%. This comment states that the loan agreement provides for an
annual interest rate adjustment cap of 2%, and a lifetime maximum
interest rate of 10%. The first rate adjustment occurs on the due date
of the 36th monthly payment; the rate can adjust to no more than 7% (5%
initial discounted rate plus 2% annual interest rate adjustment cap).
The second rate adjustment occurs on the due date of the 48th monthly
payment; the rate can adjust to no more than 9% (7% rate plus 2% annual
interest rate adjustment cap). The third rate adjustment occurs on the
due date of the 60th monthly payment, which occurs more than five years
after consummation. This proposed comment explains that the maximum
interest rate during the first five years after consummation is 9% (the
rate on the due date of the 48th monthly payment).
[[Page 27459]]
Proposed comment 43(e)(2)(iv)-4 would further clarify the meaning
of the phrase ``first five years after consummation.'' This comment
would reiterate that under proposed Sec. 226.43(e)(2)(iv)(A), the
creditor must underwrite the loan using the maximum interest rate that
may apply during the first five years after consummation of the loan,
and would provide the following illustrative example: Assume an
adjustable-rate mortgage with an initial fixed interest rate of 5% for
the first five years after consummation, after which the interest rate
will adjust annually to the specified index plus a margin of 6%,
subject to a 2% annual interest rate adjustment cap. The index value in
effect at consummation is 5.5%. The loan consummates on September 15,
2011, and the first monthly payment is due on November 1, 2011. The
first five years after consummation occurs on September 15, 2016. The
first rate adjustment to no more than 7% (5% plus 2% annual interest
rate adjustment cap) occurs on the due date of the 60th monthly
payment, which is October 1, 2016 and therefore, the rate adjustment
does not occur during the first five years after consummation. To meet
the definition of qualified mortgage under Sec. 226.43(e)(2), the
creditor must underwrite the loan using a monthly payment of principal
and interest based on an interest rate of 5%, which is the maximum
interest rate during the first five years after consummation.
43(e)(2)(iv)(B) Amortizing Payments of Principal and Interest
Proposed Sec. 226.43(e)(2)(iv)(B) implements TILA Section
129C(b)(2)(A)(iv) and (v), in part, and provides as a condition to
meeting the definition of a qualified mortgage that the creditor
underwrite the loan using periodic payments of principal and interest
that will repay either (1) the outstanding principal balance over the
remaining term of the loan as of the date the interest rate adjusts to
the maximum interest rate that occurs during the first five years after
consummation; or (2) the loan amount over the loan term. See proposed
Sec. 226.43(e)(2)(iv)(B)(1) and (2).
TILA Section 129C(b)(2)(A)(iv) and (v) state that underwriting
should be based ``on a payment schedule that fully amortizes the loan
over the loan term.'' The Board notes that unlike the payment
calculation assumptions set forth for purposes of the general ability-
to-repay rule under TILA Section 129C(a)(6), the underwriting
conditions for purposes of meeting the definition of a qualified
mortgage do not specify the loan amount that should be repaid, and do
not define ``loan term.'' For consistency and to facilitate compliance,
the Board proposes to use the terms ``loan amount'' and ``loan term''
in proposed Sec. 226.43(b)(5) and (b)(6), respectively, for purposes
of this underwriting condition.
However, the Board believes that a loan that meets the definition
of a qualified mortgage and which has the benefit of other safeguards,
such as limits on loan features and fees, merits flexibility in the
underwriting process. Accordingly, the Board proposes to permit
creditors to underwrite the loan using periodic payments of principal
and interest that will repay either the outstanding principal balance
as of the date the maximum interest rate takes effect under the terms
of the loan, or the loan amount as of the date of consummation. The
Board believes permitting the former approach more accurately reflects
the largest payment amount that the borrower would need to make under
the terms of the loan during the first five years after consummation,
where as the latter approach would actually overstate the payment
amounts required. This approach sets a minimum standard for qualified
mortgages, but affords creditors to choose either approach to
facilitate compliance.
Proposed comment 43(e)(2)(iv)-5 would provide further clarification
to creditors regarding the loan amount to be used for purposes of this
second condition. This comment would explain that for a creditor to
meet the definition of a qualified mortgage under proposed Sec.
226.43(e)(2), the creditor must determine the periodic payment of
principal and interest using the maximum interest rate permitted during
the first five years after consummation that repays either (1) the
outstanding principal balance as of the earliest date the maximum
interest rate can take effect under the terms of the legal obligation,
over the remaining term of the loan, or (2) the loan amount, as that
term is defined in Sec. 226.43(b)(5), over the entire loan term, as
that term is defined in Sec. 226.43(b)(6). This comment would provide
illustrative examples for both approaches.
Proposed comment 43(e)(2)(iv)-7 provides illustrative examples of
how to determine the periodic payment of principal and interest based
on the maximum interest rate during the first five years after
consummation under proposed Sec. 226.43(e)(2)(iv). For example, this
comment would illustrate the payment calculation rule for an
adjustable-rate mortgage with discount for five years. This comment
first assumes a loan in an amount of $200,000 that has a 30-year loan
term. Second, the comment would assume that the loan agreement provides
for a discounted interest rate of 6% that is fixed for an initial
period of five years, after which the interest rate will adjust
annually based on a specified index plus a margin of 3%, subject to a
2% annual interest rate adjustment cap.
The index value in effect at consummation is 4.5%. The loan
consummates on March 15, 2011 and the first regular periodic payment is
due May 1, 2011. Under the terms of the loan agreement, the first rate
adjustment is on April 1, 2016 (the due date of the 60th monthly
payment), which occurs more than five years after consummation of the
loan. This proposed comment explains that the maximum interest rate
under the terms of the loan during the first five years after
consummation is 6%. See proposed comment 43(e)(2)(iv)-7.iii.
This comment concludes that the creditor will meet the definition
of a qualified mortgage if it underwrites the loan using the monthly
payment of principal and interest of $1,199 to repay the loan amount of
$200,000 over the 30-year loan term using the maximum interest rate
during the first five years of 6%.
The Board notes that in the case of an adjustable-rate mortgage
with a fixed interest rate for the first five years after consummation,
the creditor will use the fixed initial rate as the maximum interest
rate to calculate the monthly payment using that will repay the loan
amount, in accordance with requirements in proposed Sec.
226.43(e)(2)(iv). Because the fixed initial rate does not adjust during
the first five years after consummation, the outstanding principal
balance at the end of the fifth year is equivalent to the balance of
the loan amount, assuming the first 60 monthly payments under the loan
are made as scheduled. Thus, there is no alternative calculation.
43(e)(2)(v)
Income or Assets (ALTERNATIVE 1) or Underwriting Requirements
(ALTERNATIVE 2)
As discussed above, it is not clear whether the Act intends the
definition of a ``qualified mortgage'' to be a somewhat narrowly-
defined safe harbor or a more broadly-defined presumption of
compliance. Thus, the Board is proposing two alternative requirements
for the ``qualified mortgage'' definition. Under Alternative 1, the
underwriting requirements for a qualified mortgage would be limited to
what is contained in the statutory definition, namely, considering and
verifying the
[[Page 27460]]
consumer's current or reasonably expected income or assets. Under
Alternative 2, the qualified mortgage definition would require a
creditor consider and verify all of the underwriting criteria required
under the general ability-to-repay standard, namely: (1) The consumer's
current or reasonably expected income, (2) the consumer's employment
status, (3) the monthly payment on any simultaneous loans, (4) the
consumer's current debt obligations, (5) the consumer's monthly debt-
to-income ratio or residual income, and (6) the consumer's credit
history.
ALTERNATIVE 1
43(e)(2)(v) Income or Assets
Under TILA Section 129C(b)(2)(A)(iii), a condition for a
``qualified mortgage'' is that the income and financial resources
relied upon to qualify the obligors on the residential mortgage loan
are verified and documented. This requirement is consistent with the
repayment ability requirement to consider and verify a consumer's
income or assets using third-party records, under TILA Section
129C(a)(1) and (3), as discussed above in the section-by-section
analysis of proposed Sec. 226.43(c)(2)(i) and (c)(4). Proposed Sec.
226.43(e)(2)(v) would implement TILA Section 129C(b)(2)(A)(iii) and
provides that for a covered transaction to be a ``qualified mortgage,''
the creditor must consider and verify the consumer's current or
reasonably expected income or assets to determine the consumer's
repayment ability, as required by proposed Sec. 226.43(c)(2)(i) and
(c)(4). The Board believes creditors must consider and not merely
verify a consumer's income or assets for a covered transaction to be a
``qualified mortgage,'' because TILA Section 129C(b)(2)(A)(iii)
integrates a requirement to consider the consumer's income or assets by
referring to qualifying a consumer for a covered transaction.
Qualifying a consumer for a covered transaction in general involves
considering whether or not the consumer's income or assets are
sufficient for the consumer to meet his payment obligations under the
covered transaction. In addition, the proposal uses the term ``assets''
instead of ``financial resources'' for consistency with other
provisions in Regulation Z, as discussed above in the section-by-
section analysis of proposed Sec. 226.43(c)(2)(i). Under the first
alternative requirement, proposed comment 43(e)(2)(v)-1 clarifies that
creditors may rely on commentary to Sec. 226.43(c)(2)(i), (c)(3) and
(c)(4) for guidance regarding considering and verifying the consumer's
income or assets to satisfy the conditions under Sec. 226.43(e)(2)(v)
for a ``qualified mortgage.''
ALTERNATIVE 2
43(e)(2)(v)(A)-(F) Underwriting Requirements
Under Alternative 2, proposed Sec. 226.43(e)(2)(v) would implement
TILA Section 129C(b)(2)(A)(iii) and require that creditors consider and
verify the consumer's current or reasonably expected income or assets
to determine the consumer's repayment ability, as required by proposed
Sec. 226.43(c)(2)(i) and (c)(4). This proposed requirement, which
under Alternative 2 is designated Sec. 226.43(e)(2)(v)(A), is
discussed in detail under Alternative 1 above.
In addition, proposed Sec. 226.43(e)(2)(v)--Alternative 2 would
require that creditors consider and verify the following additional
underwriting requirements, which are also required under the general
ability-to-repay standard: The consumer's employment status, the
consumer's monthly payment on any simultaneous loans, the consumer's
current debt obligations, and the consumer's credit history. Creditors
could look to commentary on the general repayment ability provisions
under proposed Sec. 226.43(c)(2)(i), (ii), (iv), and (vi) through
(viii), and (c)(3), (c)(4), (c)(6), and (c)(7) for guidance regarding
considering and verifying the consumer's repayment ability to satisfy
the conditions under Sec. 226.43(e)(2)(v) for a ``qualified
mortgage.'' See proposed comment 43(e)(2)(v)-1 (Alternative 2). The
Board proposes these additions pursuant to its legal authority pursuant
under TILA Section 129C(b)(3)(B)(i). The Board believes that adding
these requirements may be necessary to better ensure that the consumers
are offered and receive loans on terms that reasonably reflect their
ability to repay the loan.
The Board solicits comments on adding each of these criteria to the
definition of a ``qualified mortgage.'' Specifically, the Board
solicits comment on whether, for each criterion, the inclusion of the
criterion strikes the appropriate balance between ensuring the
consumer's ability to repay the loan and providing creditors with an
incentive to make a qualified mortgage. In addition, the Board solicits
comment on whether consideration of simultaneous loans should be
required for both purchase transactions and non-purchase transactions
(i.e., refinancings).
43(e)(2)(v)(E) Debt-to-Income Ratio or Residual Income
TILA Section 129C(b)(2)(vi) states that the term ``qualified
mortgage'' includes any mortgage loan ``that complies with any
guidelines or regulations established by the Board relating to ratios
of total monthly debt to monthly income or alternative measure of
ability to pay regular expenses after payment of total monthly debt,
taking into account the income levels of the borrower and such other
factors as the Board may determine relevant and consistent with the
purposes described in paragraph (3)(B)(i).'' As stated above, under
proposed Sec. 226.43(e)(2)(v)--Alternative 1, creditors are not
required to consider the consumer's debt-to-income ratio or residual
income to make a qualified mortgage. However, under proposed Sec.
226.43(e)(2)(v)--Alternative 2, a ``qualified mortgage'' is a loan for
which, among other things, the creditor considers the consumer's
monthly debt-to-income ratio or residual income, as required by Sec.
226.43(c)(2)(vii) and (c)(7). Without determining the consumer's debt-
to-income ratio, a creditor could originate a qualified mortgage
without any requirement to consider the effect of the new loan payment
on the consumer's overall financial picture. The consumer could have a
very high total debt-to-income ratio under widely accepted underwriting
standards, and be predicted to default soon after the first scheduled
mortgage payment. Accordingly, including the debt-to-income ratio or
residual income in the definition of ``qualified mortgage'' might
ensure that the consumer has a reasonable ability to repay the loan.
The Board solicits comment on whether consideration of the debt-to-
income ratio or residual income should be part of the criteria for a
``qualified mortgage.''
Quantitative standards. The Board is not proposing a quantitative
standard for the debt-to-income ratio or residual income in the
qualified mortgage definition for several reasons. First, as explained
in the Board's 2008 HOEPA Final Rule, the Board is concerned that
setting a specific debt-to-income ratio or residual income level could
limit credit availability without providing adequate off-setting
benefits. 73 FR 44550, July 30, 2008. For this proposal, the Board
analyzed data from the Applied Analytics division (formerly McDash
Analytics) of Lender Processing Services (LPS) for the years 2005-2008
\69\ and
[[Page 27461]]
data from the Survey of Consumer Finances (the SCF) for the years 2005-
2007.\70\ Using the LPS data, the Board found that about 23 percent of
all borrowers exceeded a debt-to-income ratio of 45 percent, the
typical maximum permitted by creditors and the secondary market for
loans that are manually underwritten. The data show that this rate was
even higher for borrowers living in low-income or high-cost areas.
Using the SCF data, the Board found that about 44 percent of borrowers
located in low-income areas and about 31 percent of borrowers located
in high-cost areas exceeded the 45 percent limit.\71\ If the Board were
to adopt a quantitative standard, the Board seeks comment on what
exceptions may be necessary for low-income borrowers or borrowers
living in high-cost areas, or for other cases.
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\69\ The LPS data include mortgage underwriting and performance
information. The LPS data do not include detailed information on
borrower income and on other debts the borrower may have in addition
to the mortgage.
\70\ The SCF is conducted every three years by the Board, in
cooperation with the U.S. Department of Treasury, to provide
detailed information on the finances of U.S. families. The SCF
collects information on the balance sheet, pension, income, and
other demographic characteristics of U.S. families. To ensure the
representativeness of the study, respondents are selected randomly
using a scientific sampling methodology that allows a relatively
small number of families to represent all types of families in the
nation. Additional information on the SCF is available at http://www.federalreserve.gov/pubs/oss/oss2/method.html.
\71\ See also Wardrip, Keith, An Annual Look at the Housing
Affordability Challenges of America's Working Households (Center for
Housing Policy 2011) (showing that just over 20 percent of working
households, defined as households that report household members
working at least 20 hours per week, on average, with incomes no
higher than 120 percent of the median income in their area, who own
a home spend more than half its income on housing costs).
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Second, outreach conducted by the Board revealed a range of
underwriting guidelines for debt-to-income ratios based on product
type, whether creditors used manual or automated underwriting, and
special considerations for high- and low-income borrowers. Setting a
quantitative standard would require the Board to address the
operational issues related to the calculation of the debt-to-income
ratio or residual income. For example, the Board would need clearly to
define income and current debt obligations, as well as compensating
factors and the situations in which creditors may use compensating
factors, In addition, the debt-to-income ratio is often a floating
metric, since the percentage changes as new information about income or
current debt obligations becomes available. A quantitative standard
would require guidelines on the timing of the debt-to-income ratio
calculation, and what circumstances would necessitate a re-calculation
of the debt-to-income ratio. Furthermore, a quantitative standard may
also need to provide tolerances for mistakes made in calculating the
debt-to-income ratio. The rule would also need to address the use of
automated underwriting systems in determining the debt-to-income ratio
or residual income.
Finally, setting a quantitative standard for residual income could
prove particularly challenging. Except for one small creditor and the
Department of Veterans' Affairs, the Board is not aware of any
creditors that routinely use residual income in underwriting, other
than as a compensating factor.\72\ As noted in the supplementary
information to the 2008 HOEPA Final Rule, the residual income
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. 73 FR
44550, July 30, 2008. Moreover, the residual income guidelines
developed by the Department of Veterans' Affairs have not been updated
since 1997. It is not clear that such guidelines would be appropriate
or provide sufficient flexibility for consumers outside the market
served by the Department of Veterans' Affairs.
---------------------------------------------------------------------------
\72\ See also Stone, Michael E., 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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For these reasons, the Board is not proposing a quantitative
standard for the debt-to-income ratio or residual income. The Board
recognizes, however, that creditors, and ultimately consumers, may
benefit from a higher degree of certainty surrounding the qualified
mortgage definition that a quantitative standard could provide.
Therefore, the Board solicits comment on whether and how it should
prescribe a quantitative standard for the debt-to-income ratio or
residual income for the qualified mortgage definition.
43(e)(3) Limits on Points and Fees for Qualified Mortgages
Proposed Sec. 226.43(e)(3) sets forth two alternative proposals
establishing the points and fees that a creditor may charge on a
qualified mortgage:
Alternative 1
For a loan amount of $75,000 or more, 3 percent of the
total loan amount;
For a loan amount of greater than or equal to $60,000 but
less than $75,000, 3.5 percent of the total loan amount;
For a loan amount of greater than or equal to $40,000 but
less than $60,000, 4 percent of the total loan amount;
For a loan amount of greater than or equal to $20,000 but
less than $40,000, 4.5 percent of the total loan amount; and
For a loan amount of less than $20,000, 5 percent of the
total loan amount.
Alternative 2
For a loan amount of $75,000 or more, 3 percent of the
total loan amount;
For a loan amount of greater than or equal to $20,000 but
less than $75,000, a percent of the total loan amount not to exceed the
percentage of the total loan amount yielded by the following formula--
[cir] Total loan amount-$20,000 = $Z
[cir] $Z x .0036 basis points = Y basis points
[cir] 500 basis points -Y basis points = X basis points
[cir] X basis points x .01 = Allowable points and fees as a
percentage of the total loan amount.
For a loan amount of less than $20,000, 5 percent of the
total loan amount.
For both alternatives, Proposed comment 43(e)(3)(i)-1 cross-references
comment 32(a)(1)(ii)-1 for an explanation of how to calculate the
``total loan amount'' under this provision. Proposed comment
43(e)(3)(i)-2 also clarifies that a creditor must determine which
category the loan falls into based on the face amount of the note (the
``loan amount''), but must apply the allowable points and fees
percentage to the ``total loan amount,'' which may be an amount that is
different than the face amount of the note. Specifically, the comment
explains that a creditor must calculate the allowable amount of points
and fees for a qualified mortgage as follows:
First, the creditor must determine the ``tier'' into which
the loan falls based on the loan amount. The loan amount is the
principal amount the consumer will borrow as reflected in the
promissory note or loan contract. See Sec. 226.43(b)(5). For example,
if the loan amount is $75,000, the loan falls into the tier for loans
of $75,000 or more, to which a three percent cap on points and fees
applies.
Second, the creditor must determine the ``total loan
amount'' based on the calculation for the ``total loan amount'' under
comment 32(a)(1)(ii)-1. If the loan amount is $75,000, for
[[Page 27462]]
example, the ``total loan amount'' may be a different amount, such as
$73,000.
Third, the creditor must apply the percentage cap on
points and fees to the ``total loan amount.'' For example, for a loan
of $75,000 where the ``total loan amount'' is $73,000, the allowable
points and fees is three percent of $73,000 or $2,190.
For a discussion of the Board's proposed revisions to the ``total loan
amount'' calculation, see the section-by-section analysis of Sec.
226.32(a)(1)(ii), above.
Discussion
The Board proposes the two alternative calculations for the
qualified mortgage points and fees test to implement TILA Section
129C(b)(2)(A)(vii), which requires that the points and fees of a
qualified mortgage may not exceed three percent of the total loan
amount. 15 U.S.C. 1639c(b)(2)(A)(vii). Proposed Sec. 226.43(e)(3) is
also intended to implement TILA Section 129C(b)(2)(D), which requires
the Board to adjust this three percent points and fees limit for
``smaller loans'' and also requires that, ``[i]n prescribing such
rules, the Board * * * consider the potential impact of such rules on
rural areas and other areas where home values are lower.'' 15 U.S.C.
1639C(b)(2)(D). The statute does not define, and the legislative
history does not provide guidance on, the terms ``smaller loan'' or the
phrase ``rural areas and other areas where home values are lower.''
Therefore, to gather information on how best to implement the
statutory requirement that the Board ``adjust'' the points and fees
threshold for ``smaller loans,'' Board staff consulted with consumer
advocates and numerous types of creditors, including representatives of
banks and credit unions in rural areas, as well as manufactured home
loan creditors. In addition, Board staff also examined recent data on
loan size distributions for home purchase loans and refinances by
county and based on whether the loan was a conventional mortgage or a
mortgage secured by manufactured homes. The Board also considered that
creditors can, to some extent, increase the interest rate to offset
limits on points and fees. The Board recognizes that loan pricing is
typically a blend of points and fees and interest rate and that limits
on points and fees tend to drive loan costs into the rate.
As an initial matter, the Board considered a few options for
implementing the statutory mandate to ``adjust[] the criteria'' of the
three percent points and fees cap--namely, narrowing the charges
required to be included in the ``points and fees'' calculation, raising
the percentage cap, or a combination of both. Outreach participants
generally disfavored an approach that would require different ways of
calculating points and fees depending on loan size. Industry
representatives in particular raised concerns about compliance burden
and the increased risk of error resulting from a more complex rule. The
Board believes that requiring separate ways of calculating points and
fees is unnecessary to effect the statutory mandate to ``adjust the
criteria'' for the qualified mortgage three percent points and fees
threshold. The proposal therefore simply would set higher percentage
caps on points and fees for loans of less than $75,000.
Outreach participants had varying views on appropriate loan size
thresholds for an alternative points and fees limitation applicable to
``smaller loans.'' Industry representatives shared a concern that loans
below a certain size could not meet the three percent points and fees
cap because the minimum costs to originate any loan would exceed three
percent of loans of that size. While recognizing that loan costs can be
covered in part by charging a higher interest rate, creditors were
concerned that for smaller loans, the needed rate increase might result
in loan becoming a high-cost mortgage; as a result, creditors would be
reluctant to make these loans and credit availability would be
compromised. Based on calculations using loans in their own portfolios,
some creditors indicated that the point at which minimum loan
origination costs exceed three percent of the total loan amount is
$50,000 to $75,000. At least one creditor indicated that, in addition,
for loans of $40,000 or less, the creditor would be unable to meet a
four percent cap on points and fees. Others suggested $100,000 as the
appropriate ``smaller loan'' threshold, while still others recommended
that the Board propose a ``smaller loan'' threshold of greater than
$100,000, such as at least $150,000. Community bank representatives in
particular raised concerns that they would be unable to retain
profitability without an adjustment to the points and fees cap for
loans of less than $100,000. They argued that the sizes of loans
originated by community banks and other institutions in less populated
areas are ``small'' on average, leaving less opportunity for community
banks than larger institutions to make up any losses on originations of
small loans through originations of larger loans.
Industry representatives also generally expressed concerns about
limiting the availability of credit to low-income or rural borrowers if
the points and fees cap for qualified mortgages were too low with
respect to ``smaller loans.'' If creditors could not meet the qualified
mortgage points and fees cap, these loans would not meet the definition
of a ``qualified mortgage'' and creditors therefore would be less
likely to make these loans.
Consumer advocates generally favored a narrower exception to the
three percent qualified mortgage points and fees threshold for
``smaller loans,'' recommending a ``smaller loan'' size of no higher
than $50,000 and preferably lower. They questioned industry concerns
that the three percent threshold would limit the availability of credit
for borrowers of comparatively low loan amounts. Instead, they
emphasized the importance of ensuring that qualified mortgages are
affordable because, depending on the Board's interpretation of the
statute, these loans potentially would not be subject to some or all of
the specific repayment ability requirements in TILA Section 129C(a)
(see proposed Sec. 226.43(c)). (For a detailed discussion of the
Board's alternative proposals regarding which of the general repayment
ability requirements apply to creditors of qualified mortgages, see the
section-by-section analysis of proposed Sec. 226.43(e), above.) In
their view, the three percent points and fees cap is a centerpiece of
ensuring affordability and should be relaxed only in very limited
circumstances.
The Board's Proposal
Based on outreach and the Board's research, the Board is issuing
two alternative proposals to implement the points and fees limitation
on qualified mortgages. The first consists of five ``tiers'' of loan
sizes and corresponding limits on points and fees. The second consists
of three ``tiers,'' with the middle tier of allowable points and fees
based on a formula yielding a greater allowable percentage of the total
loan amount to be charged in points and fees for each dollar increase
in loan size.
The Board proposes a ``tiered'' approach, rather than a single
``smaller loan'' threshold and a single alternate points and fees cap
for loans at or below that amount, for several reasons. First, the
Board understands that most creditors have a minimum cost for
originating a mortgage loan of any size and that this cost may vary
somewhat by creditor. If a single minimum origination cost is assumed,
that cost will obviously comprise a different percentage of a loan
depending on its size. Total points and fees of $2,500 will
[[Page 27463]]
obviously be a smaller percentage of a loan of $100,000 (2.5%) than for
a loan of $50,000 (5%), for example. A single threshold therefore may
not be sufficiently flexible to allow loans of a full range of sizes to
be deemed qualified mortgages.
In addition, the Board believes that a rule allowing for
incremental increases in the points and fees cap for several ranges of
loan sizes will help mitigate market distortions that might otherwise
result. For example, a rule setting a five percent points and fees cap
for all loans less than $75,000 would create a significant disparity
between the amount of points and fees that could be charged on loans of
substantially equal amounts. For a loan of $75,000, for instance, a
creditor could charge up to $2,250 (3% of $75,000). But for a loan of
$74,000, a creditor could charge as much as $3,700 (5% of $74,000). As
a result, loans slightly above the threshold at which a five percent
cap applies--for example, from $75,000 to $85,000--might be less likely
to be made at all.
Finally, the Board is reluctant to require a single threshold due
to limitations inherent in available data on origination costs. Various
resources that track points and fees in loan originations tend to use
different methods for calculating the points and fees and to date do
not include all items that must be counted as points and fees under
TILA as amended by the Dodd-Frank Act. See TILA Section 103(aa)(4); 15
U.S.C. 1602(aa)(4). See also section-by-section analysis of Sec.
226.32, above.
Alternative 1. The five-tiered approach proposed as Alternative 1
is intended to facilitate compliance by setting clear categories based
on loan size to which specific points and fees thresholds apply. The
Board derived the loan size ranges for each category (with
corresponding points and fees thresholds of three percent, 3.5 percent,
four percent, 4.5 percent, and five percent of the ``total loan
amount,'' respectively) based on a calculation that would generally
achieve a ``sliding scale'' points and fees cap from three to five
percent for loans from $20,000 to $75,000. To make the proposal more
straightforward, the Board chose increments of .5% and rounded the loan
size ranges proposed for each category. Thus, for example:
An $80,000 loan would fall into the category for loans of
$75,000 or more, to which a three percent points and fees rate cap
applies. Assuming that the ``total loan amount'' for the loan is also
$80,000, the dollar amount of allowable points and fees for this loan
would be $2,400.
A $60,000 loan would fall into the category for loans of
$60,000 but less than $75,000, to which a 3.5 percent points and fees
rate cap applies. Assuming that the ``total loan amount'' for the loan
is also $60,000, the dollar amount of allowable points and fees for
this loan would be $2,100.
A $40,000 loan would fall into the category for loans of
$40,000 but less than $60,000, to which a four percent points and fees
rate cap applies. Assuming that the ``total loan amount'' for the loan
is also $40,000, the dollar amount of allowable points and fees for
this loan would be $1,600.
A $20,000 loan would fall into the category for loans of
$20,000 but less than $40,000, to which a 4.5 percent points and fees
rate cap applies. Assuming that the ``total loan amount'' for the loan
is also $40,000, the dollar amount of allowable points and fees for
this loan would be $900.
A $10,000 loan would fall into the category for loans of
less than $20,000, to which a five percent points and fees rate cap
applies. Assuming that the ``total loan amount'' for the loan is also
$10,000, the dollar amount of allowable points and fees for this loan
would be $500.
Proposed alternative comment 43(e)(3)(i)-3 provides the following
illustration of how to calculate the allowable points and fees for a
$50,000 loan with a $48,000 total loan amount: A covered transaction
with a loan amount of $50,000 falls into the third points and fees
tier, to which a points and fees cap of 3.5 percent of the total loan
amount applies. See Sec. 226.43(e)(3)(i)(C). If a $48,000 total loan
amount is assumed, the allowable points and fees for this loan is 3.5
percent of $48,000 or $1,920.
One concern is that this approach yields anomalous results in some
instances--namely, that a greater dollar amount of points and fees
would be allowable on some loans than on other loans of a larger size.
For example, the allowable points and fees that could be charged on a
loan of $40,000 (also assuming in this example a ``total loan amount''
of $40,000) would be $1,600--four percent of the total loan amount. At
the same time, the allowable points and fees that could be charged on a
loan of $38,000 (also assuming in this example a ``total loan amount''
of $38,000) would be $1,710--4.5 percent of the total loan amount. The
Board considered and could revise the first alternative to solve the
anomalies mathematically, but not without adding significant complexity
to the regulation, which in turn would increase the risk of compliance
errors. For these reasons, the Board is also proposing the alternative
discussed below.
Alternative 2. The Board proposes an alternative with three tiers
that incorporates a formula designed to ensure that allowable points
and fees as a dollar amount will increase as the loan amount increases,
thus eliminating the anomalies resulting from the proposed five-tier
approach. Specifically, as noted, for a loan amount of $75,000 or more,
allowable points and fees would be 3 percent of the total loan amount.
For a loan amount of less than $20,000, allowable points and fees would
be 5 percent of the total loan amount. These two categories correspond
with the first and last tiers of the five-tiered approach discussed
above.
For a loan amount of greater than or equal to $20,000 but less than
$75,000, however, the allowable points and fees would be a percentage
of the total loan amount not to exceed the amount yielded by the
following formula--
[cir] Total loan amount-$20,000 = $Z
[cir] $Z x .0036 = Y basis points
[cir] 500 basis points-Y basis points = X basis points
[cir] X basis points x .01 = Allowable points and fees as a
percentage of the total loan amount.
In effect, for every dollar increase in the total loan amount, the
allowable points and fees would increase by .0036 basis points.
Proposed alternative comment 43(e)(3)(i)-3 provides the following
illustration of how to apply this formula: Assume a loan amount of
$50,000 with a ``total loan amount'' of $48,000. The amount of $20,000
must be subtracted from $48,000 to yield the number of dollars to which
the .0036 basis points multiple must be applied--in this case, $28,000.
$28,000 must be multiplied by .0036 basis points--in this case
resulting in 100.8 basis points.
This amount must be subtracted from the maximum allowable points
and fees on any loan, which, under the proposed rule, is 500 basis
points. (Five percent of the total loan amount for loans of less than
$20,000 is the maximum allowable points and fees on any loan. Five
percent expressed in basis points is 500.) Five hundred minus 100.8
equals 399.2 basis points: This is the allowable points and fees in
basis points. Translating basis points into a percentage of the total
loan amount requires multiplying 399.2 by .01--resulting, in this case,
in 3.99 percent. Allowable points and fees for this loan as a dollar
figure is therefore 3.99 percent of $48,000 (i.e., the total loan
amount), or $1,915.20.
The Board recognizes that a formula is potentially more complex for
[[Page 27464]]
creditors to comply with than the multiple tiers proposed under the
first alternative. In particular, the Board requests comment on whether
a formula would be difficult for smaller creditors to integrate into
their lending operations.
Three to five percent cap. The upper end of the points and fees cap
for smaller loans is proposed to be five percent for loans of less than
$20,000. One reason for the maximum cap of five percent for loans of
less than $20,000 is to achieve general consistency with the Dodd-Frank
Act amendments to the points and fees thresholds for high-cost
mortgages.\73\ Specifically, TILA now defines a high-cost mortgage as
one for which the points and fees equal five percent of the total
transaction amount if the transaction is $20,000 or more and, if the
transaction is less than $20,000, the lesser of eight percent of the
total transaction amount or $1,000. See TILA Section
103(aa)(1)(A)(ii)(I) and (II); 15 U.S.C. 1602(aa)(1)(A)(ii)(I) and
(II).
---------------------------------------------------------------------------
\73\ Public Law 111-203, 124 Stat. 1376, Title XIV, Sec. 1431.
---------------------------------------------------------------------------
The proposal seeks to ensure that if a loan is a qualified
mortgage, it would not also be a high-cost mortgage based on the points
and fees, and therefore subject to the more stringent high-cost
mortgage rules of TILA Section 129 (as amended by the Dodd-Frank
Act).\74\ For example, five percent of a loan of $19,999 is $999.95.
Thus, for this loan to meet the points and fees test for qualified
mortgages, the maximum points and fees that could be charged would be
$999.95. If the maximum points and fees that could be charged on this
loan under the qualified mortgage test were $1,000, this loan would
also be a high-cost mortgage.
---------------------------------------------------------------------------
\74\ Id. Sec. 1432, 1433.
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As discussed earlier, the Board believes that the statute is
designed to reduce the compliance burden on creditors when they make
qualified mortgages, in order to encourage creditors to make loans with
stable, understandable loan features. Creating points and fees
thresholds for small loans that might result in qualified mortgages
also being high-cost mortgages would discourage creditors from making
qualified mortgages because the requirements and limitations of high-
cost loans are generally more stringent than for other loans. High-cost
mortgages, for example, are subject to a cap on the late fees that may
be imposed and timing restrictions regarding when the fee may be
imposed, but other mortgages are not subject to these and several other
rules applicable solely to high-cost mortgages. See TILA Section
129(k); 15 U.S.C. 1639(k). They also require that the consumer obtain
``pre-loan counseling'' not required for other mortgages. See TILA
Section 129(u); 15 U.S.C. 1639(u).
Three percent cap for loans of $75,000 or greater. The Board
proposes a loan size of $75,000 as the point at which the statutory
three percent points and fees cap begins to apply for several reasons.
First, the Board believes that Congress intended the exception to the
qualified mortgage points and fees cap to affect more than a minimal--
although still limited--proportion of home-secured loans. The 2008 Home
Mortgage Disclosure Act \75\ (HMDA) data show that 8.4 percent of
first-lien, home-purchase (site-built) mortgages had a loan amount of
$74,000 or less.\76\ That percentage significantly drops for loans of
$49,000 or less, to 2.8 percent, with only .5 percent of all loans at
$24,000 or less. The percentage of first-lien, home-purchase (site-
built) mortgages of $100,000 or less is significantly higher than 8.4
percent, however--totaling 16 percent of the market.
---------------------------------------------------------------------------
\75\ 12 U.S.C. 2801 et seq.
\76\ See The 2008 HMDA Data: The Mortgage Market during a
Turbulent Year, Federal Reserve Bulletin, vol. 95, p. A201 (April
2010).
---------------------------------------------------------------------------
Similarly, in 2009, the percentage of first-lien home-purchase
(site-built) mortgages was 9.7 percent, with a significant drop for
loans of $50,000 or less to 3.3 percent of the total market and .3
percent for loans of $20,000 or less.\77\ Again, however, the
percentage of first-lien home-purchase (site-built) mortgages jumps
substantially--from 9.7 percent to 18.5 percent--for loans of $100,000
or less. Parallel results occurred for first-lien refinances secured by
site-built homes.\78\
---------------------------------------------------------------------------
\77\ See HMDA data for 2009 is available at Federal Financial
Institutions Examination Council, http://www.ffiec.gov.hmda/hmdaproducts.htm.
\78\ See The 2008 HMDA Data: The Mortgage Market during a
Turbulent Year, Federal Reserve Bulletin, vol. 95, p. A201 (April
2010); Federal Financial Institutions Examination Council, http://www.ffiec.gov/hmda/hmdaproducts.htm
---------------------------------------------------------------------------
Thus, the Board believes that a loan size of less than $75,000
would capture a material portion of the first-lien home-purchase (site-
built) mortgage market (close to 10 percent), but would not undermine
the statute by creating an exception that might be over-broad.\79\
---------------------------------------------------------------------------
\79\ The proposed loan size threshold would have applied to the
majority of second-lien home-purchase and refinance loans secured by
site-built homes in 2008 and 2009. In 2008, 78.3 percent of all
second-lien home-purchase (site-built) mortgages were $74,000 or
less and 75.3 percent of all second-lien refinances (site-built)
were $74,000 or less. See The 2008 HMDA Data: The Mortgage Market
during a Turbulent Year, Federal Reserve Bulletin, vol. 95, p. A201
(April 2010). In 2009, 85.1 percent of all second-lien home-purchase
(site-built) and 78.1 percent of all second-lien refinance (site-
built) mortgages were in an amount of $75,000 or less. See Federal
Financial Institutions Examination Council, http://www.ffiec.gov/hmda/hmdaproducts.htm.
---------------------------------------------------------------------------
Second, Board outreach and research indicate that $2,250--three
percent of $75,000--is within range of average costs to originate a
first-lien home mortgage. Thus $75,000 appears to be an appropriate
benchmark for applying the three percent limit, with a higher percent
limit applying to loans below that amount to afford creditors of these
loans a reasonable opportunity to recoup their origination costs. The
sliding scale approach to loans below $75,000 is intended in part to
help ensure that creditors of these loans would not have to add a
significant amount to the rate to recoup their origination costs and
thus cannot be classified as high-cost mortgages. In addition, the
Board seeks to limit compensating rate increases because it recognizes
that increasing the rate is not necessarily in the consumer's
interest--for example, a loan with a higher rate can be costly for a
consumer who plans to stay in the home (and loan) for a long time.
Higher rates also can decrease credit access because some consumers may
not be able to make the resulting payments over time, but may have the
cash to pay the costs upfront.
Third, the Board interprets Congress's express concern for ``loans
in areas where home values are lower'' to encompass not only geographic
areas but also ``areas'' of mortgage lending generally--in particular,
property types such as manufactured homes, which tend to be less
expensive than site-built homes. Regarding property types, the Board
focused on manufactured homes and found that, in 2009, 74.8 percent of
all first-lien home-purchase loans secured by manufactured homes were
$75,000 or less, while 61.8 percent of all first-lien refinances
secured by manufactured homes were $75,000 or less. Thus the Board
believes that the proposal would appropriately address Congress's
concern with the ``lower'' home values typical of manufactured homes.
The Board considers manufactured homes to be an important homeownership
option for many consumers and intends through this proposal to protect
manufactured home loan consumers from excessive costs, while allowing
more of these loans to be deemed qualified mortgages.
In general, the Board is reluctant to propose an adjustment to the
three percent qualified mortgage points and fees cap based on
geographic area alone. Property values shift over time, and in some
cases, properties in what today are
[[Page 27465]]
remote, inexpensive areas may become more populated and costly over
time. The Board considered imposing an alternate points and fees
threshold for defined geographic areas such as ``non-MSA'' areas.
However, even within those areas, origination costs and loan sizes may
vary widely, so the Board believes that an inadequate basis exists for
such a proposal.
Nevertheless, regarding whether loan sizes are ``lower'' on average
in some geographic areas than others, the Board has conducted
preliminary research on loan size by county. HMDA data indicate that in
2009, for example, there were eight counties in which loans under
$75,000 comprised more than 90 percent of all first-lien mortgages made
in those counties, and 1,366 counties in which loans under $75,000
comprised more than 90 percent of all second-lien loans made in those
counties.\80\ The Board also noted that counties in which at least 70
percent of second-lien mortgages made were under $75,000 (2,616
counties) accounted for 91 percent of the entire second-lien mortgage
market for loans of under $75,000. These data suggest that the proposal
may affect access to credit differently across the country.
---------------------------------------------------------------------------
\80\ See Federal Financial Institutions Examination Council,
http://www.ffiec.gov/hmda/hmdaproducts.htm.
---------------------------------------------------------------------------
The Board requests comment on the proposed alternative loan size
ranges and corresponding points and fees caps for qualified mortgages.
The Board encourages commenters to provide specific data to support
their recommendations. The Board also solicits comment on whether the
proposal should index the loan size ranges for inflation and
periodically change them by regulation. In addition, the Board requests
comment on the potential impact of the proposal on access to credit,
particularly on how the impact may vary based on geographic area.
43(e)(3)(ii) Exclusions From Points and Fees for Qualified Mortgages
Proposed Sec. 226.43(e)(3)(ii) excludes three types of charges
from the points and fees calculation for qualified mortgages:
Any bona fide third party charge not retained by the
creditor, loan originator, or an affiliate of either, subject to the
limitations under proposed Sec. 226.32(b)(1)(i)(B), which requires
that premiums for private mortgage insurance be included in points and
fees under certain circumstances, even if they are not retained by the
creditor, loan originator, or an affiliate of either.
Up to two bona fide discount points paid by the consumer
in connection with the covered transaction, but only if certain
conditions are met (discussed below).
Up to one bona fide discount point paid by the consumer in
connection with the covered transaction, but only if certain conditions
are met (discussed below).
See proposed Sec. 226.43(e)(3)(ii)(A)-(C).
43(e)(3)(ii)(A) Bona Fide Third Party Charges
Proposed Sec. 226.43(e)(3)(ii)(A) excludes from ``points and
fees'' for qualified mortgages ``any bona fide third party charge not
retained by the creditor, loan originator, or an affiliate of either,
unless the charge is required to be included in `points and fees' under
Sec. 226.32(b)(1)(i)(B).'' This provision would implement TILA Section
129C(b)(2)(C), which defines ``points and fees'' for qualified
mortgages to have the same meaning as ``points and fees'' for high-cost
mortgages (TILA Section 103(aa)(4)), but expressly excludes ``bona fide
third party charges not retained by the mortgage originator, creditor,
or an affiliate of the creditor or mortgage originator.'' 15 U.S.C.
1602(aa)(4), 1639c(b)(2)(C). With the following example, proposed
comment 43(e)(3)(ii)-1 clarifies the meaning of ``retained by'' the
loan originator, creditor, or an affiliate of either: If a creditor
charges a consumer $400 for an appraisal conducted by a third party not
affiliated with the creditor, pays the third party appraiser $300 for
the appraisal, and retains $100, the creditor may exclude $300 of this
fee from ``points and fees'' but must count the $100 it retains in
``points and fees.''
Proposed Sec. 226.43(e)(3)(ii)(A) would also implement TILA
Section 103(aa)(1)(C), which requires that premiums for private
mortgage insurance be included in ``points and fees'' as defined in
TILA Section 103(aa)(4) under certain circumstances. 15 U.S.C.
1602(aa)(1)(C). Applying general rules of statutory construction, the
Board believes that the more specific provision on private mortgage
insurance supersedes the more general provision permitting any bona
fide third party charge not retained by the creditor, mortgage
originator, or an affiliate of either to be excluded from ``points and
fees.'' Thus, comment 43(e)(3)(ii)-2 explains that Sec.
226.32(b)(1)(i)(B) requires creditors to include in ``points and fees''
premiums or charges payable at or before closing for any private
guaranty or insurance protecting the creditor against the consumer's
default or other credit loss to the extent that the premium or charge
exceeds the amount payable under policies in effect at the time of
origination under Section 203(c)(2)(A) of the National Housing Act (12
U.S.C. 1709(c)(2)(A)). These premiums or charges must also be included
if the premiums or charges are not required to be refundable on a pro-
rated basis, or the refund is not automatically issued upon
notification of the satisfaction of the underlying mortgage loan. The
comment clarifies that, under these circumstances, even if the premiums
and charges are not retained by the creditor, loan originator, or an
affiliate of either, they must be included in the ``points and fees''
calculation for qualified mortgages. The comment also cross-references
comments 32(b)(1)(i)-3 and -4 for further discussion of including
upfront private mortgage insurance premiums in the points and fees
calculation.
For a detailed discussion of the Board's proposal to apply the
Dodd-Frank Act provisions on mortgage insurance to the meaning of
``points and fees'' for qualified mortgages, see the section-by-section
analysis of proposed Sec. 226.32(b)(1)(i) (implementing TILA Section
103(aa)(1)(C)).
43(e)(3)(ii)(B) and 43(e)(3)(ii)(C) Bona Fide Discount Points
Proposed Sec. 226.43(e)(3)(ii)(B) and (e)(3)(ii)(C) permit a
creditor to exclude a limited number of discount points from the
calculation of points and fees under specific circumstances. These
provisions are proposed to implement TILA Section 129C(b)(2)(C)(ii),
(iii), and (iv), and mirror the statutory language with minor
clarifying revisions. 15 U.S.C. 1639c(b)(2)(C)(ii), (iii), and (iv).
Exclusion of up to two bona fide discount points. Specifically,
proposed Sec. 226.43(e)(3)(ii)(B) permits a creditor to exclude from
points and fees for a qualified mortgage up to two bona fide discount
points paid by the consumer in connection with the covered transaction,
provided that the following conditions are met--
The interest rate before the rate is discounted does not
exceed the average prime offer rate, as defined in Sec.
226.45(a)(2)(ii),\81\ by more than one percent; and
---------------------------------------------------------------------------
\81\ See 76 FR 11319, March 2, 2011 (2011 Jumbo Loan Escrow
Final Rule).
---------------------------------------------------------------------------
The average prime offer rate used for purposes of
paragraph 43(e)(3)(ii)(B)(1) is the same average prime offer rate that
applies to a comparable transaction as of the date
[[Page 27466]]
the discounted interest rate for the covered transaction is set.
Proposed comment 43(e)(3)(ii)-3 provides the following example to
illustrate this rule: Assume a covered transaction that is a first-
lien, purchase money home mortgage with a fixed interest rate and a 30-
year term. Assume also that the consumer locks in an interest rate of
6.00 percent on May 1, 2011, that was discounted from a rate of 6.50
percent because the consumer paid two discount points. Finally, assume
that the average prime offer rate (APOR) as of May 1, 2011 for first-
lien, purchase money home mortgages with a fixed interest rate and a
30-year term is 5.50 percent.
In this example, the creditor may exclude two discount points from
the ``points and fees'' calculation because the rate from which the
discounted rate was derived exceeded APOR for a comparable transaction
as of the date the rate on the covered transaction was set by only one
percent.
Exclusion of up to one bona fide discount point. Proposed Sec.
226.43(e)(3)(ii)(C) permits a creditor to exclude from points and fees
for a qualified mortgage up to one bona fide discount point paid by the
consumer in connection with the covered transaction, provided that the
following conditions are met--
The interest rate before the discount does not exceed the
average prime offer rate, as defined in Sec. 226.45(a)(2)(ii),\82\ by
more than two percent;
---------------------------------------------------------------------------
\82\ See id.
---------------------------------------------------------------------------
The average prime offer rate used for purposes of Sec.
226.43(e)(3)(ii)(C)(1) is the same average prime offer rate that
applies to a comparable transaction as of the date the discounted
interest rate for the covered transaction is set; and
Two bona fide discount points have not been excluded under
Sec. 226.43(e)(3)(ii)(B) of this section.
Proposed comment 43(e)(3)(ii)-4 provides the following example to
illustrate this rule: Assume a covered transaction that is a first-
lien, purchase money home mortgage with a fixed interest rate and a 30-
year term. Assume also that the consumer locks in an interest rate of
6.00 percent on May 1, 2011, that was discounted from a rate of 7.00
percent because the consumer paid four discount points. Finally, assume
that the average prime offer rate (APOR) as of May 1, 2011 for first-
lien, purchase money home mortgages with a fixed interest rate and a
30-year term is 5.00 percent.
In this example, the creditor may exclude one discount point from
the ``points and fees'' calculation because the rate from which the
discounted rate was derived (7.00 percent) exceeded APOR for a
comparable transaction as of the date the rate on the covered
transaction was set (5.00 percent) by only two percent.
Comparable transaction. Both proposed exclusions for bona fide
discount points require the creditor to determine the APOR for a
``comparable transaction.'' Comment 43(e)(3)(ii)-5 clarifies that the
APOR table published by the Board indicates how to identify the
comparable transaction.\83\ This comment also cross-references proposed
comment 45(a)(2)(ii)-2 contained in the 2011 Escrow Proposal (see also
existing comment 35(a)(2)-2), which makes the same clarification in a
different context. Currently, the APOR table published by the Board
indicates that one loan characteristic on which the APOR may vary is
whether the rate is fixed or adjustable. Another variable is the length
of the loan term. For a fixed-rate mortgage, the relevant term is the
length of the entire contractual obligation, such as 30 years. For an
adjustable-rate mortgage, the relevant term is the length of the
initial fixed-rate period. The examples provided in proposed comments
43(e)(3)(ii)-3 and -4 are based on a fixed-rate mortgage with a 30-year
term and accordingly refer to the APOR for a fixed-rate mortgage with a
30-year term.
---------------------------------------------------------------------------
\83\ Federal Financial Institutions Examination Council (FFIEC),
``FFIEC Rate Spread Calculator,'' http://www.ffiec.gov/ratespread/newcalc.aspx.
---------------------------------------------------------------------------
Risk-based price adjustments. The Board is aware that, in setting
the purchase price for specific loans, Fannie Mae and Freddie Mac make
loan-level price adjustments (LLPAs) to compensate offset added risks,
such as a high LTV or low credit score, among many other risk
factors.\84\ Creditors may, but are not required to, pass the resulting
costs directly through to the consumer in the form of points. During
outreach, some creditors argued that these points should not be counted
in points and fees for qualified mortgages under the exclusion for
``bona fide third party charges not retained by the loan originator,
creditor, or an affiliate of either.'' Proposed Sec.
226.43(e)(3)(ii)(A); TILA Section 129C(b)(2)(C).
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\84\ See e.g., Fannie Mae, ``Loan-Level Price Adjustment (LLPA)
Matrix and Adverse Market Delivery Charge (AMDC) Information,''
Selling Guide (Dec. 23, 2010).
---------------------------------------------------------------------------
The Board understands creditors' concerns about exceeding the
qualified mortgage points and fees thresholds due to LLPAs required by
the GSEs. At the same time, the Board questions whether an exemption
for LLPAs is consistent with congressional intent in limiting points
and fees for qualified mortgages. Points charged to meet GSE risk-based
price adjustment requirements are arguably no different than other
points charged on loans sold to any secondary market purchaser to
compensate that purchaser for added loan-level risks. Congress clearly
contemplated that discount points generally should be included in
points and fees for qualified mortgages; as discussed above, the Dodd-
Frank Act exempts from the qualified mortgage points and fees
calculation up to only two discount points, and under limited
circumstances. See TILA Section 129C(b)(2)(C)(ii), (iii), and (iv),
proposed to be implemented in new Sec. 226.43(e)(3)(ii)(B) and
(e)(3)(ii)(C).
An exclusion for points charged by creditors in response to
secondary market LLPAs also raises questions about the appropriate
treatment of points charged by creditors to offset loan-level risks on
mortgage loans that they hold in portfolio. Under normal circumstances,
these points are retained by the creditor, so an argument that they
should be excluded from points and fees under the ``bona fide third
party charge'' exclusion (see above) seems inapt. Yet requiring that
these points be included in points and fees, when similar charges on
loans sold into the secondary market are excluded, may create
undesirable market imbalances between loans sold to the secondary
market and loans held in portfolio.
Creditors may offset risks on their portfolio loans (or on loans
sold into the secondary market) by charging a higher rate rather than
additional points and fees; however, the Board recognizes the limits of
this approach to loan-level risk mitigation due to concerns such as
exceeding high-cost mortgage rate thresholds. Nonetheless, in practice,
an exclusion from the qualified mortgage points and fees calculation
for all points charged to offset loan-level risks may create compliance
and enforcement difficulties. The Board questions whether meaningful
distinctions between points charged to offset loan-level risks and
other points and fees charged on a loan can be made clearly and
consistently. In addition, such an exclusion could be overbroad and
inconsistent with Congress's intent that points generally be counted
toward the points and fees threshold for qualified mortgages.
The Board requests comment on whether and on what basis the final
rule should exclude from points and fees for qualified mortgages points
charged to meet risk-based price adjustment requirements of secondary
market purchasers and points charged to offset
[[Page 27467]]
loan-level risks on mortgages held in portfolio.
43(e)(3)(iii) Definition of Loan Originator
Proposed Sec. 226.43(e)(3)(iii) defines the term ``loan
originator'' in Sec. 226.43(e)(3) to have the same meaning as in Sec.
226.36(a)(1). For a discussion of the Board's proposal to use the term
``loan originator'' as defined in Sec. 226.36(a)(1) rather than the
statutory term ``mortgage originator,'' see the section-by-section
analysis of proposed Sec. 226.32(b)(1)(ii).
43(e)(3)(iv) Definition of Bona Fide Discount Point
Proposed Sec. 226.43(e)(3)(iv) defines the term ``bona fide
discount point'' as used in the exclusions of certain ``bona fide
discount points'' from ``points and fees'' for qualified mortgages
described above. This provision is intended to implement TILA Section
129C(b)(2)(C)(iii), which defines the term ``bona fide discount
point,'' as well as TILA Section 129C(b)(2)(C)(iv), which limits the
types of discount points that may be excluded from ``points and fees''
to those for which ``the amount of the interest rate reduction
purchased is reasonably consistent with established industry norms and
practices for secondary market transactions.'' 15 U.S.C.
1639c(b)(2)(C)(iii) and (iv).
Thus, ``bona fide discount point'' is proposed to be defined as
``any percent of the loan amount'' paid by the consumer that reduces
the interest rate or time-price differential applicable to the mortgage
loan by an amount based on a calculation that--
Is consistent with established industry practices for
determining the amount of reduction in the interest rate or time-price
differential appropriate for the amount of discount points paid by the
consumer; and
Accounts for the amount of compensation that the creditor
can reasonably expect to receive from secondary market investors in
return for the mortgage loan.
Consistent with the express statutory language, the Board's
proposal requires that the creditor be able to show a relationship
between the amount of interest rate reduction purchased by a discount
point to the value of the transaction in the secondary market. Based on
outreach with representatives of creditors and government-sponsored
enterprises (GSEs) in particular, the Board understands that the value
of a rate reduction in a particular mortgage transaction on the
secondary market is based on many complex factors, which interact in a
variety of complex ways. These factors may include, among others:
The product type, such as whether the loan is a fixed-rate
or adjustable-rate mortgage, or has a 30-year term or a 15-year term.
How much the mortgage-backed securities (MBS) market is
willing to pay for a loan at that interest rate and the liquidity of an
MBS with loans at that rate.
How much the secondary market is willing to pay for excess
interest on the loan that is available for capitalization outside of
the MBS market.
The amount of the guaranty fee required to be paid by the
creditor to the investor.
The proposal therefore is intended to facilitate compliance by
affording flexibility, while still requiring, as mandated by the
statute, that the amount of discount points paid by consumers for a
particular interest rate reduction be tied to the capital markets. The
Board is concerned that a more prescriptive interpretation would be
operationally unworkable for most creditors and would lead to excessive
legal and regulatory risk. In addition, the Board recognizes that, due
to the variation in inputs described above, a more prescriptive rule
likely would require continual updating, creating additional compliance
burden and potential confusion.
Concerns have been raised that small creditors such as community
banks that often hold loans in portfolio rather than sell them on the
secondary market may have difficulty complying with this requirement.
The Board requests comment on whether any exemptions from the
requirement that the interest rate reduction purchased by a ``bona fide
discount point'' be tied to secondary market factors are appropriate.
43(f) Balloon-Payment Qualified Mortgages Made by Certain Creditors
As discussed above, under this proposal, a qualified mortgage
generally may not provide for a balloon payment. TILA Section
129C(b)(2)(E), however, authorizes the Board to permit qualified
mortgages with balloon payments, provided the loans meet four
conditions. Those conditions are that (1) the loan meets all of the
criteria for a qualified mortgage, with certain exceptions discussed in
the more detailed section-by-section analysis, below; (2) the creditor
makes a determination that the consumer is able to make all scheduled
payments, except the balloon payment, out of income or assets other
than the collateral; (3) the loan is underwritten based on a payment
schedule that fully amortizes the loan over a period of not more than
30 years and takes into account all applicable taxes, insurance, and
assessments; and (4) the creditor meets four prescribed qualifications.
Those four qualifications are that the creditor (1) operates
predominantly in rural or underserved areas; (2) together with all
affiliates, has total annual residential mortgage loan originations
that do not exceed a limit set by the Board; (3) retains the balloon-
payment loans in portfolio; and (4) meets any asset-size threshold and
any other criteria the Board may establish.
Based on outreach, certain community banks appear to originate
balloon-payment loans to hedge against interest rate risk, rather than
making adjustable-rate mortgages. The Board understands that the
community banks hold these balloon-payment loans in portfolio virtually
without exception because they are not eligible for sale in the
established secondary market. The Board believes Congress enacted the
exception in TILA Section 129C(b)(2)(E) to ensure access to credit in
rural and underserved areas where consumers may be able to obtain
credit only from such community banks offering these balloon-payment
loans. Accordingly, proposed Sec. 226.43(f) implements TILA Section
129C(b)(2)(E) by providing an exception to the general provision that a
qualified mortgage may not provide for a balloon payment.
Proposed Sec. 226.43(f)(1) sets forth the four statutory
conditions described above, as well as an additional condition that the
loan term be five years or longer, which the Board is proposing
pursuant to its authority to ``revise, add to, or subtract from the
criteria that define a qualified mortgage'' under TILA Section
129C(b)(3)(B)(i). Proposed Sec. 226.43(f)(2) provides definitions of
``rural'' and ``underserved'' for use in determining whether the
creditor satisfies the first qualification that it ``operates
predominantly in rural or underserved areas.'' These proposed
provisions are discussed in greater detail below.
43(f)(1) Exception
43(f)(1)(i) Criteria for a Qualified Mortgage
Proposed Sec. 226.43(f)(1)(i) implements TILA Section
129C(b)(2)(E)(i) by providing that a balloon-payment qualified mortgage
must meet all of the criteria for a qualified mortgage except those
requiring that the loan (1) not provide for deferral of principal
repayment, (2) not provide for a balloon payment, and (3) be
underwritten based on a fully amortizing payment schedule
[[Page 27468]]
that takes into account all mortgage-related obligations and using the
maximum interest rate that may apply during the first five years after
consummation. Proposed comment 43(f)(1)(i)-1 clarifies that a balloon-
payment qualified mortgage under this exception therefore must provide
for regular periodic payments that do not result in an increase of the
principal balance as required by Sec. 226.43(e)(2)(i)(A), must have a
loan term that does not exceed 30 years as required by Sec.
226.43(e)(2)(ii), must have total points and fees that do not exceed
specified thresholds pursuant to Sec. 226.43(e)(2)(iii), and must
satisfy the consideration and verification requirements in Sec.
226.43(e)(2)(v).
Under this provision, in accordance with the statutory provisions,
the exception would excuse balloon-payment qualified mortgages from the
requirement in proposed Sec. 226.43(e)(2)(i)(B) that a qualified
mortgage not allow the consumer to defer repayment of principal. As
noted above, deferred principal repayment may occur if the payment is
applied to both accrued interest and principal but the consumer makes
periodic payments that are less than the amount that would be required
under a payment schedule that has substantially equal payments that
fully repay the loan amount over the loan term. The scheduled payments
that fully repay a balloon-payment loan over the loan term include the
balloon payment itself and, therefore, are not substantially equal.
Thus, balloon-payment loans permit the consumer to defer repayment of
principal. The Board believes that Congress excused balloon-payment
qualified mortgages from the restriction on principal repayment
deferral for this reason. That rationale, however, does not necessarily
extend to loans that permit principal repayment deferral by providing
for interest-only payments. The Board solicits comment on whether the
exception should provide that balloon-payment qualified mortgages may
permit only principal repayment deferral resulting from the use of an
amortization period that exceeds the loan term, as balloon-payment
loans commonly do, but may not permit principal repayment deferral
resulting from interest-only payments.
43(f)(1)(ii) Underwriting Using Scheduled Payments
Proposed Sec. 226.43(f)(1)(ii) implements TILA Section
129C(b)(2)(E)(ii) by providing that, to make a balloon-payment
qualified mortgage, a creditor must determine that the consumer can
make all of the scheduled payments under the terms of the legal
obligation, except the balloon payment, from the consumer's current or
reasonably expected income or assets other than the dwelling that
secures the loan. Proposed comment 43(f)(1)(ii)-1 provides the
following example to illustrate the calculation of the monthly payment
on which this determination must be based: Assume a loan in an amount
of $200,000 that has a five-year loan term, but is amortized over 30
years. The loan agreement provides for a fixed interest rate of 6%. The
loan consummates on March 15, 2011, and the monthly payment of
principal and interest scheduled for the first five years is $1,199,
with the first monthly payment due on May 1, 2011. The balloon payment
of $187,308 is required on the due date of the 60th monthly payment,
which is April 1, 2016. The loan remains a qualified mortgage if the
creditor underwrites the loan using the scheduled principal and
interest payment of $1,199 (plus all mortgage-related obligations,
pursuant to Sec. 226.43(f)(1)(iii)(B)).
Proposed comment 43(f)(1)(ii)-2 provides additional clarification
on how a creditor may make the required determination that the consumer
is able to make all scheduled payments other than the balloon payment.
It states that a creditor must determine that the consumer is able to
make all scheduled payments other than the balloon payment to satisfy
Sec. 226.43(f)(1)(ii), but the creditor is not required to meet the
repayment ability requirements of Sec. 226.43(c)(2)-(7) because those
requirements apply only to covered transactions that are not qualified
mortgages. Nevertheless, a creditor satisfies Sec. 226.43(f)(1)(ii) if
it complies with the requirements of Sec. 226.43(c)(2)-(7). A creditor
also may make the determination that the consumer is able to make the
scheduled payments (other than the balloon payment) by other means. For
example, a creditor need not determine that the consumer is able to
make the scheduled payments based on a payment amount that is
calculated in accordance with Sec. 226.43(c)(5)(ii)(A) or may choose
to consider a debt-to-income ratio that is not determined in accordance
with Sec. 226.43(c)(7).
43(f)(1)(iii) Calculation of Scheduled Payments
TILA Section 129C(b)(2)(E)(iii) provides that a balloon-payment
qualified mortgage must be underwritten based on a payment schedule
that fully amortizes the loan over a period of not more than 30 years
and takes into account all applicable taxes, insurance, and
assessments. To implement this provision, proposed Sec.
226.43(f)(1)(iii) requires that the scheduled payments on which the
determination required by Sec. 226.43(f)(1)(ii) is based are
calculated using an amortization period that does not exceed 30 years
and include all mortgage-related obligations. The Board believes that
the underwriting referenced in TILA Section 129C(b)(2)(E)(iii)
corresponds to the determination of the consumer's repayment ability
referenced in TILA Section 129C(b)(2)(E)(ii).
Further, the Board believes that the statutory reference to ``a
payment schedule that fully amortizes the loan over a period of not
more than 30 years'' refers to the amortization period used to
determine the scheduled periodic payments (other than the balloon
payment) under the legal obligation and not to the actual loan term of
the obligation, which often is considerably shorter for a balloon-
payment loan. Proposed comment 43(f)(1)(iii)-1 clarifies that balloon
payments often result when the periodic payment would fully repay the
loan amount only if made over some period that is longer than the loan
term. The Board believes this type of transaction was the reason for
the statutory exception for certain balloon-payment loans.
43(f)(1)(iv) Loan Term
As noted above, the Board is proposing to add a condition for a
balloon-payment qualified mortgage that is not established by TILA
Section 129C(b)(2)(E). Proposed Sec. 226.43(f)(1)(iv) provides that a
balloon-payment qualified mortgage must have a loan term of five years
or longer. The Board makes this proposal pursuant to TILA Section
129C(b)(3)(B)(i), which authorizes the Board ``to revise, add to, or
subtract from the criteria that define a qualified mortgage upon a
finding that such regulations are necessary or proper to ensure that
responsible, affordable mortgage credit remains available to consumers
in a manner consistent with the purposes of this section, necessary and
appropriate to effectuate the purposes of this section and Section
129B, to prevent circumvention or evasion thereof, or to facilitate
compliance with such sections.'' The purpose of TILA Section 129C is to
ensure that consumers are offered and receive loans on terms that they
are reasonably able to repay. TILA Section 129B(a)(2). The Board
believes that a minimum loan term for balloon-payment loans is
necessary and appropriate both to effectuate the purposes of TILA
Section 129C and to
[[Page 27469]]
prevent circumvention or evasion thereof.
The Board believes that the exception should be structured to
prevent balloon-payment loans with very short loan terms from being
qualified mortgages because such loans would present certain risks to
consumers. A consumer with a loan term of less than five years,
particularly where the amortization period is especially long, would
face a balloon payment soon after consummation, in an amount virtually
equal to the original loan amount. The consumer would establish little
equity in the property under such terms, and if the pattern is repeated
the consumer may never make any significant progress toward owning the
home unencumbered. Thus, the greater the difference between a balloon-
payment loan's amortization period and its loan term, the more likely
the consumer would face this problem. The Board's proposal to require a
minimum term therefore complements the 30-year maximum amortization
period prescribed by TILA Section 129C(b)(2)(E)(iii).
In addition, the Board believes that some consumers may obtain
balloon-payment loans as a temporary solution when they cannot afford a
longer-term, fully amortizing loan. That is, because the interest rate
is likely to be lower on a shorter-term obligation, a consumer may use
a balloon-payment loan for more affordable financing currently,
intending to refinance into a longer-term, fully amortizing loan once
either the consumer's financial condition has improved or current
market rates have become more favorable, or both. The Board believes
that the proposed five-year minimum loan term would help ensure that
qualified mortgages with balloon payments provide consumers an adequate
time window in which to refinance into longer-term loans. Thus, the
Board believes that the purpose of ensuring that consumers are offered
and receive affordable loan terms would be served by requiring that
balloon-payment qualified mortgages have a minimum loan term of five
years.
The Board notes that the statute requires underwriting for an
adjustable-rate qualified mortgage to be based on the maximum interest
rate permitted during the first five years. TILA Section
129C(b)(2)(A)(v). Therefore, proposed Sec. 226.43(f)(1)(iv) reflects
the statutory intent that five years is a reasonable period to repay a
loan.
For the foregoing reasons, the Board believes that proposed Sec.
226.43(f)(1)(iv), in limiting the exception for balloon-payment
qualified mortgages to covered transactions with loan terms of at least
five years and thus ensuring that such products truly support mortgage
affordability, would effectuate the purposes of TILA Section 129C and
prevent circumvention or evasion thereof. The Board solicits comment on
the appropriateness of this proposed additional condition as well as on
the proposed use of five years as the minimum loan term.
43(f)(1)(v) Creditor Qualifications
TILA Section 129C(b)(2)(E)(iv) includes among the conditions for a
balloon-payment qualified mortgage that the creditor (1) operates
predominantly in rural or underserved areas; (2) together with all
affiliates, has total annual residential mortgage loan originations
that do not exceed a limit set by the Board; (3) retains the balloon-
payment loans in portfolio; and (4) meets any asset-size threshold and
any other criteria as the Board may establish. These four creditor
qualifications are similar to the conditions for an exemption from the
requirement that an escrow account be established for certain mortgages
set forth in TILA Section 129D(c), as enacted by Section 1461 of the
Dodd-Frank Act. The Board proposed to implement the escrow exemption in
the 2011 Escrow Proposal. The provisions of proposed Sec.
226.43(f)(1)(v), which implement TILA Section 129C(b)(2)(E)(iv), differ
in some respects from the provisions of proposed Sec.
226.45(b)(2)(iii) in the 2011 Escrow Proposal because of differences in
the rationales underlying the two exceptions.
Proposed Sec. 226.43(f)(1)(v) implements TILA Section
129C(b)(2)(E)(iv) by providing that a balloon-payment loan may be a
qualified mortgage if the creditor (1) makes most of its balloon-
payment loans in counties designated by the Board as ``rural or
underserved,'' (2) together with all affiliates extended only limited
covered transactions, (3) has not sold, assigned, or otherwise
transferred ownership of its balloon-payment loans, and (4) has total
assets that do not exceed a threshold established and published
annually by the Board, based on the year-to-year change in the average
of the Consumer Price Index for Urban Wage Earners and Clerical
Workers. These qualifications are discussed in more detail in the
following parts of this section-by-section analysis.
``Operates Predominantly in Rural or Underserved Areas''
Under TILA Section 129C(b)(2)(E)(iv)(I), to qualify for the
exception, a creditor must ``operate predominantly in rural or
underserved areas.'' To implement this provision, proposed Sec.
226.43(f)(1)(v)(A) provides that, during the preceding calendar year, a
creditor must have made more than 50% of its total balloon-payment
loans in counties designated by the Board as ``rural or underserved.''
Proposed comment 43(f)(1)(v)-1.i states that the Board publishes
annually a list of counties that qualify as ``rural'' or
``underserved.'' The Board's annual determinations would be based on
the criteria set forth in proposed Sec. 226.43(f)(2), discussed below.
``Areas.'' In determining what is a rural or underserved area, the
Board is proposing to use counties as the relevant area. The Board
believes that the county level is the most appropriate area for this
purpose, even though the sizes of counties can vary. In determining the
relevant area for consumers who are shopping for mortgage loans, census
tracts would be too small, while states generally would be too large.
Because a single standard nationwide would facilitate compliance, the
Board is proposing to use counties for all geographic areas. The Board
seeks comment on the appropriateness of this approach.
``Operates predominantly.'' As noted, the proposed rule requires a
creditor to have made during the preceding calendar year more than 50%
of its total balloon-payment loans in ``rural or underserved''
counties. The Board believes that ``predominantly'' indicates a portion
greater than half, hence the proposed regulatory requirement of more
than 50%. The Board proposes to implement ``operates'' consistently
with the scope of the relevant qualified mortgage provision. Thus,
because the definition of qualified mortgage generally excludes
balloon-payment loans, see proposed Sec. 226.43(e)(2)(i)(C), only
those loans would be counted toward this element of the exception. The
Board solicits comment on the appropriateness of both of these proposed
approaches to implementing the phrase, ``operates predominantly.''
Total Annual Residential Mortgage Loan Originations
Under TILA Section 129C(b)(2)(E)(iv)(II), to qualify for the
exception, the creditor and all affiliates together must have total
annual residential mortgage loan originations that do not exceed a
limit set by the Board. The Board has identified two primary issues
presented in implementing this provision: (1) Whether total annual
originations should be measured by number of loans or by aggregate
dollar volume; and (2)
[[Page 27470]]
the appropriate threshold under either measure.
The Board has only limited information on which to base the
foregoing determinations. Thrift Financial Reports provide limited data
concerning thrifts' balloon-payment loan originations; other types of
depository institutions do not identify which of their mortgage
originations are balloon-payment loans. Moreover, the balloon-payment
loans reported by thrifts include some unknown number of commercial-
purpose loans, which would not be subject to Regulation Z. Based on the
limited thrift data available from 2009, the Board estimates that a
threshold of $100 million in annual aggregate loan amounts originated
would make approximately two-thirds of all thrifts eligible for the
exception (assuming they also meet the other qualifications), and those
thrifts are responsible for approximately 10% of all thrift-originated
balloon-payment loans. Thus, at least among thrifts, the vast majority
of balloon-payment loans are made by a minority of creditors with
relatively large overall mortgage origination volumes. It is not clear,
however, that 10% is the correct percentage of all balloon-payment
loans to be eligible for the exception.
In light of these uncertainties, the Board is not proposing a
specific threshold. To implement TILA Section 129C(b)(2)(E)(iv)(II),
the Board is proposing two alternative versions of Sec.
226.43(f)(1)(v)(B). Alternative 1 would require that, during the
preceding calendar year, the creditor together with all affiliates have
extended covered transactions with principal amounts that in the
aggregate total a to-be-determined dollar amount or less. Alternative 2
would require that, during the preceding calendar year, the creditor
together with all affiliates have extended a to-be-determined number of
covered transactions or fewer. The Board is soliciting comment on both
which alternative is more appropriate and the correct dollar amount or
number of loans, as applicable. For example, should the threshold be
100 loans per year, something greater, or something less?
Alternatively, should the threshold be $100 million in aggregate
covered-transaction loan amounts per year, something greater, or
something less? The Board also requests that commenters explain their
rationales for any suggested thresholds. In particular, how would a
specific threshold correlate with the size and scope of activity of
creditors that, in the absence of the exception, would be likely to
cease offering balloon-payment loans and consequently leave consumers
in their markets with limited access to responsible, affordable
mortgage credit? The Board also requests that commenters share any data
on which their recommendations are based.
Retention of Balloon-Payment Loans in Portfolio
Under TILA Section 129C(b)(2)(E)(iv)(III), to qualify for the
exception, the creditor must ``retain[] the balloon loans in
portfolio.'' Read as literally as possible, this requirement would
apply to all balloon-payment loans ever made by the creditor, even
those made prior to the enactment of the statute. The Board believes,
however, that very few creditors, if any, would be eligible for the
exception under such a reading. Therefore, the Board is proposing two
alternative versions of Sec. 226.43(f)(1)(v)(C) to implement this
provision, both of which would require that the creditor not have sold,
assigned, or otherwise transferred legal title to the debt obligation
for any balloon-payment loan. The difference between the two
alternatives lies entirely in the period during which any such transfer
may not occur.
Alternative 1 would provide that the creditor must not sell any
balloon-payment loan on or after the effective date of the final rule
made pursuant to this proposal. This approach would implement the
statute's language requiring that the creditor ``retain[] the balloon
loans in portfolio.'' The Board recognizes, however, that even this
approach may be unduly limited as a practical matter; once a creditor
sold even one balloon-payment loan after the effective date, it would
become permanently ineligible for the exception. By contrast,
Alternative 2 would limit the period during which the creditor must not
have sold any balloon-payment loan to the preceding and current
calendar years.
The Board solicits comment on the relative merits of Alternatives 1
and 2. The Board also seeks comment on whether, under either
alternative, some de minimis number of transfers that may be made
without losing eligibility for the exception, such as two per calendar
year, would be appropriate. Finally, the Board seeks comment on whether
there are any other situations in which creditors should be permitted
to transfer balloon-payment loans without becoming ineligible for the
exception, such as troubled institutions that need to raise capital by
selling assets or institutions that enter into mergers or acquisitions.
Asset-Size Threshold
Under TILA Section 129C(b)(2)(E)(iv)(IV), to qualify for the
exception, a creditor must meet any asset-size threshold established by
the Board. Accordingly, proposed Sec. 226.43(f)(1)(v)(D) requires the
creditor to have total assets as of December 31 of the preceding
calendar year that do not exceed an asset threshold established and
published annually by the Board. The threshold dollar amount would be
adjusted annually based on the year-to-year change in the average of
the Consumer Price Index for Urban Wage Earners and Clerical Workers,
not seasonally adjusted, for each 12-month period ending in November,
with rounding to the nearest million dollars. Comment 43(f)(1)(v)-1.iv
would be updated each December to publish the applicable threshold for
the following calendar year. The comment would clarify that creditors
that had total assets at or below the threshold on December 31 of the
preceding year satisfy this criterion for purposes of the exception
during the current calendar year.
This proposal would set the threshold for calendar year 2011 at $2
billion. Thus, a creditor would satisfy this element of the test if it
had total assets of $2 billion or less on December 31, 2010. This
number is based on the limited data available to the Board through
Thrift Financial Reports, noted above, and information from commercial
banks' Consolidated Reports of Condition and Income. Because of the
limited information available on originations of balloon-payment loans,
the Board cannot identify which creditors make more than 50% of such
loans in ``rural'' or ``underserved'' counties. The Board can identify,
however, the institutions that likely conduct the majority of their
overall business in such locations by reference to their office
locations and to the origins of their deposits. The Board believes that
the locations in which creditors have offices and from which they draw
their deposits likely correlate with the locations in which they extend
balloon-payment loans. Of those institutions that either have over 50%
of their office locations in or derive over 50% of their deposits from
``rural'' or ``underserved'' counties (under the proposed definitions
of those terms, discussed below), none had total assets as of the end
of 2009 greater than $2 billion.
The Board believes that Congress's intent in authorizing the Board
to establish an asset-size test is to ensure that only smaller
institutions that serve areas with otherwise limited credit
[[Page 27471]]
options may qualify for the exception. At the same time, the Board
believes that the asset-size test should not exclude creditors that
otherwise probably are the type of community bank for which the
exception is intended, i.e., those engaged primarily in serving rural
or underserved areas. Accordingly, the Board is proposing to set the
asset-size threshold at the highest level currently held by any of the
institutions that appear to meet that description. The annual
adjustment to the threshold would ensure that institutions growing at a
pace consistent with inflation continue to be eligible for the
exception. If an institution should grow substantially beyond the rate
of inflation, however, it would effectively ``outgrow'' the exception,
consistent with Congress's intent to restrict the exception to
relatively small creditors. The Board seeks comment on the
appropriateness of the proposed $2 billion asset-size threshold and of
the proposed annual adjustments thereto.
TILA Section 129C(b)(2)(E)(iv)(IV) authorizes but does not require
an asset-size test. The Board recognizes that the other qualifications
that a creditor must satisfy, discussed above, likely would be
satisfied only by relatively small creditors. Thus, there may be no
need for a separate asset-size test, and the exception may be as
readily implemented with lesser burden to creditors by omitting such a
test. Moreover, in the parallel provisions of the 2011 Escrow Proposal,
the Board proposed no asset-size test on the belief that it would be
unnecessary. Accordingly, the Board seeks comment on whether an asset-
size test is necessary to this exception. The Board also seeks comment
on what threshold is appropriate, and why, if an asset-size test is
necessary. The Board requests that commenters provide any data they
have underlying their recommendations on these questions.
43(f)(2) ``Rural'' and ``Underserved'' Defined
Proposed Sec. 226.43(f)(2) sets out the criteria for a county to
be designated by the Board as ``rural or underserved'' for purposes of
proposed Sec. 226.43(f)(1)(v)(A), discussed above. Under that section,
a creditor's balloon-payment loan originations in all counties
designated as ``rural or underserved'' during a calendar year are
measured as a percentage of the creditor's total balloon-payment loan
originations during that calendar year to determine whether the
creditor may be eligible for the exemption during the following
calendar year. If the creditor's balloon-payment loan originations in
``rural or underserved'' counties during a calendar year exceeded 50%
of the creditor's total balloon-payment loan originations in that
calendar year, the creditor would satisfy Sec. 226.43(f)(1)(v)(A) for
purposes of the following calendar year.
Proposed Sec. 226.43(f)(2) establishes separate criteria for both
``rural'' and ``underserved,'' thus a county could qualify for
designation by the Board under either definition. Under proposed Sec.
226.43(f)(2)(i), a county is designated as ``rural'' during a calendar
year if it is not in a metropolitan statistical area or a micropolitan
statistical area, as those terms are defined by the U.S. Office of
Management and Budget, and either (1) it is not adjacent to any
metropolitan or micropolitan area; or (2) it is adjacent to a
metropolitan area with fewer than one million residents or adjacent to
a micropolitan area, and it contains no town with 2,500 or more
residents. Under proposed Sec. 226.43(f)(2)(ii), a county is
designated as ``underserved'' during a calendar year if no more than
two creditors extend covered transactions five or more times in that
county.
These two definitions, discussed in more detail below, parallel the
definitions of the same terms as they are used in proposed Sec.
226.45(b)(2)(iv) as set forth in the Board's 2011 Escrow Proposal. See
proposed Sec. 226.45(b)(2)(iv), 76 FR 11598, 11621; March 2, 2011.
Both sets of proposed regulatory definitions are for purposes of
implementing identical statutory provisions, thus the Board believes
consistent definitions are appropriate. See TILA Sections
129C(b)(2)(E)(iv)(I) and 129D(c)(1) (``operates predominantly in rural
or underserved areas'').
``Rural''
The Board is proposing to limit the definition of ``rural'' areas
to those areas most likely to have only limited sources of mortgage
credit because of their remoteness from urban centers and their
resources. The test for ``rural'' in proposed Sec. 226.43(f)(2)(i),
described above, is based on the ``urban influence codes'' numbered 7,
10, 11, and 12, maintained by the Economic Research Service (ERS) of
the United States Department of Agriculture. The ERS devised the urban
influence codes to reflect such factors as counties' relative
population sizes, degrees of ``urbanization,'' access to larger
communities, and commuting patterns.\85\ The four codes captured in the
proposed ``rural'' definition represent the most remote rural areas,
where ready access to the resources of larger, more urban communities
and mobility are most limited. Proposed comment 43(f)(2)-1 states that
the Board classifies a county as ``rural'' if it is categorized under
ERS urban influence code 7, 10, 11, or 12. The Board seeks comment on
all aspects of this approach to designating ``rural'' counties,
including whether the definition should be broader or narrower, as well
as whether the designation should be based on information other than
the ERS urban influence codes.
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\85\ See http://www.ers.usda.gov/briefing/Rurality/UrbanInf/.
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``Underserved''
In determining what areas should be considered ``underserved,'' the
Board has considered the minimum number of creditors that must be
engaged in significant mortgage operations in an area for consumers to
have meaningful access to mortgage credit. The test for ``underserved''
in proposed Sec. 226.43(f)(2)(ii), described above, is based on the
Board's judgment that, where no more than two creditors are
significantly active (measured by extending mortgage credit at least
five times in a year), the unwillingness of one creditor to offer a
balloon-payment loan would be detrimental to consumers with otherwise
limited credit options. Thus, proposed Sec. 226.43(f)(2)(ii)
designates a county as ``underserved'' during a calendar year if no
more than two creditors extend covered transactions five or more times
in that county. Proposed comment 43(f)(2)-1 states that the Board bases
its determinations of whether counties are ``underserved'' for purposes
of Sec. 226.43(f)(1)(v)(A) by reference to data submitted by mortgage
lenders under the Home Mortgage Disclosure Act (HMDA).
The Board believes the purpose of the exception is to permit
creditors that rely on certain balloon-payment loan products to
continue to offer credit to consumers, rather than leave the mortgage
loan market, if such creditors' withdrawal would significantly limit
consumers' ability to obtain mortgage credit. In light of this
rationale, the Board believes that ``underserved'' should be
implemented in a way that protects consumers from losing meaningful
access to mortgage credit. The Board is proposing to do so by
designating as ``underserved'' only those areas where the withdrawal of
a creditor from the market could leave no meaningful competition for
consumers' mortgage business. The Board seeks comment on the
appropriateness of both the proposed use of two or fewer
[[Page 27472]]
existing competitors to delineate areas that are ``underserved'' and
the proposed use of five or more covered transaction originations to
identify competitors with a significant presence in a market.
43(g) Prepayment Penalties
Proposed Sec. 226.43(g) would implement TILA Section 129C(c),
which establishes certain limits on prepayment penalties for covered
transactions. Specifically, TILA Section 129C(c) provides that:
Only a covered transaction that is a qualified mortgage
may contain a prepayment penalty;
A qualified mortgage with a prepayment penalty may not
have an adjustable rate and may not have an annual percentage rate that
exceeds the threshold for a higher-priced mortgage loan;
The prepayment penalty may not exceed three percent of the
outstanding balance during the first year after consummation, two
percent during the second year after consummation, and one percent
during the third year after consummation;
There can be no prepayment penalty after the end of the
third year after consummation; and
A creditor may not offer a consumer a loan with a
prepayment penalty without offering the consumer a loan that does not
include a prepayment penalty.\86\
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\86\ Also, TILA Section 129C(c)(2) requires weekly publication
of the ``average prime offer rate'' used to determine if a
transaction is a ``higher-priced mortgage loan.''
The Board's proposal to implement TILA Section 129C(c) is discussed in
detail below. The Board at this time does not propose to implement
limitations on prepayment penalties the Dodd-Frank Act adds under other
TILA provisions, also discussed below.
Limitations for higher-priced mortgage loans. Currently, Sec.
226.35(b)(2) prohibits a prepayment penalty for higher-priced mortgage
loans, unless certain conditions are met. In particular, the prepayment
penalty must not apply after the two-year period following
consummation, and the amount of the periodic payment of principal and
interest or both must not change during the four-year period following
consummation. New TILA Section 129C(c), as added by Section 1414 of the
Dodd-Frank Act, establishes limitations on prepayment penalties that
apply to all covered transactions. Thus, TILA Section 129C(c) renders
superfluous the limitations on prepayment penalties with higher-priced
mortgage loans adopted in the Board's 2008 HOEPA Final Rule. See 15
U.S.C. 1639(c), (l); Sec. 226.35(b)(2). The Board accordingly proposes
to remove the limitations on prepayment penalties for higher-priced
mortgage loans under Sec. 226.35(b)(2) and other requirements under
Sec. 226.35, as discussed in detail above in the section-by-section
analysis of proposed Sec. 226.35.
Limitations for high-cost mortgages. Section 1432(a) of the Dodd-
Frank Act prohibits prepayment penalties with high-cost mortgages by
removing TILA Section 129(c)(2), which had allowed prepayment penalties
with high-cost mortgages in certain circumstances. Currently, Sec.
226.32(d)(7) implements TILA Section 129(c)(2). At this time, the Board
does not propose to remove Sec. 226.32(d)(7) because the proposal in
general does not propose to implement the other revisions to the high-
cost mortgage requirements under Section 1431 of the Act. Nevertheless,
under the proposal, a high-cost mortgage can include a prepayment
penalty only if the high-cost mortgage meets the conditions under both
current Sec. 226.32(d)(7) and proposed Sec. 226.43(g)(1). The joint
operation of those two sets of conditions significantly limits the
circumstances in which a high-cost mortgage may have a prepayment
penalty.\87\
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\87\ In particular, the high-cost mortgage cannot be a higher-
priced mortgage loan. See proposed Sec. 226.43(g)(1)(ii)(C). Also,
the prepayment penalty must be permitted by applicable law. See
Sec. 226.32(d)(7); proposed Sec. 226.43(g)(1)(i).
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Scope; reverse mortgages. Proposed Sec. 226.43(g) implements TILA
Section 129C(c), which applies to a ``residential mortgage loan,'' that
is, to a consumer credit transaction secured by a dwelling, other than
an open-end credit plan or a transaction secured by a consumer's
interest in a timeshare plan. See TILA Section 103(cc)(5). In contrast
with the exclusions for open-end credit plans and transactions secured
by timeshares from coverage by ability-to-repay requirements, neither
the definition of ``residential mortgage loan'' nor the prepayment
penalty provision excludes reverse mortgages or temporary or ``bridge''
loans with a term of 12 months or less, such as a loan to finance the
purchase of a new dwelling where the consumer plans to sell a current
dwelling. See TILA Sections 103(cc)(5), 129C(a)(8), 129C(c).
Accordingly, the prepayment penalty requirements in proposed Sec.
226.43(g) apply to such transactions. See proposed Sec. 226.43(a)(3).
A covered transaction may include a prepayment penalty only if the
transaction is a qualified mortgage. See TILA Section 129C(c)(1)(A);
see also proposed Sec. 226.43(g)(1)(ii)(B). Among other limitations, a
qualified mortgage may not have a prepayment penalty if the transaction
provides for an increase in the principal balance. Reverse mortgages
provide for interest and fees to be added to the principal balance and
thus could not include a prepayment penalty. However, the Board has
authority to define a category of ``qualified'' closed-end reverse
mortgages that can include a prepayment penalty if certain other
conditions are met, pursuant to authority under TILA Sections
129C(b)(2)(A)(ix) and 129C(b)(3)(B).\88\ Section 129C(b)(2)(A)(ix)
authorizes the Board to define a ``qualified'' reverse mortgage that
``meets the standards for a qualified mortgage, as set by the Board in
rules that are consistent with the purposes'' of TILA Section 129C(b).
Also, TILA Section 129C(b)(3)(B) authorizes the Board to prescribe
regulations that revise, add to, or subtract from the criteria that
define a qualified mortgage upon a finding that such regulations are
(1) necessary or proper to ensure that responsible, affordable mortgage
credit remains available to consumers in a manner consistent with the
purposes of Section 129C(b), or (2) necessary and appropriate to
effectuate the purposes of Sections 129B and 129C, to prevent
circumvention or evasion thereof, or to facilitate compliance
therewith.
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\88\ Open-end credit plans are excluded from the definition of
``residential mortgage loan,'' and thus open-end reverse mortgages
are not subject to the prepayment penalty requirements under TILA
Section 129C(c). TILA Section 103(cc)(5).
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The Board does not propose to exclude ``qualified'' reverse
mortgages from the coverage of the prepayment penalty requirements, for
two reasons. First, the Board does not believe that such exclusion is
necessary or proper to ensure that responsible, affordable mortgage
credit remains available to consumers. The overwhelming majority of
reverse mortgages to date have been insured by the Federal Housing
Administration, which does not allow reverse mortgages to contain
prepayment penalties.\89\ The Board believes that most proprietary
reverse mortgages also do not contain prepayment penalties.
Accordingly, the Board believes that applying prepayment penalty
requirements under TILA Section 129C(c) to closed-end reverse mortgages
would have little or no effect on the availability of reverse
[[Page 27473]]
mortgages. Second, the Board believes that excluding ``qualified''
reverse mortgages from coverage of the prepayment penalty requirements
is not necessary or appropriate to effectuate the purposes of TILA
Section 129C, because the Board is unaware of a reason why such
exclusion would ``assure that consumers are offered and receive
residential mortgage loans on terms that reasonably affect their
ability to repay the loans and that are understandable and not unfair,
deceptive, or abusive.'' See TILA Section 129B(a)(2).
---------------------------------------------------------------------------
\89\ See Hui Shan, ``Reversing the Trend: The Recent Expansion
of the Reverse Mortgage Market Finance and Economics Discussion
Series,'' Board of Governors of the Federal Reserve System, 2009-42
(2009), available at http://www.federalreserve.gov/pubs/feds/2009/200942/200942pap.pdf.; 24 CFR 209(a).
---------------------------------------------------------------------------
Only a qualified mortgage may have a prepayment penalty, and
reverse mortgages typically do not satisfy the qualified mortgage
conditions. In particular, a qualified mortgage may not provide for an
increase in the transaction's principal balance. See TILA Section
129C(b)(2)(A)(i). However, a reverse mortgage provides for interest and
fees to be added to the loan balance, instead of providing for the
consumer to make payments during the loan term. Also, creditors do not
consider a consumer's repayment ability for a reverse mortgage because
the consumer does not make payments. Thus, because the proposal does
not establish special conditions for reverse mortgages to be qualified
mortgages, closed-end reverse mortgages likely may not have prepayment
penalties.\90\ See TILA Section 129C(c)(1)(A).
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\90\ Open-end credit plans are excluded from the definition of
``residential mortgage loan,'' and thus open-end reverse mortgages
are not subject to the prepayment penalty requirements under TILA
Section 129C(c). TILA Section 103(cc)(5).
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The Board requests comment on whether special rules should be
created to permit certain reverse mortgages to have prepayment
penalties. In particular, the Board requests comment on how applying
such conditions would be consistent with the purposes of the
alternative requirements for qualified mortgages under TILA Section
129C(b). The Board also requests comment and any supporting data on the
prepayment rates for reverse mortgages.
43(g)(1) When Permitted
TILA Section 129C(c)(1)(A) provides that a covered transaction must
not include a penalty for paying all or part of the principal balance
after consummation unless the transaction is a qualified mortgage as
defined in TILA Section 129C(b)(2). TILA Section 129C(c)(1)(B) provides
that, for purposes of TILA Section 129C(c), a qualified mortgage does
not include a covered transaction that has an adjustable rate or a
covered transaction that has an APR that exceeds the average prime
offer rate for a comparable transaction, as of the date the rate is
set, by a specified number of percentage points. The applicable APR
threshold depends on whether a first lien or subordinate lien secures
the transaction and whether or not the transaction's original principal
obligation exceeds the maximum principal obligation for a loan eligible
for purchase by Freddie Mac, that is, whether or not the covered
transaction is a ``jumbo'' loan. Specifically, the APR threshold is:
(1) 1.5 percentage points above the average prime offer rate, for a
first-lien, non-``jumbo'' loan; (2) 2.5 percentage points above the
average prime offer rate, for a first-lien ``jumbo'' loan; and (3) 3.5
percentage points above the average prime offer rate, for a
subordinate-lien loan. These thresholds also are used for purposes of
escrow account requirements for ``higher-priced mortgage loans,'' as
discussed in the 2011 Escrow Proposal.\91\ Proposed Sec. 226.43(g)(1)
would implement TILA Section 129C(c)(1) and provides that a covered
transaction may not include a prepayment penalty unless the prepayment
penalty is otherwise permitted by law, and the transaction: (1) Has an
APR that cannot increase after consummation; (2) is a qualified
mortgage, as defined in proposed Sec. 226.43(e) or (f); and (3) is not
a higher-priced mortgage loan, as defined in proposed Sec. 226.45(a).
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\91\ 76 FR 11598, 11608, Mar. 2, 2011 (discussing proposed new
Sec. 226.45(a)).
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43(g)(1)(i) Permitted by Applicable Law
Under proposed Sec. 226.43(g)(1)(i), a prepayment penalty must be
otherwise permitted by applicable law. The Board believes that TILA
Section 129C(c) limits, but does not specifically authorize, including
a prepayment penalty with a covered transaction. That is, TILA Section
129C(c) does not override other applicable laws, such as state laws,
that may be more restrictive. Thus, a prepayment penalty would not be
permitted if otherwise prohibited by applicable law. This approach is
consistent with prepayment penalty requirements for high-cost mortgages
and higher-priced mortgage loans. See Sec. 226.32(d)(7)(i),
226.35(b)(2)(i).
43(g)(1)(ii) Transaction Conditions
43(g)(1)(ii)(A) APR Cannot Increase After Consummation
TILA Section 129C(c)(1)(B)(i) provides that a covered transaction
may not include a prepayment penalty if the transaction has an
``adjustable rate.'' The statute differs from the Board's 2008 HOEPA
Final Rule, in which a high-cost mortgage or a higher-priced mortgage
loan may not include a prepayment penalty if the periodic payment of
principal or interest may change during the first four years after
consummation. See Sec. 226.32(d)(7)(iv), 226.35(b)(2)(C). TILA Section
129C(c)(1)(B)(i) does not specify whether the term ``adjustable rate''
refers to the transaction's interest rate or annual percentage rate.
Rules under Regulation Z for closed-end transactions generally
categorize transactions based on the possibility of APR changes rather
than interest rate changes.\92\ This distinction is relevant because
covered transactions may have an APR that cannot increase after
consummation even though the interest rate or payments may increase
after consummation. For example, the APR for a ``step-rate mortgage''
without a variable rate feature does not change after consummation,
because the rates that will apply and the periods for which they will
apply are known at consummation. Cf. Sec. 226.18(s)(7)(ii) (defining
``step-rate mortgage'' for purposes of transaction-specific interest
rate and payment disclosures).
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\92\ See, e.g., Sec. 226.18(f) (requiring disclosures regarding
APR increases), 226.18(s)(7)(i)-(iii) (categorizing disclosures for
purposes of interest rate and payment disclosures), 226.36(e)(2)(i)-
(ii) (categorizing transactions for purposes of the safe harbor for
the anti-steering requirement under Sec. 226.36(e)(1)).
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The Board proposes to interpret the prohibition on a prepayment
penalty with a covered transaction that has an ``adjustable rate'' in
TILA Section 129C(c)(1)(B)(i) to apply to covered transactions for
which the APR can increase after consummation, to facilitate creditors'
compliance with the various rate-related requirements under Regulation
Z. Accordingly, to implement TILA Section 129C(c)(1)(B)(i), proposed
Sec. 226.43(g)(1)(ii)(A) provides that a covered transaction cannot
include a prepayment penalty unless the transaction's APR cannot
increase after consummation. Thus, under the Board's proposal a fixed-
rate mortgage or a step-rate mortgage may have a prepayment penalty,
but an adjustable-rate mortgage may not have a prepayment penalty. See
Sec. 226.18(s)(7)(i)-(iii) (defining ``fixed-rate mortgage,'' ``step-
rate mortgage,'' and ``adjustable-rate mortgage''). The Board solicits
comment on this approach.
43(g)(1)(ii)(B) Qualified Mortgage
Under TILA Section 129C(c)(1)(A), a covered transaction may not
include a prepayment penalty unless the transaction is a qualified
mortgage under TILA Section 129C(b)(2). Proposed Sec.
226.43(g)(1)(ii)(B) would implement TILA Section 129C(c)(1)(A)
[[Page 27474]]
and provides that a covered transaction must not include a prepayment
penalty unless the transaction is a qualified mortgage under Sec.
226.43(e) or (f). To be a qualified mortgage, a covered transaction in
general may not have a balloon payment. However, a covered transaction
with a balloon payment may be a qualified mortgage if the creditor
originates covered transactions primarily in ``rural'' or
``underserved'' areas, as discussed in detail above in the section-by-
section analysis of Sec. 226.43(f). Thus, there are certain situations
in which a consumer could face a prepayment penalty if she attempts to
refinance out of a balloon-payment qualified mortgage before the
balloon payment is due. The Board solicits comment on whether it would
be appropriate to use legal authority under TILA Sections 105(a) and
129B(e) to provide that a balloon-payment qualified mortgage may not
have a prepayment penalty in any case.
43(g)(1)(ii)(C) Threshold for a Higher-Priced Mortgage Loan
Under TILA Section 129C(c)(1)(B), a covered transaction may not
include a prepayment penalty unless the transaction's APR is below
specified thresholds. Accordingly, to implement TILA Section
129C(c)(1)(B), proposed Sec. 226.43(g)(1)(ii)(C) provides that a
consummated covered transaction must not include a prepayment penalty
unless the transaction is not a higher-priced mortgage loan, as defined
in proposed Sec. 226.45(a) of the 2011 Escrow Proposal.
Under the Board's 2010 Mortgage Proposal, creditors would determine
whether a transaction is a higher-priced mortgage loan by comparing the
transaction's ``transaction coverage rate,'' rather than APR, to the
average prime offer rate, as discussed in detail in that proposal.\93\
Under the 2010 Mortgage Proposal, the transaction coverage rate is a
transaction-specific rate that is used solely for coverage
determinations and would not be disclosed to consumers. The creditor
would calculate the transaction coverage rate based on Regulation Z's
rules for calculating the APR, except the creditor would make the
calculation using a modified value for the prepaid finance charge. In
summary, the Board explained that using the APR as the coverage metric
for requirements for higher-priced mortgage loans poses a risk of over-
inclusive coverage beyond the subprime market.\94\ The Board noted that
the average prime offer rate is based on Freddie Mac's Primary Mortgage
Market Survey[supreg] of the contract interest rates and points of
loans offered to consumers with low-risk transaction terms and credit
profiles. APRs, however, are based on a broader set of charges,
including some third-party charges such as mortgage insurance premiums.
The Board also recognized that, under the Board's 2009 Closed-End
Mortgage Proposal, the APR would be based on a finance charge that
includes most third-party fees in addition to points, origination fees,
and any other fees the creditor retains. Thus, the 2009 Closed-End
Mortgage Proposal would expand the existing difference between fees
included in the APR and fees included in the average prime offer rate.
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\93\ See 74 FR 58539, 58709-58710, Sept. 24, 2010 (proposing
revisions to the definition of ``higher-priced mortgage loan'' under
Sec. 226.35(a)).
\94\ See 74 FR at 58660-58662.
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To address this concern, the Board proposed in the 2010 Mortgage
Proposal to require creditors to compare the transaction coverage rate,
rather than the APR, to the average prime offer rate to determine
whether a transaction is covered by the protections for higher-priced
mortgage loans. The Board also proposed to use the transaction coverage
rate for the definition of a higher-priced mortgage loan in the 2011
Escrow Proposal.\95\ Similarly, under the present proposal, creditors
would determine whether a transaction is a higher-priced mortgage loan
based on the transaction coverage rate rather than the APR, for
purposes of the prepayment penalty restriction. The Board solicits
comment on this approach.
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\95\ See 75 FR 11598, 11620, Mar. 2, 2011 (proposing a new Sec.
226.45(a)).
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43(g)(2) Limits on Prepayment Penalties
TILA Section 129C(c)(3) provides that a prepayment penalty may not
be imposed more than three years after the covered transaction is
consummated and limits the maximum amount of the prepayment penalty.
Specifically, a prepayment penalty is limited to (1) three percent of
the outstanding principal balance during the first year following
consummation; (2) two percent during the second year following
consummation; and (3) one percent during the third year following
consummation.
Proposed Sec. 226.43(g)(2) would implement and is substantially
similar to TILA Section 129C(c)(3). However, under proposed Sec.
226.43(g)(2) the maximum penalty amount is determined based on the
amount of the outstanding loan balance prepaid, rather than the entire
outstanding loan balance, because the requirements under TILA Section
129C(c) apply if a penalty is imposed for either partial or full
prepayment. Thus, for example, if the outstanding loan balance is
$100,000 when the consumer prepays $20,000 eleven months after
consummation, the maximum prepayment penalty is $600 (three percent of
$20,000), rather than $3,000 (three percent of $100,000). The Board
proposes this adjustment pursuant to the Board's authority under TILA
Section 105(a) to issue regulations with such requirements,
classifications, differentiations, or other provisions, and that
provide for such adjustments and exceptions for all or any class of
transactions, as in the judgment of the Board are necessary and proper
to effectuate the purposes of TILA, to prevent circumvention or evasion
thereof, or to facilitate compliance therewith. 15 U.S.C. 1604(a). The
Board believes that calculating the maximum prepayment penalty based on
the amount of the outstanding loan balance that is prepaid, rather than
the entire outstanding loan balance, would effectuate the purposes of
TILA Section 129C(c) to facilitate partial (and full) prepayment by
limiting the amount of a prepayment penalty. The Board believes it
would be inconsistent with congressional intent, for example, for a
consumer that makes several partial prepayments to pay a percentage of
the outstanding loan balance each time. The Board also believes that
the proposed adjustment would facilitate compliance, because
determining the maximum prepayment penalty is simpler if the
calculation is based on the amount of the outstanding balance prepaid
in all cases, whether the consumer prepays in full or in part.
Proposed comment 43(g)(2)-1 clarifies that a covered transaction
may include a prepayment penalty that may be imposed only during a
shorter period or in a lower amount than provided in proposed Sec.
226.43(g)(2). Proposed comment 43(g)(2)-1 provides the example of a
prepayment penalty that a creditor may impose for two years after
consummation that is limited to two percent of the amount prepaid.
The Board recognizes that two other sections of TILA may limit the
maximum amount of the prepayment penalty. First, TILA Section
129C(b)(2)(A)(vii) indirectly limits the maximum amount of a prepayment
penalty with a qualified mortgage, by limiting the maximum ``points and
fees'' for a qualified mortgage, which include prepayment penalties, to
three percent of the total loan amount. See also proposed Sec.
226.43(e)(2)(iii), discussed above. The definition of ``points and
fees'' includes the maximum
[[Page 27475]]
prepayment penalty that may be charged, as well as any prepayment
penalty incurred by the consumer if the loan refinances a previous loan
made or currently held by the same creditor or an affiliate of the
creditor. See TILA Section 103(aa)(4)(E) and proposed Sec.
226.32(b)(1), discussed above. Thus, if a creditor wants to include the
maximum three percent prepayment penalty as a term of a qualified
mortgage, it generally would have to forego any other charges that are
included in the definition of points and fees.
Second, TILA Section 103(aa)(1)(A)(iii) defines a ``high-cost
mortgage'' as any loan secured by the consumer's principal dwelling in
which the creditor may charge prepayment fees or penalties more than 36
months after the closing of the transaction, or in which the fees or
penalties exceed, in the aggregate, more than two percent of the amount
prepaid. In turn, a high-cost mortgage may not contain a prepayment
penalty under TILA Section 129(c), as amended by Section 1432 of the
Dodd-Frank Act. At this time, the Board is not proposing to implement
these limitations on prepayment penalties. The Board nevertheless
solicits comment on whether proposed Sec. 226.43(g)(2) should
incorporate the limitation of prepayment penalty amounts to two percent
of the amount prepaid, as provided under TILA Section
103(aa)(1)(A)(iii), or some other threshold to account for the
limitation of points and fees, including prepayment penalties, for
``qualified mortgages,'' under TILA Section 129C(b)(2)(A)(vii) and
proposed Sec. 226.43(e)(2)(iii).
43(g)(3) Alternative Offer Required
Under TILA Section 129C(c)(4), if a creditor offers a consumer a
covered transaction with a prepayment penalty, the creditor also must
offer the consumer a covered transaction without a prepayment penalty.
As discussed in detail below, proposed Sec. 226.43(g)(3) would
implement TILA Section 129C(c)(4) and includes additional conditions:
The alternative covered transaction without a prepayment penalty must
(1) have an APR that cannot increase after consummation and the same
type of interest rate as the covered transaction with a prepayment
penalty (that is, both must be fixed-rate mortgages or both must be
step-rate mortgages); (2) have the same loan term as the covered
transaction with a prepayment penalty; (3) satisfy the periodic payment
conditions for qualified mortgages; and (4) satisfy the points and fees
conditions for qualified mortgages. The proposed additional conditions
are intended to ensure that the alternative covered transactions
offered have substantially similar terms. Also, proposed Sec.
226.43(g)(3) requires that the alternative covered transaction be a
transaction for which the consumer likely qualifies.
The Board proposes these additional requirements pursuant to the
Board's authority under TILA Section 105(a) to prescribe regulations
that contain such additional requirements, classifications,
differentiations, or other provisions, or provide for such adjustments
or exceptions for all or any class of transactions, as in the judgment
of the Board are necessary or proper to effectuate the purposes of
TILA, to prevent circumvention or evasion thereof, or to facilitate
compliance therewith. 15 U.S.C. 1604(a). The Board believes that
requirements designed to ensure that the alternative covered
transaction with and without a prepayment penalty are substantially
similar would effectuate the purposes of TILA Section 129C(c)(4), by
enabling consumers to focus on a prepayment penalty's risks and
benefits without having to consider or evaluate other differences
between the alternative covered transactions. For example, a consumer
would compare a fixed-rate mortgage with a prepayment penalty with a
fixed-rate mortgage without a prepayment penalty, not with a step-rate
mortgage without a prepayment penalty. Also, the Board believes that
requiring the alternative covered transaction without a prepayment
penalty be one for which the consumer likely qualifies would effectuate
the purposes of and prevent circumvention of TILA Section 129C(c)(4),
by providing for consumers to be able to choose between options that
likely are available. Finally, proposed comment 43(g)(3)-1 cross-
references comment 25(a)-7, discussed above, for guidance on the
requirements for retaining records as evidence of compliance with Sec.
226.43(g)(3).
Higher-priced mortgage loans. Under the proposal, a covered
transaction cannot have a prepayment penalty if the transaction is a
higher-priced mortgage loan. However, the requirement to offer an
alternative covered transaction without a prepayment penalty is not
similarly restricted. Although the Board believes the covered
transaction with a prepayment penalty and the alternative covered
transaction without a prepayment penalty must be substantially similar,
the Board also believes a higher-priced mortgage loan without a
prepayment penalty should be a permissible alternative transaction for
a non-higher-priced mortgage loan with a prepayment penalty, for two
reasons. First, the Board believes TILA Section 129C(c)(4) is intended
to ensure consumers have a choice whether or not to obtain a covered
transaction with a prepayment penalty, not to limit the pricing of the
alternative covered transaction without a prepayment penalty that the
creditor must offer.
Second, the Board is concerned about the likely consequences of
restricting the pricing of the required alternative covered transaction
without a prepayment penalty. If the alternative covered transaction
must not be a higher-priced mortgage loan, the creditor may choose not
to offer the consumer a loan at all, or to offer the consumer only a
higher-priced mortgage loan. For example, assume that the higher-priced
mortgage loan coverage threshold for a 30-year, non-jumbo, fixed-rate
covered transaction is 6.50 percent, and that the creditor charges 0.25
percentage points more in interest for a covered transaction without a
prepayment penalty. Assume further that the creditor would make such a
loan to a consumer in a covered transaction either (1) with a
prepayment penalty and with a transaction coverage rate of 6.45 percent
(Transaction A); or (2) without a prepayment penalty and with a
transaction coverage rate of 6.70 percent (Transaction B). However, if
offering Transaction A means the creditor must offer the consumer an
alternative covered transaction without a prepayment penalty that is
not a higher-priced mortgage loan, the creditor may choose not to offer
the consumer a covered transaction at all. Alternatively, the creditor
might elect to offer the consumer only Transaction B, which is a
higher-priced mortgage loan. For the foregoing reasons, under proposed
Sec. 226.43(g)(3) if a creditor offers a covered transaction with a
prepayment penalty, which may not be a higher-priced mortgage loan, the
creditor may offer the consumer an alternative covered transaction
without a prepayment penalty that is a higher-priced mortgage loan.
Timing of offer. Proposed Sec. 226.43(g)(3) does not require that
the creditor offer an alternative covered transaction without a
prepayment penalty at or by a particular time. This is consistent with
Sec. 226.36(e)(2) and (3), which provide a safe harbor for the anti-
steering requirement if a loan originator presents certain loan options
to the consumer, but do not contain a timing requirement. The Board
recognizes that there may be costs and benefits to this approach.
On the one hand, a timing requirement could ensure that
[[Page 27476]]
consumers can consider an offer of an alternative covered transaction
without a prepayment penalty before committing to a transaction, for
example, by requiring that creditors present such an offer before the
consumer pays a non-refundable fee, other than a fee for obtaining the
consumer's credit history.\96\ Alternatively, consumers might benefit
from being offered an alternative covered transaction without a
prepayment penalty later in the lending process, after the creditor has
underwritten the loan and determined the terms on which it would
originate an alternative covered transaction to the consumer. On the
other hand, timing requirements might unduly limit creditors'
flexibility to determine the terms on which they will offer a
particular consumer an alternative covered transaction without a
prepayment penalty. In addition, there may be operational difficulties
in determining exactly when a creditor offered the alternative covered
transaction (for example, when a consumer accesses options for covered
loans via the Internet) and how to cure a violation if the creditor
offers the required alternative after the required time.
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\96\ Under the Board's 2010 Mortgage Proposal, a non-refundable
fee could be imposed no earlier than three business days after a
consumer receives the early disclosures that creditors must provide
soon after receiving the consumer's application (within three
business days). See 75 FR 58539, 58696-58697, Sept. 24, 2010
(proposing a new Sec. 226.19(a)(1)(iv)).
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The Board solicits comment on whether it would be appropriate to
require that creditors offer the alternative covered transaction
without a prepayment penalty during a specified time period, for
example, before the consumer pays a non-refundable fee or at least
fifteen calendar days before consummation. If a timing requirement is
included for purposes of proposed Sec. 226.43(g)(3), the Board also
solicits comment on whether a timing requirement should be included
under the safe harbor for the anti-steering requirement under Sec.
226.36(e)(2) and (3), for consistency.
43(g)(3)(i) APR Cannot Increase After Consummation
Under proposed Sec. 226.43(g)(1)(i), a covered transaction with an
APR that can increase after consummation may not have a prepayment
penalty. Proposed Sec. 226.43(g)(3)(i) provides that, if a creditor
offers a covered transaction with a prepayment penalty, the creditor
must offer an alternative covered transaction without a prepayment
penalty and with an APR that cannot increase after consummation, to
ensure consumers are able to choose between substantially similar
alternative transactions. See proposed Sec. 226.43(g)(1)(ii)(A).
Proposed Sec. 226.43(g)(3)(i) also requires that the covered
transaction with a prepayment penalty and the alternative covered
transaction without a prepayment penalty have the same type of interest
rate. For purposes of proposed Sec. 226.43(g)(3)(i), the term ``type
of interest rate'' means whether the covered transaction is a fixed-
rate mortgage, as defined in Sec. 226.18(s)(7)(iii), or a step-rate
mortgage, as defined in Sec. 226.18(s)(7)(ii).\97\ Proposed comment
43(g)(3)(i)-1 clarifies that the covered transaction with a prepayment
penalty and the alternative covered transaction without a prepayment
penalty must either both be fixed-rate mortgages or both be step-rate
mortgages.
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\97\ Under Sec. 226.18(s)(7)(i)-(iii), a transaction secured by
real property or a dwelling is (1) an ``adjustable-rate mortgage''
if the APR may increase after consummation, (2) a ``step-rate
mortgage'' if the interest rate will change after consummation, and
the rates that will apply and the periods for which they will apply
are known at consummation, or (3) a ``fixed-rate mortgage,'' if the
transaction is not an adjustable-rate mortgage or a step-rate
mortgage.
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43(g)(3)(ii) Through (iv) Criteria for a Qualified Mortgage
As discussed above, proposed Sec. 226.43(g)(1)(ii)(A) provides
that a covered transaction with a prepayment penalty must be a
qualified mortgage, as defined under proposed Sec. 226.43(e)(2) or
(f). The Board also proposes to require that an alternative covered
transaction offered without a prepayment penalty must meet three
conditions for qualified mortgages, so that consumers may choose
between alternative covered transactions that are substantially
similar. Accordingly, proposed Sec. 226.43(g)(3)(ii) through (iv)
provide that an alternative covered transaction without a prepayment
penalty must: (1) Have the same loan term as the covered transaction
with a prepayment penalty; (2) satisfy the periodic payment conditions
in Sec. 226.43(e)(2)(i); and (3) satisfy the points and fees condition
under Sec. 226.43(e)(2)(iii), based on the information known to the
creditor at the time the transaction is offered. Proposed comment
43(g)(3)(iv)-1 provides guidance for cases where a creditor offers a
consumer an alternative covered transaction without a prepayment
penalty under proposed Sec. 226.43(g)(3) and knows only some of the
points and fees that will be charged for the loan. For example, a
creditor may not know that a consumer intends to buy single-premium
credit unemployment insurance, which would be included in the points
and fees for the covered transactions. Proposed comment 43(g)(3)(iv)-1
clarifies that the points and fees condition is satisfied if the
creditor reasonably believes, based on the information known to the
creditor at the time the offer is made, that the amount of points and
fees to be charged for an alternative covered transaction without a
prepayment penalty will be less than or equal to the amount of points
and fees allowed for a qualified mortgage under Sec.
226.43(e)(2)(iii).
43(g)(3)(v) Likely Qualifies
Proposed Sec. 226.43(g)(3)(v) provides that the alternative
covered transaction without a prepayment penalty must be a transaction
for which the creditor has a good faith belief that the consumer likely
qualifies, as determined based on the information known to the creditor
at the time the creditor offers the alternative covered transaction.
Proposed comment 43(g)(3)(v)-1 provides an example where the creditor
has a good faith belief the consumer can afford monthly payments of up
to $800. The proposed comment clarifies that, if the creditor offers
the consumer a fixed-rate mortgage with a prepayment penalty for which
monthly payments are $700 and an alternative covered transaction
without a prepayment penalty for which monthly payments are $900, the
requirements of Sec. 226.43(g)(3)(v) are not met. Proposed comment
43(g)(3)(v)-1 also clarifies that, in making the determination the
consumer likely qualifies for the alternative covered transaction, the
creditor may rely on information provided by the consumer, even if the
information subsequently is determined to be inaccurate. Proposed Sec.
226.43(g)(3)(v) and proposed comment 43(g)(3)(v)-1 are substantially
similar to Sec. 226.36(e)(3)(ii), which provides a safe harbor for the
anti-steering requirements if, among other things, a loan originator
presents the consumer with loan options for which the consumer likely
qualifies. See also comment 36(e)(3)-4 (providing guidance on
information used to determine whether or not a consumer likely
qualifies for a transaction).
43(g)(4) Offer Through a Mortgage Broker
The requirement to offer an alternative covered transaction without
a prepayment penalty applies to a ``creditor.'' See TILA Section
129C(c)(4). TILA Section 103(f), in relevant part, defines ``creditor''
to mean a person who
[[Page 27477]]
both (1) regularly extends consumer credit which is payable by
agreement in more than four installments or for which the payment of a
finance charge is or may be required, and (2) is the person to whom the
debt arising from the consumer credit transaction is initially payable
on the face of the evidence of indebtedness (or, if there is no such
evidence of indebtedness, by agreement). 15 U.S.C. 1602(f); Sec.
226.2(a)(17). The Board proposes special rules where a creditor offers
a covered transaction with a prepayment penalty through a mortgage
broker, as defined in Sec. 226.36(a)(2), to account for operational
differences in offering a covered transaction through the wholesale
channel versus through the retail channel.\98\ As discussed below in
the section-by-section analysis of proposed Sec. 226.43(g)(5), the
Board proposes special rules for cases where a creditor in a table-
funded transaction also is a ``loan originator,'' as defined in Sec.
226.36(a)(1), because those creditors generally present to consumers
loan options offered by multiple persons that provide table-funding.
The Board does not propose special rules for cases where the loan
originator is the creditor's employee, because the Board believes that
in such cases the employee likely can present alternative covered
transactions with and without a prepayment penalty to the consumer
without significant operational difficulties.
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\98\ For ease of discussion, the terms ``mortgage broker'' and
``loan originator'' as used in this discussion have the same meaning
as under the Board's requirements for loan originator compensation.
See Sec. 226.36(a)(1), (2).
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The Board believes the requirement to offer an alternative covered
transaction without a prepayment penalty properly is applied to
creditors and not to mortgage brokers, because creditors ``offer''
covered transactions, even if mortgage brokers present those offers to
consumers. Further, the Board believes that if Congress had intended to
apply TILA Section 129C(c)(4) to mortgage brokers, Congress explicitly
would have applied that provision to ``mortgage originators'' in
addition to creditors. TILA Section 103(cc), as added by Section 1401
of the Dodd-Frank Act, defines ``mortgage originator'' to mean any
person who, for direct or indirect compensation or gain, or in the
expectation of direct or indirect compensation of gain, takes a
residential mortgage loan application, assists a consumer in obtaining
or applying to obtain a residential mortgage loan, or offers or
negotiates terms of a residential mortgage loan. 15 U.S.C. 1602(cc).
The term ``mortgage originator'' is used, for example, for purposes of
the anti-steering requirement added to TILA by Section 1403 of the
Dodd-Frank Act. See TILA Section 129B(c).
The Board also believes that requiring mortgage brokers to present
to consumers a creditor's alternative covered transaction without a
prepayment penalty could confuse consumers if they are presented with
numerous other loan options. Presenting a consumer more than four loan
options for each type of transaction in which the consumer expresses an
interest may not help the consumer to make a meaningful choice. When
compared with other loan options a mortgage broker presents to a
consumer, a creditor's covered transaction without a prepayment penalty
might not have the lowest interest rate (among transactions either with
or without risky features, such as a prepayment penalty) or the lowest
total dollar amount of origination points or fees and discount points,
and thus might not be among the loan options most important for
consumers to evaluate. Also, the Board is concerned that creditors may
have operational difficulties in confirming whether or not a mortgage
broker has presented to the consumer the alternative covered
transaction without a prepayment penalty.
Accordingly, proposed Sec. 226.43(g)(4) provides that, if a
creditor offers a covered transaction to a consumer through a mortgage
broker, as defined in Sec. 226.36(a)(2), the creditor must present to
the mortgage broker an alternative covered transaction without a
prepayment penalty that meets the conditions under Sec. 226.43(g)(3).
Proposed Sec. 226.43(g)(4) also provides that the creditor must
establish, by agreement, that the mortgage broker must present the
consumer an alternative covered transaction without a prepayment
penalty that meets the conditions under Sec. 226.43(g)(3) offered by
(1) the creditor, or (2) another creditor, if the transaction has a
lower interest rate or a lower total dollar amount of origination
points or fees and discount points. By providing for the presentation
of a loan option with a lower interest rate or a lower total dollar
amount of origination points or fees and discount points than the loan
option offered by the creditor, proposed Sec. 226.43(g)(4) facilitates
compliance with proposed Sec. 226.43(g)(3) and with the safe harbor
for the anti-steering requirement in connection with a single covered
transaction. See Sec. 226.36(e)(3)(i).\99\ Proposed Sec. 226.43(g)(4)
does not affect the conditions that a a loan originator must meet to
take advantage of the safe harbor for the anti-steering requirement,
however. Thus, if loan originators choose to use the safe harbor, they
must present the consumer the loan option with (1) the lowest interest
rate overall, (2) the loan option with the lowest interest rate without
certain risky features, including a prepayment penalty, and (3) the
loan option with the lowest total origination points or fees and
discount points. See Sec. 226.36(e)(3)(i).
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\99\ Current Sec. 226.36(e) provides that a loan originator for
a dwelling-secured consumer credit transaction must not direct or
``steer'' a consumer to consummate a transaction based on the fact
that the originator will receive greater compensation from the
creditor in that transaction than in other transactions the
originator offered or could have offered the consumer, unless the
consummated transaction is in the consumer's interest.
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Proposed comment 43(g)(4)-1 clarifies that the creditor may satisfy
the requirement to present the mortgage broker such alternative covered
transaction without a prepayment penalty by providing the mortgage
broker a rate sheet that states the terms of such an alternative
covered transaction without a prepayment penalty. Proposed comment
43(g)(4)-2 clarifies that the creditor's agreement with the mortgage
broker may provide for the mortgage broker to present both the
creditor's covered transaction and a covered transaction offered by
another creditor with a lower interest rate or a lower total dollar
amount of origination points or fees and discount points. Proposed
comment 43(g)(4)-2 also cross-references comment 36(e)(3)-3 for
guidance in determining which step-rate mortgage has a lower interest
rate. Proposed comment 43(g)(4)-3 clarifies that a creditor's agreement
with a mortgage broker for purposes of proposed Sec. 226.43(g)(4) may
be part of another agreement with the mortgage broker, for example, a
compensation agreement. The proposed comment clarifies that the
creditor thus need not enter into a separate agreement with the
mortgage broker with respect to each covered transaction with a
prepayment penalty.
The Board solicits comment on the approach proposed under Sec.
226.43(g)(4) for offering an alternative covered transaction without a
prepayment penalty through a mortgage broker. In particular, the Board
solicits comment on whether additional guidance is needed regarding
offers of covered transactions through mortgage brokers that use the
safe harbor for the anti-
[[Page 27478]]
steering requirement, under Sec. 226.36(e)(2) and (3).
43(g)(5) Creditor That Is a Loan Originator
Proposed Sec. 226.43(g)(5) addresses cases where a creditor does
not provide the funds for a covered transaction out of its own
resources but rather obtains funds from another person and, immediately
after consummation, assigns the note, loan contract, or other evidence
of the debt obligation to the other person. Such creditors generally
present to consumers loan options offered by other persons and are loan
originators subject to the anti-steering requirements under Sec.
226.36(e). See Sec. 226.36(a)(1); comment 36(a)(1)-1. Like other loan
originators, such creditors may use the safe harbor for the anti-
steering requirements under Sec. 226.36(e)(2) and (3). Proposed Sec.
226.43(g)(5) provides that, if the creditor is a loan originator, as
defined in Sec. 226.36(a)(1), and the creditor presents a consumer a
covered transaction with a prepayment penalty offered by a person to
which the creditor would assign the covered transaction after
consummation, the creditor may present the consumer an alternative
covered transaction without a prepayment penalty offered by (1) the
assignee, or (2) another person, if the transaction offered by the
other person has a lower interest rate or a lower total dollar amount
of origination points or fees and discount points. Thus, proposed Sec.
226.43(g)(5) provides flexibility with respect to the presentation of
loan options, which facilitates compliance with proposed Sec.
226.43(g)(3) and with the safe harbor for the anti-steering requirement
in connection with the same covered transaction. See Sec.
226.36(e)(3)(i). Like proposed Sec. 226.43(g)(4), however, proposed
Sec. 226.43(g)(5) does not affect the conditions that a creditor that
is a loan originator must meet to take advantage of the safe harbor for
the anti-steering requirement. Accordingly, if creditors that are loan
originators choose to use the safe harbor, they must present the
consumer the loan option with (1) the lowest interest rate overall, (2)
the loan option with the lowest interest rate without certain risky
features, including a prepayment penalty, and (3) the loan option with
the lowest total origination points or fees and discount points. See
Sec. 226.36(e)(3)(i).
Proposed comment 43(g)(5)-1 clarifies that a loan originator
includes any creditor that satisfies the definition of the term but
makes use of ``table-funding'' by a third party. See Sec.
226.36(a)(1), comment 36(a)-1.i, -1.ii. Proposed comment 43(g)(5)-2
cross-references guidance in comment 36(e)(3)-3 on determining which
step-rate mortgage has a lower interest rate.
43(g)(6) Applicability
Proposed Sec. 226.43(g)(6) provides that proposed Sec. 226.43(g)
applies only if a transaction is consummated with a prepayment penalty
and is not violated if (1) a covered transaction is consummated without
a prepayment penalty or (2) the creditor and consumer do not consummate
a covered transaction. Proposed Sec. 226.43(g)(2) limits the period
during which a prepayment penalty may be imposed and the amount of any
prepayment penalty. Those limitations apply only if a covered
transaction with a prepayment penalty is consummated. Proposed Sec.
226.43(g)(3) requires creditors that offer a consumer a covered
transaction with a prepayment penalty offer the consumer an alternative
covered transaction without a prepayment penalty, and proposed Sec.
226.43(g)(4) and (5) establish requirements for creditors to comply
with proposed Sec. 226.43(g)(3) if they (1) offer covered transactions
with a prepayment penalty through a mortgage broker or (2) are loan
originators, respectively. Where a consumer consummates a covered
transaction without a prepayment penalty, it is unnecessary to require
that the creditor offer the consumer an alternative covered transaction
without a prepayment penalty. Further, if the creditor does not
consummate a covered transaction with the consumer, the issue is
irrelevant; the purpose of the requirement to offer an alternative
covered transaction without a prepayment penalty is for consumers not
to have to accept a covered transaction with a prepayment penalty.
Accordingly, proposed Sec. 226.43(g) applies only if the consumer
consummates a covered transaction with a prepayment penalty. In
particular, proposed comment 25(a)-7 clarifies that, if a creditor
offers the consumer a covered transaction with a prepayment penalty but
a covered transaction is consummated without a prepayment penalty or if
the creditor and consumer do not consummate a covered transaction, the
creditor need not maintain records that document compliance with the
requirement that the creditor offer an alternative covered transaction
without a prepayment penalty under proposed Sec. 226.43(g)(2) through
(5), as discussed above in the section-by-section analysis of proposed
Sec. 226.25(a).
43(h) Evasion; Open-End Credit
As discussed above, TILA Section 129C, which addresses the
repayment ability requirements and qualified mortgages, applies only to
residential mortgage loans. TILA Section 103(cc)(5) defines
``residential mortgage loans'' as excluding open-end credit plans, such
as HELOCs. The Board recognizes that the exclusion of open-end credit
plans could lead some creditors to attempt to evade the requirements of
TILA Section 129C by structuring credit as open-end instead of closed-
end. Sections 226.34(b) and 226.35(b)(4) address this risk by
prohibiting structuring a transaction that does not meet the definition
of ``open-end credit'' as a HELOC to evade the repayment ability and
other requirements for high-cost mortgages and higher-priced mortgage
loans. The Board proposes to extend this approach to new Sec. 226.43,
which would implement TILA Section 129C. Proposed Sec. 226.43(h)
prohibits a creditor from structuring a transaction that does not meet
the definition of open-end credit in Sec. 226.2(a)(20) as a HELOC to
evade the requirements of proposed Sec. 226.43. Proposed comment
43(h)-1 clarifies that where a loan is documented as open-end credit
but the features and terms or other circumstances demonstrate that it
does not meet the definition of open-end credit, the loan is subject to
the rules for closed-end credit, including Sec. 226.43. The Board
proposes this provision using its authority under TILA Sections 105(a)
and 129B(e) to prevent circumvention or evasion.
As noted in the SUPPLEMENTARY INFORMATION to the Board's 2008 HOEPA
Final Rule, the Board recognizes that consumers may prefer HELOCs to
closed-end home equity loans because of the added flexibility HELOCs
provide them. See 73 FR 1697, Jan. 9, 2008. It is not the Board's
intention to limit consumers' ability to choose between these two ways
of structuring home equity credit. An overly broad anti-evasion rule
could potentially limit consumer choices by casting doubt on the
validity of legitimate open-end plans. The Board seeks comment on the
extent to which the proposed anti-evasion rule could have this
consequence, and solicits suggestions for a more narrowly tailored
rule. For example, the primary concern would appear to be with HELOCs
that are substituted for closed-end home purchase loans and
refinancings, which are usually first-lien loans, rather than with
HELOCs taken for home improvement or other consumer purposes. The Board
seeks comment on
[[Page 27479]]
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, and whether such a rule
would be effective in preventing evasion.
VI. Paperwork Reduction Act
In accordance with the Paperwork Reduction Act (PRA) of 1995 (44
U.S.C. 3506; 5 CFR part 1320 Appendix A.1), the Board reviewed the
proposed rule under the authority delegated to the Board by the Office
of Management and Budget. The rule contains no collections of
information under the PRA. See 44 U.S.C. 3502(3). Accordingly, there is
no paperwork burden associated with the rule.
VII. Initial Regulatory Flexibility Analysis
In accordance with Section 3(a) of the Regulatory Flexibility Act
(RFA), 5 U.S.C. 601-612, the Board is publishing an initial regulatory
flexibility analysis for the proposed amendments to Regulation Z. The
RFA requires an agency either to provide an initial regulatory
flexibility analysis with a proposed rule or to certify that the
proposed rule will not have a significant economic impact on a
substantial number of small entities. Under regulations issued by the
Small Business Administration (SBA), an entity is considered ``small''
if it has $175 million or less in assets for banks and other depository
institutions, and $7 million or less in revenues for non-bank mortgage
lenders and loan servicers.\100\
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\100\ 13 CFR 121.201; see also SBA, Table of Small Business Size
Standards Matched to North American Industry Classification System
Codes, available at http://www.sba.gov/sites/default/files/Size_Standards_Table.pdf.
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Based on its analysis and for the reasons stated below, the Board
believes that this proposed rule will have a significant economic
impact on a substantial number of small entities. A final regulatory
flexibility analysis will be conducted after consideration of comments
received during the public comment period. The Board requests public
comment in the following areas.
A. Reasons for the Proposed Rule
Congress enacted TILA based on findings that economic stability
would be enhanced and competition among consumer credit providers would
be strengthened by the informed use of credit resulting from consumers'
awareness of the cost of credit. As a result, TILA contains procedural
and substantive protections for consumers, and also directs the Board
to prescribe regulations to carry out the purposes of the statute. TILA
is implemented by the Board's Regulation Z.
The proposed amendments to Regulation Z implement certain
amendments to TILA as a result of the Dodd-Frank Act. Sections 1411 and
1412 of the Dodd-Frank Act amend TILA to prohibit a creditor from
making any ``residential mortgage loan'' \101\ unless the creditor
makes a reasonable and good faith determination that the consumer has a
reasonable ability to repay the loan. A creditor complies with this
requirement by: (i) Making a residential mortgage loan that satisfies
the ability-to-repay provisions, which include certain underwriting
criteria; (ii) refinancing a ``non-standard mortgage'' into a
``standard mortgage''; (iii) making a ``qualified mortgage,'' which is
defined by prohibiting certain terms, limiting certain costs, and using
certain underwriting criteria; or (iv) making a balloon-payment
qualified mortgage. In addition, Section 1414 of the Dodd-Frank Act
amends TILA to add new restrictions on prepayment penalties that may be
imposed on residential mortgage loans.
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\101\ TILA Section 103(cc) generally defines ``residential
mortgage loan'' to mean any consumer credit transaction secured by a
mortgage, deed of trust, or other equivalent consensual security
interest on ``a dwelling or on residential real property that
includes a dwelling.'' The term does not include an open-end credit
plan or an extension of credit relating to a timeshare plan, for
purposes of the repayment ability provisions. See TILA Section
103(cc)(5).
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B. Statement of Objectives and Legal Basis
The SUPPLEMENTARY INFORMATION contains the statement of objectives
and legal basis for the proposed rule. In summary, the proposed
amendments to Regulation Z are designed to: (1) Add new Sec.
226.43(a)-(f) to require creditors to determine a consumer's repayment
ability prior to making any residential mortgage loan; (2) provide a
presumption of compliance with the repayment ability requirement or
safe harbor from the repayment ability requirement for qualified
mortgages in new Sec. 226.43(e); (3) add new Sec. 226.43(g) regarding
prepayment penalty requirements for residential mortgage loans; and (4)
provide record retention requirements in Sec. 226.25(a) that evidence
compliance with proposed Sec. 226.43.
The legal basis for the proposed rule is in Sections 105(a),
129B(e) and 129C(b)(3)(B)(i) of TILA. 15 U.S.C. 1604(a), 1639b(e) and
1639c(b)(3)(B)(i). A more detailed discussion of the Board's rulemaking
authority is set forth in part III of the SUPPLEMENTARY INFORMATION.
C. Description of Small Entities to Which the Proposed Rule Would Apply
The proposed regulations would apply to all institutions and
entities that engage in originating or extending home-secured credit.
The Board is not aware of a reliable source for the total number of
small entities likely to be affected by the proposal, and the credit
provisions of TILA and Regulation Z have broad applicability to
individuals and businesses that originate and extend even small numbers
of home-secured credit. See Sec. 226.1(c)(1).\102\ All small entities
that originate or extend closed-end loans secured by a dwelling are
potentially subject to at least some aspects of the proposed rule.
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\102\ Regulation Z generally applies to ``each individual or
business that offers or extends credit when four conditions are met:
(i) The credit is offered or extended to consumers; (ii) the
offering or extension of credit is done regularly, (iii) the credit
is subject to a finance charge or is payable by a written agreement
in more than four installments, and (iv) the credit is primarily for
personal, family, or household purposes.'' Section 226.1(c)(1).
---------------------------------------------------------------------------
The Board can, however, identify through data from Reports of
Condition and Income (``Call Reports'') approximate numbers of small
depository institutions that would be subject to the proposed rule.
Based on December 2010 Call Report data, approximately 8,579 small
institutions would be subject to the proposed rule. Approximately
15,217 depository institutions in the United States filed Call Report
data, approximately 10,816 of which had total domestic assets of $175
million or less and thus were considered small entities for purposes of
the RFA. Of 3,749 banks, 502 thrifts \103\ and 6,565 credit unions that
filed Call Report data and were considered small entities, 3,621 banks,
477 thrifts, and 4,481 credit unions, totaling 8,579 institutions,
originated or extended mortgage credit.
---------------------------------------------------------------------------
\103\ For purposes of this analysis, thrifts include savings
banks, savings and loan entities, co-operative banks, and industrial
banks.
---------------------------------------------------------------------------
The Board cannot identify with certainty the number of small non-
depository institutions that would be subject to the proposed rule.
Home Mortgage Disclosure Act (HMDA) \104\
[[Page 27480]]
data indicate that 870 non-depository institutions filed HMDA reports
in 2009.\105\ Based on the small volume of lending activity reported by
these institutions, most are likely to be small.
---------------------------------------------------------------------------
\104\ The 8,022 lenders (both depository institutions and
mortgage companies) covered by HMDA in 2009 accounted for the
majority of home lending in the United States. Under HMDA, lenders
use a ``loan/application register'' (HMDA/LAR) to report information
annually to their Federal supervisory agencies for each application
and loan acted on during the calendar year. Only lenders that have
offices (or, for non-depository institutions, lenders that are
deemed to have offices) in metropolitan areas are required to report
under HMDA. However, if a lender is required to report, it must
report information on all of its home loan applications and loans in
all locations, including non-metropolitan areas.
\105\ The 2009 HMDA Data, available at http://www.ffiec.gov/hmda/default.htm.
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D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
The compliance requirements of the proposed rule are described in
part V of the SUPPLEMENTARY INFORMATION. The effect of the proposed
revisions to Regulation Z on small entities is unknown. Some small
entities would be required, among other things, to modify their
underwriting practices to account for the repayment ability analysis
for covered transactions in order to comply with the revised rule. The
precise costs to small entities of modifying their underwriting
practices are difficult to predict. These costs will depend on a number
of unknown factors, including, among other things, the current
practices used by such entities to collect and analyze consumer income,
asset, and liability information, the complexity of the terms of credit
products that they offer, and the range of such product offerings. The
proposed rule would provide small entities the option of offering only
qualified mortgages, which will enjoy either a presumption of
compliance with respect to the repayment ability requirement or a safe
harbor from the repayment ability requirement, thus reducing litigation
risks and costs for small entities.
The proposed rule also requires creditors to determine a consumer's
repayment ability using a payment schedule based on monthly, fully-
amortizing payments at the fully-indexed rate or introductory rate,
whichever is greater. Under the proposed rule, special payment
calculation rules apply to loans with a balloon payment, interest-only
loans, and negative amortization loans. The proposed rule may therefore
increase compliance costs for small entities, particularly for
creditors that offer products that contain balloon payments, interest-
only loans, and negative amortization loans. The precise costs to small
entities of updating their processes and systems to account for these
additional calculations are difficult to predict, but these costs are
mitigated, in some circumstances, by the proposed presumption of
compliance or safe harbor for qualified mortgages.
Under the proposed rule, creditors must retain evidence of
compliance with proposed Sec. 226.43 for three years after the
consummation of a covered transaction. Currently, Sec. 226.25(a)
requires that creditors retain evidence of compliance with Regulation Z
for two years after disclosures must be made or an action must be
taken, though Sec. 226.25(a) also clarifies that administrative
agencies responsible for enforcing Regulation Z may require creditors
to retain records for a longer period if necessary to carry out their
enforcement responsibilities. While increasing the period creditors
must retain certain records from two to three years would increase
creditors' compliance burden, the precise costs to small entities is
difficult to predict. However, the Board believes many creditors will
retain such records for at least three years, in an abundance of
caution, which would minimize the overall burden increase. The
compliance burden is also mitigated by proposed comment 25(a)-6, which
clarifies that creditors need not retain actual paper copies of the
documentation used to underwrite a transaction. Furthermore, the
proposal to extend the required retention period for evidence of
compliance with proposed Sec. 226.43 would not affect the retention
period for other requirements under Regulation Z.
The Board believes that costs of the proposed rule as a whole will
have a significant economic effect on small entities, including small
mortgage creditors. The Board seeks information and comment on any
costs, compliance requirements, or changes in operating procedures
arising from the application of the proposed rule to small businesses.
E. Identification of Duplicative, Overlapping, or Conflicting Federal
Rules Other Federal Rules
The Board has not identified any Federal rules that conflict with
the proposed revisions to Regulation Z.
F. Identification of Duplicative, Overlapping, or Conflicting State
Laws State Equivalents to TILA
Many states regulate consumer credit through statutory disclosure
schemes similar to TILA. Under TILA Section 111, the proposed rule
would not preempt such state laws except to the extent they are
inconsistent with the proposal's requirements. 15 U.S.C. 1610.
The Board is also aware that some states regulate mortgage loans
under ability-to-repay laws that resemble the proposed rule, and that
many states regulate only high-cost or high-priced mortgage loans under
ability-to-repay laws. The proposed rule would not preempt such state
laws except to the extent they are inconsistent with the proposal's
requirements. Id.
The Board seeks comment regarding any state or local statutes or
regulations that would duplicate, overlap, or conflict with the
proposed rule.
G. Discussion of Significant Alternatives
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. The Board has provided an
exception to the general provision that a qualified mortgage may not
provide for a balloon payment for loans that are originated by certain
small creditors and that meet specified criteria, as the Board
understands that community banks originate balloon-payment loans to
hedge against interest rate risk, rather than making adjustable-rate
mortgages, and that community banks hold these balloon-payment loans in
portfolio virtually without exception because they are not eligible for
sale in the secondary market. The Board believes that this exception
will decrease the economic impact of the proposed rules on small
entities.
The Board welcomes comments on any significant alternatives
consistent with the provisions of Sections 1411, 1412, and 1414 of the
Dodd-Frank Act that would minimize the impact of the proposed
regulations on small entities.
List of Subjects in 12 CFR Part 226
Advertising, Consumer protection, Federal Reserve System,
Mortgages, Reporting and recordkeeping requirements, Truth in Lending.
Text of Proposed Revisions
Certain conventions have been used to highlight the proposed
revisions. New language is shown inside bold arrows, and language that
would be deleted in shown inside bold brackets.
Authority and Issuance
For the reasons set forth in the preamble, the Board proposes to
amend Regulation Z, 12 CFR part 226, as follows:
PART 226--TRUTH IN LENDING (REGULATION Z)
1. The authority citation for part 226 is revised to read as
follows:
[[Page 27481]]
Authority: 12 U.S.C. 3806; 15 U.S.C. 1604, 1637(c)(5), and
1639(l); Sec. 2, Pub. L. 111-24, 123 Stat. 1734; Pub. L. 111-203,
124 Stat. 1376.
Subpart D--Miscellaneous
2. Section 226.25 is amended by revising paragraph (a) to read as
follows:
Sec. 226.25 Record retention.
(a) General rule. A creditor shall retain evidence of compliance
with [lsqbb]this regulation[rsqbb][rtrif]Sec. 226.43 of this
regulation for 3 years after consummation of a transaction covered by
that section and shall retain evidence of compliance with all other
sections of this regulation[ltrif] (other than advertising requirements
under Sec. Sec. 226.16 and 226.24) for 2 years after the date
disclosures are required to be made or action is required to be taken.
The administrative agencies responsible for enforcing the regulation
may require creditors under their jurisdictions to retain records for a
longer period if necessary to carry out their enforcement
responsibilities under section 108 of the act.
* * * * *
Subpart E--Special Rules for Certain Home Mortgage Transactions
3. Section 226.32 is amended by revising paragraph (b) to read as
follows:
Sec. 226.32 Requirements for certain closed-end home mortgages.
* * * * *
(b) Definitions. For purposes of this subpart, the following
definitions apply:
(1) For purposes of paragraph (a)(1)(ii) of this section, points
and fees means:
(i) All items [rtrif]considered to be a finance charge[ltrif]
[lsqbb]required to be disclosed[rsqbb] under Sec. 226.4(a) and
226.4(b), except [rtrif]--[ltrif] [lsqbb]interest or the time-price
differential[rsqbb]
[rtrif](A) Interest or the time-price differential;
(B) Any premium or other charge for any guaranty or insurance
protecting the creditor against the consumer's default or other credit
loss to the extent that the premium or charge is--
(1) Assessed in connection with any Federal or state agency
program;
(2) Not in excess of the amount payable under policies in effect at
the time of origination under section 203(c)(2)(A) of the National
Housing Act (12 U.S.C. 1709(c)(2)(A)), provided that the premium or
charge is required to be refundable on a pro rata basis and the refund
is automatically issued upon notification of the satisfaction of the
underlying mortgage loan; or
(3) Payable after the loan closing.[ltrif]
(ii) All compensation paid [lsqbb]to mortgage brokers[rsqbb]
[rtrif]directly or indirectly by a consumer or creditor to a loan
originator, as defined in Sec. 226.36(a)(1), including a loan
originator that is also the creditor in a table-funded
transaction;[ltrif]
(iii) All items listed in Sec. 226.4(c)(7) (other than amounts
held for future payment of taxes) [rtrif]payable at or before closing
of the mortgage loan,[ltrif] unless--[lsqbb]the charge is reasonable,
the creditor receives no direct or indirect compensation in connection
with the charge, and the charge is not paid to an affiliate of the
creditor; and[rsqbb]
[rtrif](A) The charge is reasonable;
(B) The creditor receives no direct or indirect compensation in
connection with the charge; and
(C) The charge is not paid to an affiliate of the creditor; [ltrif]
(iv) [rtrif]Premiums or other charges payable at or before closing
of the mortgage loan for any credit life, credit disability, credit
unemployment, or credit property insurance, or any other life,
accident, health, or loss-of-income insurance, or any payments directly
or indirectly for any debt cancellation or suspension agreement or
contract.[ltrif] [lsqbb]Premiums or other charges for credit life,
accident, health, or loss-of-income insurance, or debt-cancellation
coverage (whether or not the debt-cancellation coverage is insurance
under applicable law) that provides for cancellation of all or part of
the consumer's liability in the event of the loss of life, health, or
income or in the case of accident, written in connection with the
credit transaction.[rsqbb]
[rtrif](v) The maximum prepayment penalty, as defined in Sec.
226.43(b)(10), that may be charged or collected under the terms of the
mortgage loan; and
(vi) The total prepayment penalty, as defined in Sec.
226.43(b)(10), incurred by the consumer if the mortgage loan is
refinanced by the current holder of the existing mortgage loan, a
servicer acting on behalf of the current holder, or an affiliate of
either.
(2) For purposes of paragraph (b)(1)(ii) of this section, the term
points and fees does not include compensation paid to--
(i) An employee of a retailer of manufactured homes who does not
take a residential mortgage loan application, offer or negotiate terms
of a residential mortgage loan, or advise a consumer on loan terms
(including rates, fees, and other costs) but who, for compensation or
other monetary gain, or in expectation of compensation or other
monetary gain, assists a consumer in obtaining or applying to obtain a
residential mortgage loan;
(ii) A person that only performs real estate brokerage activities
and is licensed or registered in accordance with applicable state law,
unless such person is compensated by a creditor or loan originator, as
defined in Sec. 226.36(a)(1), or by any agent of the creditor or loan
originator; or
(iii) A servicer or servicer employees, agents and contractors,
including but not limited to those who offer or negotiate terms of a
covered transaction for purposes of renegotiating, modifying, replacing
and subordinating principal of existing mortgages where borrowers are
behind in their payments, in default or have a reasonable likelihood of
being in default or falling behind.
(3)[ltrif][lsqbb](2)[rsqbb] Affiliate means any company that
controls, is controlled by, or is under common control with another
company, as set forth in the Bank Holding Company Act of 1956 (12
U.S.C. 1841 et seq.).
* * * * *
4. Section 226.34, is amended by removing paragraph (a)(4).
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
[[Page 27482]]
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.[rsqbb]
* * * * *
Sec. 226.35 [Removed and reserved]
5. Section 226.35 is removed and reserved.
6. Add Sec. 226.43 to read as follows:
[rtrif]Sec. 226.43 Minimum standards for transactions secured by a
dwelling.
(a) Scope. This section applies to any consumer credit transaction
that is secured by a dwelling, as defined in Sec. 226.2(a)(19), other
than:
(1) A home equity line of credit subject to Sec. 226.5b;
(2) A mortgage transaction secured by a consumer's interest in a
timeshare plan, as defined in 11 U.S.C. 101(53(D)); or
(3) For purposes of paragraphs (c) through (f) of this section--
(i) A reverse mortgage subject to Sec. 226.33; or
(ii) A temporary or ``bridge'' loan with a term of 12 months or
less, such as a loan to finance the purchase of a new dwelling where
the consumer plans to sell a current dwelling within 12 months or a
loan to finance the initial construction of a dwelling.
(b) Definitions. For purposes of this section:
(1) Covered transaction means a consumer credit transaction that is
secured by a dwelling, as defined in Sec. 226.2(a)(19), other than a
transaction exempt from coverage under paragraph (a) of this section.
(2) Fully amortizing payment means a periodic payment of principal
and interest that will fully repay the loan amount over the loan term.
(3) Fully indexed rate means the interest rate calculated using the
index or formula at the time of consummation and the maximum margin
that can apply at any time during the loan term.
(4) Higher-priced covered transaction means a covered transaction
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 a first-lien covered
transaction, or by 3.5 or more percentage points for a subordinate-lien
covered transaction.
(5) Loan amount means the principal amount the consumer will borrow
as reflected in the promissory note or loan contract.
(6) Loan term means the period of time to repay the obligation in
full.
(7) Maximum loan amount means the loan amount plus any increase in
principal balance that results from negative amortization, as defined
in Sec. 226.18(s)(7)(v), based on the terms of the legal obligation
assuming--
(i) The consumer makes only the minimum periodic payments for the
maximum possible time, until the consumer must begin making fully
amortizing payments; and
(ii) The maximum interest rate is reached at the earliest possible
time.
(8) Mortgage-related obligations mean property taxes; mortgage-
related insurance premiums required by the creditor as set forth in
Sec. 226.45(b)(1); homeowner's association, condominium, and
cooperative fees; ground rent or leasehold payments; and special
assessments.
(9) Points and fees has the same meaning as in Sec. 226.32(b)(1).
(10) Prepayment penalty means a charge imposed for paying all or
part of a covered transaction's principal before the date on which the
principal is due. For purposes of this section--
(i) The following are examples of prepayment penalties:
(A) A charge determined by treating the loan balance as outstanding
for a period of time after prepayment in full and applying the interest
rate to such ``balance,'' even if the charge results from the interest
accrual amortization method used for other payments in the transaction;
and
(B) A fee, such as a loan closing cost, that is waived unless the
consumer prepays the covered transaction.
(ii) A prepayment penalty does not include fees imposed for
preparing and providing documents when a loan is paid in full, whether
or not the loan is prepaid, such as a loan payoff statement, a
reconveyance document, or another document releasing the creditor's
security interest in the dwelling that secures the loan.
(11) Recast means--
(i) For an adjustable-rate mortgage, as defined in Sec.
226.18(s)(7)(i), the expiration of the period during which payments
based on the introductory fixed interest rate are permitted under the
terms of the legal obligation;
(ii) For an interest-only loan, as defined in Sec.
226.18(s)(7)(iv), the expiration of the period during which interest-
only payments are permitted under the terms of the legal obligation;
and
(iii) For a negative amortization loan, as defined in Sec.
226.18(s)(7)(v), the expiration of the period during which negatively
amortizing payments are permitted under the terms of the legal
obligation.
(12) Simultaneous loan means another covered transaction or home
equity line of credit subject to Sec. 226.5b that will be secured by
the same dwelling and made to the same consumer at or before
consummation of the covered transaction.
(13) Third-party record means--
(i) A document or other record prepared or reviewed by a person
other than the consumer, the creditor, or the mortgage broker, as
defined in Sec. 226.36(a)(2), or an agent of the creditor or mortgage
broker;
(ii) A copy of a tax return filed with the Internal Revenue Service
or a state taxing authority;
(iii) A record the creditor maintains for an account of the
consumer held by the creditor; or
(iv) If the consumer is an employee of the creditor or the mortgage
broker, a document or other record maintained by the creditor or
mortgage broker regarding the consumer's employment status or
employment income.
[[Page 27483]]
(c) Repayment ability--(1) General requirement. A creditor shall
not make a loan in a covered transaction unless the creditor makes a
reasonable and good faith determination at or before consummation that
the consumer will have a reasonable ability, at the time of
consummation, to repay the loan according to its terms, including any
mortgage-related obligations.
(2) Basis for determination. Except as provided otherwise in
paragraphs (d), (e), and (f) of this section, in making the repayment
ability determination required under paragraph (c)(1) of this section,
a creditor must consider the following:
(i) The consumer's current or reasonably expected income or assets,
other than the value of the dwelling that secures the loan;
(ii) If the creditor relies on income from the consumer's
employment in determining repayment ability, the consumer's current
employment status;
(iii) The consumer's monthly payment on the covered transaction,
calculated in accordance with paragraph (c)(5) of this section;
(iv) The consumer's monthly payment on any simultaneous loan that
the creditor knows or has reason to know will be made, calculated in
accordance with paragraph (c)(6) of this section;
(v) The consumer's monthly payment for mortgage-related
obligations;
(vi) The consumer's current debt obligations;
(vii) The consumer's monthly debt-to-income ratio, or residual
income in accordance with paragraph (c)(7) of this section; and
(viii) The consumer's credit history.
(3) Verification using third-party records. A creditor must verify
a consumer's repayment ability using reasonably reliable third-party
records, except that--
(i) For purposes of paragraph (c)(2)(ii) of this section, a
creditor may verify a consumer's employment status orally if the
creditor prepares a record of the information obtained orally; and
(ii) For purposes of paragraph (c)(2)(vi) of this section, if a
creditor relies on a consumer's credit report to verify a consumer's
current debt obligations and a consumer's application states a current
debt obligation not shown in the consumer's credit report, the creditor
need not independently verify such obligation.
(4) Verification of income or assets. A creditor must verify the
amounts of income or assets it relies on to determine a consumer's
ability to repay a covered transaction using third-party records that
provide reasonably reliable evidence of the consumer's income or
assets. A creditor may verify the consumer's income using a tax-return
transcript issued by the Internal Revenue Service (IRS). Examples of
other records the creditor may use to verify the consumer's income or
assets include:
(i) Copies of tax returns the consumer filed with the Internal
Revenue Service or a state taxing authority;
(ii) IRS Form W-2s or similar IRS forms used for reporting wages or
tax withholding;
(iii) Payroll statements, including military Leave and Earnings
Statements;
(iv) Financial institution records;
(v) Records from the consumer's employer or a third-party that
obtained information from the employer;
(vi) Records from a Federal, state, or local government agency
stating the consumer's income from benefits or entitlements;
(vii) Receipts from the consumer's use of check cashing services;
and
(viii) Receipts from the consumer's use of a funds transfer
service.
(5) Payment calculation--(i) General rule. Except as provided in
paragraph (c)(5)(ii) of this section, a creditor must make the
determination required under paragraph (c)(2)(iii) using--
(A) The fully indexed rate or any introductory interest rate,
whichever is greater; and
(B) Monthly, fully amortizing payments that are substantially
equal.
(ii) Special rules for loans with a balloon payment, interest-only
loans, and negative amortization loans. A creditor must make the
determination required under paragraph (c)(2)(iii) for--
(A) A loan with a balloon payment, as defined in Sec.
226.18(s)(5)(i), using--
(1) The maximum payment scheduled during the first five years after
consummation for a loan that is not a higher-priced covered
transaction; or
(2) The maximum payment in the payment schedule, including any
balloon payment, for a higher-priced covered transaction;
(B) An interest-only loan, as defined in Sec. 226.18(s)(7)(iv),
using--
(1) The fully indexed rate or any introductory interest rate,
whichever is greater; and
(2) Substantially equal, monthly payments of principal and interest
that will repay the loan amount over the term of the loan remaining as
of the date the loan is recast.
(C) A negative amortization loan, as defined in Sec. 226.18(s)(7),
using--
(1) The fully indexed rate or any introductory interest rate,
whichever is greater; and
(2) Substantially equal, monthly payments of principal and interest
that will repay the maximum loan amount over the term of the loan
remaining as of the date the loan is recast.
(6) Payment calculation for simultaneous loans. For purposes of
making the determination required under paragraph (c)(2)(iv) of this
section, a creditor must consider a consumer's payment on a
simultaneous loan that is--
(i) A covered transaction, by following paragraphs (c)(5)(i)-(ii)
of this section; or
(ii) A home equity line of credit subject to Sec. 226.5b, by using
the periodic payment required under the terms of the plan and the
amount of credit drawn at consummation of the covered transaction.
(7) Monthly debt-to-income ratio or residual income--(i)
Definitions. For purposes of this paragraph, the following definitions
apply--
(A) Total monthly debt obligations. The term total monthly debt
obligations means the sum of: the payment on the covered transaction,
as required to be calculated by paragraphs (c)(2)(iii) and (c)(5) of
this section; simultaneous loans, as required by paragraphs (c)(2)(iv)
and (c)(6) of this section; mortgage-related obligations, as required
by paragraph (c)(2)(v) of this section; and current debt obligations,
as required by paragraph (c)(2)(vi) of this section.
(B) Total monthly income. The term total monthly income means the
sum of the consumer's current or reasonably expected income, including
any income from assets, as required paragraphs (c)(2)(i) and (c)(4) of
this section.
(ii) Calculations. (A) Monthly debt-to-income ratio. For purposes
of considering the consumer's monthly debt-to-income ratio under
paragraph (c)(2)(vii) of this section, the creditor must consider the
ratio of the consumer's total monthly debt obligations to total monthly
income.
(B) Monthly residual income. For purposes of considering the
consumer's monthly residual income under paragraph (c)(2)(vii) of this
section, the creditor must consider the consumer's remaining income
after subtracting the consumer's total monthly debt obligations from
the total monthly income.
(d) Refinancing of non-standard mortgages--(1) Scope. The
provisions of this paragraph (d) apply to the refinancing of a non-
standard mortgage into a standard mortgage when the following
conditions are met--
(i) The creditor for the standard mortgage is the current holder of
the existing non-standard mortgage or the servicer acting on behalf of
the current holder.
[[Page 27484]]
(ii) The monthly payment for the standard mortgage is materially
lower than the monthly payment for the non-standard mortgage, as
calculated under paragraph (d)(5) of this section.
(iii) The creditor receives the consumer's written application for
the standard mortgage before the non-standard mortgage is recast.
(iv) The consumer has made no more than one payment more than 30
days late on the non-standard mortgage during the 24 months immediately
preceding the creditor's receipt of the consumer's written application
for the standard mortgage.
(v) The consumer has made no payments more than 30 days late during
the six months immediately preceding the creditor's receipt of the
consumer's written application for the standard mortgage.
(2) Definitions. For purposes of this paragraph (d), the following
definitions apply:
(i) Non-standard mortgage. The term non-standard mortgage means a
covered transaction that is--
(A) An adjustable-rate mortgage, as defined in Sec.
226.18(s)(7)(i), with an introductory fixed interest rate for a period
of one year or longer;
(B) An interest-only loan, as defined in Sec. 226.18(s)(7)(iv); or
(C) A negative amortization loan, as defined in Sec.
226.18(s)(7)(v).
(ii) Standard mortgage. The term standard mortgage means a covered
transaction--
(A) That provides for regular periodic payments that do not:
(1) Cause the principal balance to increase;
(2) Allow the consumer to defer repayment of principal; or
(3) Result in a balloon payment, as defined in Sec.
226.18(s)(5)(i);
(B) For which the total points and fees payable in connection with
the transaction do not exceed the amounts specified in paragraph (e)(3)
of this section;
(C) For which the term does not exceed 40 years;
(D) For which the interest rate is fixed for at least the first
five years after consummation; and
(E) For which the proceeds from the loan are used solely for the
following purposes--
(1) To pay off the outstanding principal balance on the non-
standard mortgage; and
(2) To pay closing or settlement charges required to be disclosed
under the Real Estate Settlement Procedures Act, 12 U.S.C. 2601 et seq.
(iii) Refinancing. The term refinancing has the same meaning as in
Sec. 226.20(a).
(3) Exemption from certain repayment ability requirements. (i) A
creditor is not required to comply with the income and asset
verification requirements of paragraphs (c)(2)(i) and (c)(4) of this
section or the payment calculation requirements under paragraphs
(c)(2)(iii) and (c)(5) of this section if--
(A) The conditions in paragraph (d)(1) of this section are met; and
(B) The creditor has considered whether the standard mortgage will
prevent a likely default by the consumer on the non-standard mortgage
at the time of its recast.
(ii) If the conditions in paragraph (d)(3)(i) of this section are
met, the creditor shall satisfy the requirements under paragraphs
(c)(2)(iii) and (c)(5) of this section for the standard mortgage by
using the payment calculation prescribed under paragraph (d)(5)(ii) of
this section.
(4) Offer of rate discounts and other favorable terms. A creditor
making a covered transaction under this paragraph (d) may offer to the
consumer the same or better rate discounts and terms that the creditor
offers to new consumers, consistent with the creditor's documented
underwriting practices and to the extent not prohibited by applicable
state or Federal law.
(5) Payment calculations. For purposes of determining whether the
consumer's monthly payment for a standard mortgage will be materially
lower than the monthly payment for the non-standard mortgage, the
following provisions shall be used:
(i) Non-standard mortgage. The monthly payment for a non-standard
mortgage must be based on substantially equal, monthly, fully
amortizing payments of principal and interest using--
(A) The fully indexed rate as of a reasonable period of time before
or after the date on which the creditor receives the consumer's written
application for the standard mortgage;
(B) The term of the loan remaining as of the date on which the
recast occurs, assuming all scheduled payments have been made up to the
recast date and the payment due on the recast date is made and credited
as of that date; and
(C) A remaining loan amount that is--
(1) For an adjustable-rate mortgage under paragraph (d)(2)(i)(A) of
this section, the outstanding principal balance as of the date of the
recast, assuming all scheduled payments have been made up to the recast
date and the payment due on the recast date is made and credited as of
that date;
(2) For an interest-only loan under paragraph (d)(2)(i)(B) of this
section, the loan amount, assuming all scheduled payments have been
made up to the recast date and the payment due on the recast date is
made and credited as of that date;
(3) For a negative amortization loan under paragraph (d)(2)(i)(C)
of this section, the maximum loan amount.
(ii) Standard mortgage. The monthly payment for a standard mortgage
must be based on substantially equal, monthly, fully amortizing
payments based on the maximum interest rate that may apply during the
first five years after consummation.
(e) Qualified mortgages.
Alternative 1--Paragraph (e)(1)
(1) Safe harbor. A creditor or assignee of a covered transaction
complies with the repayment ability requirement of paragraph (c)(1) of
this section if the covered transaction is a qualified mortgage, as
defined in paragraph (e)(2) of this section.
Alternative 2--Paragraph (e)(1)
(1) Presumption of compliance. A creditor or assignee of a covered
transaction is presumed to have complied with the repayment ability
requirements of paragraph (c)(1) of this section if the covered
transaction is a qualified mortgage, as defined in paragraph (e)(2) of
this section.
(2) Qualified mortgage defined. A qualified mortgage is a covered
transaction--
(i) That provides for regular periodic payments that do not--
(A) Result in an increase of the principal balance;
(B) Allow the consumer to defer repayment of principal, except as
provided in paragraph (f) of this section; or
(C) Result in a balloon payment, as defined in Sec.
226.18(s)(5)(i), except as provided in paragraph (f) of this section;
(ii) For which the loan term does not exceed 30 years;
(iii) For which the total points and fees payable in connection
with the loan do not exceed the amounts specified in paragraph (e)(3)
of this section;
(iv) For which the creditor underwrites the loan, taking into
account any mortgage-related obligations, using--
(A) The maximum interest rate that may apply during the first five
years after consummation; and
(B) Periodic payments of principal and interest that will repay
either--
(1) The outstanding principal balance over the remaining term of
the loan as of the date the interest rate adjusts to the maximum
interest rate set forth in paragraph (e)(2)(iv)(A) of this section; or
[[Page 27485]]
(2) The loan amount over the loan term.
Alternative 1--Paragraph (e)(2)(v)
(v) For which the creditor considers and verifies the consumer's
current or reasonably expected income or assets to determine the
consumer's repayment ability, as required by paragraphs (c)(2)(i),
(c)(3), and (c)(4) of this section.
Alternative 2--Paragraph (e)(2)(v)
(v) For which the creditor considers and verifies, in accordance
with paragraph (c)(3) of this section, the following:
(A) The consumer's current or reasonably expected income or assets
other than the value of the dwelling that secures the loan, in
accordance with paragraphs (c)(2)(i) and (c)(4) of this section;
(B) If the creditor relies on income from the consumer's employment
in determining repayment ability, the consumer's current employment
status, in accordance with paragraph (c)(2)(ii) of this section;
(C) The consumer's monthly payment on any simultaneous loan that
the creditor knows or has reason to know will be made, in accordance
with paragraphs (c)(2)(iv) and (c)(6) of this section;
(D) The consumer's current debt obligations, in accordance with
paragraph (c)(2)(vi) of this section;
(E) The consumer's monthly debt-to-income ratio, or residual
income, in accordance with paragraphs (c)(2)(vii) and (c)(7) of this
section; and
(F) The consumer's credit history, in accordance with paragraph
(c)(viii) of this section.
(3) Limits on points and fees for qualified mortgages.
Alternative 1--Paragraph (e)(3)(i)
(i) A covered transaction is not a qualified mortgage unless the
total points and fees payable in connection with the loan do not
exceed--
(A) For a loan amount of $75,000 or more, three percent of the
total loan amount;
(B) For a loan amount of greater than or equal to $60,000 but less
than $75,000, 3.5 percent of the total loan amount;
(C) For a loan amount of greater than or equal to $40,000 but less
than $60,000, four percent of the total loan amount;
(D) For a loan amount of greater than or equal to $20,000 but less
than $40,000, 4.5 percent of the total loan amount; and
(E) For a loan amount of less than $20,000, five percent of the
total loan amount.
Alternative 2--Paragraph (e)(3)(i)
(i) A covered transaction is not a qualified mortgage unless the
total points and fees payable in connection with the loan do not
exceed--
(A) For a loan amount of $75,000 or more, three percent of the
total loan amount;
(B) For a loan amount of greater than or equal to $20,000 but less
than $75,000, a percentage of the total loan amount resulting from the
following formula--
(1) Total loan amount - $20,000 = $Z;
(2) $Z x .0036 = Y;
(3) 500 - Y = X; and
(4) X x .01 = Allowable points and fees as a percentage of the
total loan amount; and
(C) For a loan amount of less than $20,000, five percent of the
total loan amount.
(ii) For purposes of calculating the total amount of points and
fees that are payable in connection with a covered transaction under
(e)(3)(i), the following may be excluded:
(A) Any bona fide third party charge not retained by the creditor,
loan originator, or an affiliate of either, unless the charge is
required to be included in ``points and fees'' under Sec.
226.32(b)(1)(i)(B).
(B) Up to two bona fide discount points paid by the consumer in
connection with the transaction, provided that the following conditions
are met--
(1) The interest rate before the discount does not exceed the
average prime offer rate, as defined in Sec. 226.45(a)(2)(ii), by more
than one percent; and
(2) The average prime offer rate used for purposes of paragraph
(e)(3)(ii)(B)(1) of this section is the same average prime offer rate
that applies to a comparable transaction as of the date the discounted
interest rate for the transaction is set.
(C) Up to one bona fide discount point paid by the consumer in
connection with the transaction, provided that the following conditions
are met--
(1) The interest rate before the discount does not exceed the
average prime offer rate, as defined in Sec. 226.45(a)(2)(ii), by more
than two percent;
(2) The average prime offer rate used for purposes of paragraph
(e)(3)(ii)(C)(1) of this section is the same average prime offer rate
that applies to a comparable transaction as of the date the discounted
interest rate for the transaction is set; and
(3) Two bona fide discount points have not been excluded under
paragraph (e)(3)(ii)(B) of this section.
(iii) The term loan originator has the same meaning as in Sec.
226.36(a)(1).
(iv) The term bona fide discount point means any percent of the
loan amount of a covered transaction paid by the consumer that reduces
the interest rate or time-price differential applicable to the covered
transaction based on a calculation that--
(A) Is consistent with established industry practices for
determining the amount of reduction in the interest rate or time-price
differential appropriate for the amount of discount points paid by the
consumer; and
(B) Accounts for the amount of compensation that the creditor can
reasonably expect to receive from secondary market investors in return
for the mortgage loan.
(f) Balloon-payment qualified mortgages made by certain creditors--
(1) Exception. Notwithstanding paragraph (e)(2)(i)(C) of this section,
a qualified mortgage may provide for a balloon payment, provided--
(i) The loan satisfies all of the requirements for a qualified
mortgage in paragraph (e)(2) of this section, other than paragraphs
(e)(2)(i)(B), (e)(2)(i)(C), and (e)(2)(iv) of this section;
(ii) The creditor determines that the consumer can make all of the
scheduled payments under the terms of the legal obligation, except the
balloon payment, from the consumer's current or reasonably expected
income or assets other than the dwelling that secures the loan;
(iii) The scheduled payments on which the determination required by
paragraph (f)(1)(ii) of this section is based:
(A) Are calculated using an amortization period that does not
exceed 30 years; and
(B) Include all mortgage-related obligations;
(iv) The loan term is five years or longer; and
(v) The creditor:
(A) During the preceding calendar year, extended more than 50% of
its total covered transactions that provide for balloon payments in one
or more counties designated by the Board as ``rural'' or
``underserved,'' as defined in paragraph (f)(2) of this section;
Alternative 1--Paragraph (f)(1)(v)(B)
(B) During the preceding calendar year, together with all
affiliates, extended covered transactions with loan amounts that in the
aggregate total $------ or less;
Alternative 2--Paragraph (f)(1)(v)(B)
(B) During the preceding calendar year, together with all
affiliates,
[[Page 27486]]
extended ------ or fewer covered transactions;
Alternative 1--Paragraph (f)(1)(v)(C)
(C) On or after [effective date of final rule], has not sold,
assigned, or otherwise transferred legal title to the debt obligation
for any covered transaction that provides for a balloon payment; and
Alternative 2--Paragraph (f)(1)(v)(C)
(C) During the preceding and current calendar year, has not sold,
assigned, or otherwise transferred legal title to the debt obligation
for any covered transaction that provides for a balloon payment; and
(D) As of the end of the preceding calendar year, had total assets
that do not exceed the asset threshold established and published
annually by the Board, based on the year-to-year change in the average
of the Consumer Price Index for Urban Wage Earners and Clerical
Workers, not seasonally adjusted, for each 12-month period ending in
November, with rounding to the nearest million dollars. (See staff
comment 43(f)(1)(v)-1.iv for the current threshold.)
(2) ``Rural'' and ``underserved'' defined. For purposes of
paragraph (f)(1)(v)(A) of this section--
(i) A county is ``rural'' during a calendar year if it is not in a
metropolitan statistical area or a micropolitan statistical area, as
those terms are defined by the U.S. Office of Management and Budget,
and:
(A) It is not adjacent to any metropolitan area or micropolitan
area; or
(B) It is adjacent to a metropolitan area with fewer than one
million residents or adjacent to a micropolitan area, and it contains
no town with 2,500 or more residents.
(ii) A county is ``underserved'' during a calendar year if no more
than two creditors extend covered transactions five or more times in
the county.
(g) Prepayment penalties--(1) When permitted. A covered transaction
must not include a prepayment penalty unless:
(i) The prepayment penalty is otherwise permitted by law; and
(ii) The transaction--
(A) Has an annual percentage rate that cannot increase after
consummation;
(B) Is a qualified mortgage under paragraph (e)(2) or (f) of this
section; and
(C) Is not a higher-priced mortgage loan, as defined in Sec.
226.45(a).
(2) Limits on prepayment penalties. A prepayment penalty--
(i) Must not apply after the three-year period following
consummation; and
(ii) Must not exceed the following percentages of the amount of the
outstanding loan balance prepaid:
(A) Three percent, if incurred during the first year following
consummation;
(B) Two percent, if incurred during the second year following
consummation; and
(C) One percent, if incurred during the third year following
consummation.
(3) Alternative offer required. Except as provided otherwise in
paragraph (g)(4) or (g)(5) of this section, a creditor must not offer a
consumer a covered transaction with a prepayment penalty unless the
creditor also offers the consumer an alternative covered transaction
without a prepayment penalty and the alternative covered transaction--
(i) Has an annual percentage rate that cannot increase after
consummation and has the same type of interest rate as the covered
transaction with a prepayment penalty. For purposes of this paragraph
(g), the term ``type of interest rate'' refers to whether a
transaction:
(A) Is a fixed-rate mortgage, as defined in Sec.
226.18(s)(7)(iii); or
(B) Is a step-rate mortgage, as defined in Sec. 226.18(s)(7)(ii).
(ii) Has the same loan term as the loan term for the covered
transaction with a prepayment penalty;
(iii) Satisfies the periodic payment conditions under paragraph
(e)(2)(i) of this section;
(iv) Satisfies the points and fees conditions under paragraph
(e)(2)(iii) of this section, based on the information known to the
creditor at the time the transaction is offered; and
(v) Is a transaction for which the creditor has a good faith belief
that the consumer likely qualifies, based on the information known to
the creditor at the time the creditor offers the covered transaction
without a prepayment penalty.
(4) Offer through a mortgage broker. If the creditor offers a
covered transaction with a prepayment penalty to the consumer through a
mortgage broker, as defined in Sec. 226.36(a)(2), the creditor must--
(i) Present the mortgage broker an alternative covered transaction
without a prepayment penalty that satisfies the requirements of
paragraph (g)(3) of this section; and
(ii) Establish by agreement that the mortgage broker must present
the consumer an alternative covered transaction without a prepayment
penalty that satisfies the requirements of paragraph (g)(3) of this
section, offered by--
(A) The creditor; or
(B) Another creditor, if the transaction offered by the other
creditor has a lower interest rate or a lower total dollar amount of
origination points or fees and discount points.
(5) Creditor that is a loan originator. If the creditor is a loan
originator, as defined in Sec. 226.36(a)(1), and the creditor presents
the consumer a covered transaction offered by a person to which the
creditor would assign the covered transaction after consummation, the
creditor must present the consumer an alternative covered transaction
without a prepayment penalty that satisfies the requirements of
paragraph (g)(3) of this section, offered by--
(i) The assignee; or
(ii) Another person, if the transaction offered by the other person
has a lower interest rate or a lower total dollar amount of origination
points or fees and discount points.
(6) Applicability. This paragraph (g) applies only if a covered
transaction is consummated with a prepayment penalty and is not
violated if:
(i) A covered transaction is consummated without a prepayment
penalty; or
(ii) The creditor and consumer do not consummate a covered
transaction.
(h) Evasion; open-end credit. In connection with credit secured by
a consumer's 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.[ltrif]
7. In Supplement I to Part 226:
A. Under Section 226.25--Record Retention, 25(a) General rule,
paragraph 2 is revised and paragraphs 6 and 7 are added.
B. Under Section 226.32--Requirements for Certain Closed-End Home
Mortgages,
(1) In subheading 32(a) Coverage, Paragraph 32(a)(1)(ii), paragraph
1 is revised;
(2) In subheading 32(b) Definitions, Paragraph 32(b)(1)(i),
paragraph 1 is revised and paragraphs 2, 3, and 4 are added;
(i) Paragraph 32(b)(1)(ii), paragraph 1 is revised, paragraph 2. is
redesignated as Paragraph 32(b)(1)(iii), paragraph 1, and revised, and
new paragraphs 2 and 3 are added to Paragraph 32(b)(1)(ii);
(ii) Paragraph 32(b)(1)(iv), paragraph 1 is revised and paragraph 2
is added.
C. Under Section 226.34--Prohibited Acts or Practices in Connection
with Credit Subject to Sec. 226.32, subheading 34(a) Prohibited acts
or practices for loans subject to Sec. 226.32, paragraph 34(a)(4)
Repayment ability is removed and reserved.
D. Section 226.35--Prohibited Acts or Practices in Connection with
Higher-
[[Page 27487]]
Priced Mortgage Loans is removed and reserved.
E. New entry Section 226.43--Minimum Standards for Transactions
Secured by a Dwelling is added.
The revisions, removals, and additions read as follows:
Supplement I to Part 226--Official Staff Interpretations
* * * * *
Subpart D--Miscellaneous
* * * * *
Section 226.25--Record Retention
25(a) General rule.
* * * * *
2. Methods of retaining evidence. Adequate evidence of compliance
does not necessarily mean actual paper copies of disclosure statements
or other business records. The evidence may be retained [on microfilm,
microfiche, or] by any [other] method that reproduces records
accurately (including computer programs). [rtrif]Unless otherwise
required,[ltrif] the creditor need retain only enough information to
reconstruct the required disclosures or other records. Thus, for
example, the creditor need not retain each open-end periodic statement,
so long as the specific information on each statement can be retrieved.
* * * * *
[rtrif]6. Evidence of compliance with Sec. 226.43. Creditors must
retain evidence of compliance with Sec. 226.43 for three years after
the date of consummation of a consumer credit transaction covered by
that section. (See comment 25(a)-7 for guidance on the retention of
evidence of compliance with the requirement to offer a consumer a loan
without a prepayment penalty under Sec. 226.43(g)(3).) If a creditor
must verify and document information used in underwriting a transaction
subject to Sec. 226.43, the creditor should retain evidence sufficient
to demonstrate compliance with the documentation requirements of the
rule. Although creditors need not retain actual paper copies of the
documentation used in underwriting a transaction subject to Sec.
226.43, creditors should be able to reproduce such records accurately.
For example, if the creditor uses a consumer's Internal Revenue Service
(IRS) Form W-2 to verify the consumer's income, the creditor should be
able to reproduce the IRS Form W-2 itself, and not merely the income
information that was contained in the form.
7. Dwelling-secured transactions and prepayment penalties. If a
transaction covered by Sec. 226.43 has a prepayment penalty, the
creditor must maintain records that document that the creditor complied
with requirements for offering the consumer an alternative transaction
that does not include a prepayment penalty under Sec. 226.43(g)(3),
(4), or (5). However, the creditor need not maintain records that
document compliance with those provisions if a transaction is
consummated without a prepayment penalty or if the creditor and
consumer do not consummate a covered transaction. See Sec.
226.43(g)(6). If a creditor offers a transaction with a prepayment
penalty to a consumer through a mortgage broker, to evidence compliance
with Sec. 226.43(g)(4) the creditor should retain records of the
alternative covered transaction presented to the mortgage broker, such
as a rate sheet, and the agreement with the mortgage broker required by
Sec. 226.43(g)(4)(ii).[ltrif]
* * * * *
Subpart E--Special Rules for Certain Home Mortgage Transactions
* * * * *
Section 226.32--Requirements for Certain Closed-End Home Mortgages
32(a) Coverage.
* * * * *
Paragraph 32(a)(1)(ii).
1. Total loan amount. For purposes of the ``points and fees'' test,
the total loan amount is calculated by taking the amount financed, as
determined according to Sec. 226.18(b), and deducting any cost listed
in Sec. 226.32(b)(1)(iii)[rtrif],[ltrif] [and 226.32]
(b)(1)(iv)[rtrif]and (b)(1)(vi)[ltrif] that is both included as points
and fees under Sec. 226.32(b)(1) and financed by the creditor. Some
examples follow, each using a $10,000 amount borrowed, a $300 appraisal
fee, and $400 in points. A $500 [rtrif]single[ltrif] premium for
optional credit [rtrif]unemployment[ltrif] [lsqbb]life[rsqbb] insurance
is used in one example.
i. If the consumer finances a $300 fee for a creditor-conducted
appraisal and pays $400 in points at closing, the amount financed under
Sec. 226.18(b) is $9,900 ($10,000 plus the $300 appraisal fee that is
paid to and financed by the creditor, less $400 in prepaid finance
charges). The $300 appraisal fee paid to the creditor is added to other
points and fees under Sec. 226.32(b)(1)(iii). It is deducted from the
amount financed ($9,900) to derive a total loan amount of $9,600.
ii. If the consumer pays the $300 fee for the creditor-conducted
appraisal in cash at closing, the $300 is included in the points and
fees calculation because it is paid to the creditor. However, because
the $300 is not financed by the creditor, the fee is not part of the
amount financed under Sec. 226.18(b). In this case, the amount
financed is the same as the total loan amount: $9,600 ($10,000, less
$400 in prepaid finance charges).
iii. If the consumer finances a $300 fee for an appraisal conducted
by someone other than the creditor or an affiliate, the $300 fee is not
included with other points and fees under Sec. 226.32(b)(1)(iii).
[rtrif]In this case, the amount financed is the same as the total loan
amount:[ltrif] $9,900 ($10,000 plus the $300 fee for an independently
conducted appraisal that is financed by the creditor, less the $400
paid in cash and deducted as prepaid finance charges).
iv. If the consumer finances a $300 fee for a creditor-conducted
appraisal and a $500 single premium for optional credit
[rtrif]unemployment[ltrif] [lsqbb]life[rsqbb] insurance, and pays $400
in points at closing, the amount financed under Sec. 226.18(b) is
$10,400 ($10,000, plus the $300 appraisal fee that is paid to and
financed by the creditor, plus the $500 insurance premium that is
financed by the creditor, less $400 in prepaid finance charges). The
$300 appraisal fee paid to the creditor is added to other points and
fees under Sec. 226.32(b)(1)(iii), and the $500 insurance premium is
added under section 226.32(b)(1)(iv). The $300 and $500 costs are
deducted from the amount financed ($10,400) to derive a total loan
amount of $9,600.
* * * * *
32(b) Definitions.
Paragraph 32(b)(1)(i)
1. General. Section 226.32(b)(1)(i) includes in the total ``points
and fees'' items defined as finance charges under Sec. 226.4(a) and
226.4(b). Items excluded from the finance charge under other provisions
of Sec. 226.4 are not excluded in the total ``points and fees'' under
Sec. 226.32(b)(1)(i), but may be included in ``points and fees'' under
Sec. 226.32(b)(1)(ii) [rtrif]through Sec.
226.32(b)(1)(vi).[ltrif][lsqbb]and Sec. 226.32(b)(1)(iv)[rsqbb].
Interest, including per diem interest, is excluded from ``points and
fees under Sec. 226.32(b)(1). [rtrif]To illustrate: A fee imposed by
the creditor for an appraisal performed by an employee of the creditor
meets the definition of ``finance charge'' under Sec. 226.4(a) as
``any charge payable directly or indirectly by the consumer and imposed
directly or indirectly by the creditor as an incident to or a condition
of the extension of credit.'' However, Sec. 226.4(c)(7) expressly
provides that appraisal fees are not finance charges. Therefore, under
the
[[Page 27488]]
general rule regarding the finance charges that must be counted as
points and fees, a fee imposed by the creditor for an appraisal
performed by an employee of the creditor would not be counted in points
and fees. Section 226.32(b)(1)(iii), however, expressly re-includes in
points and fees items listed in Sec. 226.4(c)(7) (including appraisal
fees) if the creditor receives compensation in connection with the
charge. A creditor would receive compensation for an appraisal
performed by its own employee. Thus, the appraisal fee in this example
must be included in the calculation of points and fees.
2. Upfront Federal and state mortgage insurance premiums and
guaranty fees. Under Sec. 226.32(b)(1)(i)(B)(1) and (3), upfront
mortgage insurance premiums or guaranty fees in connection with a
Federal or state agency program are not ``points and fees,'' even
though they are finance charges under Sec. 226.4(a) and (b). For
example, if a consumer is required to pay a $2,000 mortgage insurance
premium before or at closing for a loan insured by the U.S. Federal
Housing Administration, the $2,000 must be treated as a finance charge
but need not be counted in ``points and fees.''
3. Upfront private mortgage insurance premiums. i. Under Sec.
226.32(b)(1)(i)(B)(2) and (3), upfront private mortgage insurance
premiums are not ``points and fees,'' even though they are finance
charges under Sec. 226.4(a) and (b)--but only to the extent that the
premium amount does not exceed the amount payable under policies in
effect at the time of origination under section 203(c)(2)(A) of the
National Housing Act (12 U.S.C. 1709(c)(2)(A)).
ii. In addition, to qualify for the exclusion from points and fees,
upfront private mortgage insurance premiums must be required to be
refunded on a pro rata basis and the refund must be automatically
issued upon notification of the satisfaction of the underlying mortgage
loan.
iii. To illustrate: Assume that a $3,000 upfront private mortgage
insurance premium charged on a covered transaction is required to be
refunded on a pro rata basis and automatically issued upon notification
of the satisfaction of the underlying mortgage loan. Assume also that
the maximum upfront premium allowable under the National Housing Act is
$2,000. In this case, the creditor could exclude $2,000 from ``points
and fees'' but would have to include the $1,000 that exceeds the
allowable premium under the National Housing Act. However, if the
$3,000 upfront private mortgage insurance premium were not required to
be refunded on a pro rata basis and automatically issued upon
notification of the satisfaction of the underlying mortgage loan, the
entire $3,000 premium must be included in ``points and fees.''
4. Method of paying private mortgage insurance premiums. Upfront
private mortgage insurance premiums that do not qualify for an
exclusion from ``points and fees'' under Sec. 226.32(b)(1)(i)(B)(2)
must be included in ``points and fees'' for purposes of this section
whether paid before or at closing, in cash or financed, and whether the
insurance is optional or required. Such charges are also included
whether the amount represents the entire premium or an initial
payment.[ltrif]
Paragraph 32(b)(1)(ii).
1. [Mortgage broker fees][rtrif]Loan originator compensation--
general[ltrif]. In determining ``points and fees'' for purposes of this
section, compensation paid by a consumer [rtrif]or creditor[ltrif] to a
[rtrif]loan originator[ltrif] [mortgage broker (directly or through the
creditor for delivery to the broker)] is included in the calculation
whether or not the amount is disclosed as a finance charge. [Mortgage
broker fees that are not paid by the consumer are not included.]
[rtrif]Loan originator[ltrif][Mortgage broker] fees already included in
[rtrif]points and fees[ltrif] calculation as finance charges under
Sec. 226.32(b)(1)(i) need not be counted again under Sec.
226.32(b)(1)(ii).
[rtrif]2. Loan originator compensation--examples. i. In determining
``points and fees'' under this section, loan originator compensation
includes the dollar value of compensation paid to a loan originator for
a covered transaction, such as a bonus, commission, yield spread
premium, award of merchandise, services, trips, or similar prizes, or
hourly pay for the actual number of hours worked on a particular
transaction. Compensation paid to a loan originator for a covered
transaction must be included in the ``points and fees'' calculation for
that loan whenever paid, whether before, at, or after closing, as long
as that compensation amount can be determined at the time of closing.
Thus, loan originator compensation for a covered transaction includes
compensation that will be paid as part of a periodic bonus, commission,
or gift if a portion of the dollar value of the bonus, commission, or
gift can be attributed to that loan. The following examples illustrate
the rule:
A. Assume that, according to a creditor's compensation policies,
the creditor awards its loan officers a bonus every year based on the
number of loan applications taken by the loan officer that result in
consummated transactions during that year, and that each consummated
transaction increases the bonus by $100. In this case, the $100 bonus
must be counted in the amount of loan originator compensation that the
creditor includes in ``points and fees.''
B. Assume that, according to a creditor's compensation policies,
the creditor awards its loan officers a year-end bonus equal to a flat
dollar amount for each of the consummated transactions originated by
the loan officer during that year. Assume also that the per-transaction
dollar amount is determined at the end of the year, based on the total
dollar value of consummated transactions originated by the loan
officer. If at the time a mortgage transaction is consummated the loan
officer has originated total volume that qualifies the loan officer to
receive a $300 bonus per transaction, the $300 bonus is loan originator
compensation that must be included in ``points and fees'' for the
transaction.
C. Assume that, according to a creditor's compensation policies,
the creditor awards its loan officers a bonus every year based on the
number of consummated transactions originated by the loan officer
during that year. Assume also that for the first 10 transactions
originated by the loan officer in a given year, no bonus is awarded;
for the next 10 transactions originated by the loan officer up to 20, a
bonus of $100 per transaction is awarded; and for each transaction
originated after the first 20, a bonus of $200 per transaction is
awarded. In this case, for the first 10 transactions originated by a
loan officer during a given year, no amount of loan originator
compensation need be included in ``points and fees.'' For any mortgage
transaction made after the first 10, up to the 20th transaction, $100
must be included in ``points and fees.'' For any mortgage transaction
made after the first 20, $200 must be included in ``points and fees.''
ii. In determining ``points and fees'' under this section, loan
originator compensation excludes compensation that cannot be attributed
to a particular transaction at the time or origination, including, for
example:
A. Compensation based on the long-term performance of the loan
originator's loans.
B. Compensation based on the overall quality of a loan originator's
loan files.
C. The base salary of a loan originator who is also the employee of
the creditor, not accounting for any bonuses, commissions, pay raises,
or other financial awards based solely on a particular transaction or
the number or
[[Page 27489]]
amount of covered transactions originated by the loan originator.
3. Name of fee. Loan originator compensation includes amounts the
loan originator retains and is not dependent on the label or name of
any fee imposed in connection with the transaction. For example, if a
loan originator imposes a ``processing fee'' and retains the fee, the
fee is loan originator compensation under Sec. 226.32(b)(1)(ii)
whether the originator expends the fee to process the consumer's
application or uses it for other expenses, such as overhead.
Paragraph 32(b)(1)(iii).
1. Other charges.[ltrif][2. Example.] Section 32(b)(1)(iii) defines
``points and fees'' to include all items listed in Sec. 226.4(c)(7),
other than amounts held for the future payment of taxes. An item listed
in Sec. 226.4(c)(7) may be excluded from the ``points and fees''
calculation, however, if the charge is reasonable[rtrif]; [ltrif][,]
the creditor receives no direct or indirect compensation from the
charge[rtrif];[ltrif][,] and the charge is not paid to an affiliate of
the creditor. For example, a reasonable fee paid by the consumer to an
independent, third-party appraiser may be excluded from the ``points
and fees'' calculation (assuming no compensation is paid to the
creditor[rtrif] or its affiliate[ltrif]). [rtrif]By contrast,
a[ltrif][A] fee paid by the consumer for an appraisal performed by the
creditor must be included in the calculation, even though the fee may
be excluded from the finance charge if it is bona fide and reasonable
in amount.
Paragraph 32(b)(1)(iv).
1. [rtrif]Credit insurance and debt cancellation or suspension
coverage [ltrif][Premium amount]. In determining ``points and fees''
for purposes of this section, premiums paid at or before closing for
credit insurance or [rtrif]any debt cancellation or suspension
agreement or contract[ltrif] are included [rtrif]in ``points and fees''
if they are paid at or before closing,[ltrif] whether they are paid in
cash or financed, [rtrif]and whether the insurance or coverage is
optional or required. Such charges are also included[ltrif][and]
whether the amount represents the entire premium or payment for the
coverage or an initial payment.
[rtrif]2. Credit property insurance. Credit property insurance
includes insurance against loss of or damage to personal property, such
as a houseboat or manufactured home. Credit property insurance covers
the creditor's security interest in the property. Credit property
insurance does not include homeowners insurance, which, unlike credit
property insurance, typically covers not only the dwelling but its
contents, and designates the consumer, not the creditor, as the
beneficiary.[ltrif]
* * * * *
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. [rtrif][lsqbb]Reserved.[rsqbb][ltrif]
* * * * *
Section 226.35 [rtrif][lsqbb]Reserved.[rsqbb][ltrif]
* * * * *
[rtrif]Section 226.43--Minimum Standards for Transactions Secured by a
Dwelling
1. Record retention. See Sec. 226.25(a) and comments 25(a)-6 and -
7 for guidance on the required retention of records as evidence of
compliance with Sec. 226.43.
43(a) Scope.
1. Consumer credit. In general, Sec. 226.43 applies to consumer
credit transactions secured by a dwelling, but certain dwelling-secured
consumer credit transactions are exempt from coverage under Sec.
226.43(a)(1)-(3). (See Sec. 226.2(a)(12) for the definition of
``consumer credit.'') Section 226.43 does not apply to an extension of
credit primarily for a business, commercial, or agricultural purpose,
even if it is secured by a dwelling. See Sec. 226.3 and associated
commentary for guidance in determining the primary purpose of an
extension of credit.
2. Real property. ``Dwelling'' means a residential structure that
contains one to four units, whether or not the structure is attached to
real property. See Sec. 226.2(a)(19). For purposes of Sec. 226.43,
the term ``dwelling'' includes any real property to which the
residential structure is attached that also secures the covered
transaction. For example, for purposes of Sec. 226.43(c)(2)(i), the
value of the dwelling that secures the covered transaction includes the
value of any real property to which the residential structure is
attached that also secures the covered transaction.
3. Renewable temporary or ``bridge'' loan. Under Sec.
226.43(a)(3)(ii), a temporary or ``bridge'' loan with a term of 12
months or less is excluded from coverage by Sec. 226.43(c) through
(f). Examples of such a loan are a loan to finance the purchase of a
new dwelling where the consumer plans to sell a current dwelling within
12 months and a loan to finance the initial construction of a dwelling.
Where a temporary or ``bridge loan'' is renewable, the loan term does
not include any additional period of time that could result from a
renewal provision. For example, if a construction loan has an initial
loan term of 12 months but is renewable for another 12-month loan term,
the loan is excluded from coverage by Sec. 226.43(c) through (f),
because the initial loan term is 12 months.
43(b) Definitions.
43(b)(3) Fully indexed rate.
1. Discounted and premium adjustable-rate transactions. In some
adjustable-rate transactions, creditors may set an initial interest
rate that is not determined by the index or formula used to make later
interest rate adjustments. Typically, this initial rate charged to
consumers is lower than the rate would be if it were calculated using
the index or formula at consummation (i.e., a ``discounted rate''). In
some cases, this initial rate may be higher (i.e., a ``premium rate'').
For purposes of determining the fully indexed rate where the initial
interest rate is not determined using the index or formula for
subsequent interest rate adjustments, the creditor must use the
interest rate that would have applied had the creditor used such index
or formula plus margin at the time of consummation. That is, in
determining the fully indexed rate, the creditor must not take into
account any discounted or premium rate. To illustrate, assume an
adjustable-rate transaction where the initial interest rate is not
based on an index or formula, and is set at 5% for the first five
years. The loan agreement provides that future interest rate
adjustments will be calculated based on the London Interbank Offered
Rate (LIBOR) plus a 3% margin. If the value of the LIBOR at
consummation is 5%, the interest rate that would have been applied at
consummation had the creditor based the initial rate on this index is
8% (5% plus 3% margin). For purposes of this section, the fully indexed
rate is 8%. For discussion of payment calculations based on the greater
of the fully indexed rate or ``premium rate'' for purposes of the
repayment ability determination under Sec. 226.43(c), see Sec.
226.43(c)(5)(i) and comment 43(c)(5)(i)-2.
2. Index or formula at consummation. The value of the index or
formula in effect at consummation need not be used if the contract
provides for a delay in the implementation of changes in an index value
or formula. For example, if the contract specifies that rate changes
are based on the index value in effect 45 days before the change date,
the creditor may use any index value in effect during the 45 days
before
[[Page 27490]]
consummation in calculating the fully indexed rate.
3. Interest rate adjustment caps. If the terms of the legal
obligation contain a periodic interest rate adjustment cap that would
prevent the initial rate, at the time of the first adjustment, from
changing to the rate determined using the index or formula at
consummation (i.e., the fully indexed rate), the creditor must not give
any effect to that rate cap when determining the fully indexed rate.
That is, a creditor must determine the fully indexed rate without
taking into account any periodic interest rate adjustment cap that may
limit how quickly the fully indexed rate may be reached at any time
during the loan term under the terms of the legal obligation. To
illustrate, assume an adjustable-rate mortgage has an initial fixed
rate of 5% for the first three years of the loan, after which the rate
will adjust annually to a specified index plus a margin of 3%. The loan
agreement provides for a 2% annual interest rate adjustment cap, and a
lifetime maximum interest rate of 10%. The index value in effect at
consummation is 4.5%; the fully indexed rate is 7.5% (4.5% plus 3%),
regardless of the 2% annual interest rate adjustment cap that would
limit when the fully indexed rate would take effect under the terms of
the legal obligation.
4. Lifetime maximum interest rate. A creditor may choose, in its
sole discretion, to take into account the lifetime maximum interest
rate provided under the terms of the legal obligation when determining
the fully indexed rate. If the creditor chooses to use the lifetime
maximum interest rate and the loan agreement provides a range for the
maximum interest rate, then the creditor must use the highest rate in
that range as the maximum interest rate for purposes of this section.
To illustrate, assume an adjustable-rate mortgage has an initial fixed
rate of 5% for the first three years of the loan, after which the rate
will adjust annually to a specified index plus a margin of 3%. The loan
agreement provides for a 2% annual interest rate adjustment cap, and a
lifetime maximum interest rate of 7%. The index value in effect at
consummation is 4.5%; the fully indexed rate is 7.5% (4.5% plus 3%).
For purposes of this section, the creditor can choose to use the
lifetime maximum interest rate of 7%, instead of the fully indexed rate
of 7.5%, for purposes of this section.
5. Step-rate and fixed-rate mortgages. Where the interest rate
offered under the terms of the legal obligation is not based on, and
does not vary with, an index or formula (i.e., there is no fully
indexed rate), the creditor must use the maximum interest rate that may
apply at any time during the loan term. To illustrate:
i. Assume a step-rate mortgage with an interest rate fixed at 6.5%
for the first two years of the loan, 7% for the next three years, and
7.5% thereafter for the remainder of loan term. For purposes of this
section, the creditor must use 7.5%, which is the maximum rate that may
apply during the loan term. ``Step-rate mortgage'' is defined in Sec.
226.18(s)(7)(ii).
ii. Assume a fixed-rate mortgage with an interest rate at
consummation of 7% that is fixed for the 30-year loan term. For
purposes of this section, the maximum interest rate that may apply
during the loan term is 7%, which is the interest rate that is fixed at
consummation. ``Fixed-rate mortgage'' is defined in Sec.
226.18(s)(7)(iii).
43(b)(4) Higher-priced covered transaction.
1. Average prime offer rate. The average prime offer rate generally
has the same meaning as in Sec. 226.45(a)(2)(ii). For further
explanation of the meaning of ``average prime offer rate,'' and
additional guidance on determining the average prime offer rate, see
comments 45(a)(2)(ii)-1 and -5. For further explanation of the Board
table, see comment 45(a)(2)(ii)-4.
2. Comparable transaction. A higher-priced covered transaction is a
consumer credit transaction that is secured by the consumer's 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 amount. The table of average prime offer rates
published by the Board indicates how to identify a comparable
transaction. See comment 45(a)(2)(ii)-2.
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.
43(b)(5) Loan amount.
1. Disbursement of the loan amount. The definition of ``loan
amount'' requires the creditor to use the entire loan amount as
reflected in the loan contract or promissory note, even though the loan
amount may not be fully disbursed at consummation. For example, assume
the consumer enters into a loan agreement where the consumer is
obligated to repay the creditor $200,000 over 15 years, but only
$100,000 is disbursed at consummation and the remaining $100,000 will
be disbursed during the year following consummation in a series of
advances ($25,000 each quarter). For purposes of this section, the
creditor must use the loan amount of $200,000, even though the loan
agreement provides that only $100,000 will be disbursed to the consumer
at consummation. Generally, creditors should rely on Sec. 226.17(c)(6)
and associated commentary regarding treatment of multiple-advance and
construction-to-permanent loans as single or multiple transactions.
43(b)(6) Loan term.
1. General. The loan term is the period of time it takes to repay
the loan amount in full. For example, a loan with an initial discounted
rate that is fixed for the first two years, and that adjusts
periodically for the next 28 years has a loan term of 30 years, which
is the amortization period on which the periodic amortizing payments
are based.
43(b)(7) Maximum loan amount.
1. Calculation of maximum loan amount. For purposes of Sec.
226.43(c)(2)(iii) and (c)(5)(ii)(C), a creditor must determine the
maximum loan amount for a negative amortization loan by using the loan
amount plus any increase in principal balance that will result from
negative amortization based on the terms of the legal obligation. In
determining the maximum loan amount, a creditor must assume that the
consumer makes the minimum periodic payment permitted under the loan
agreement for as long as possible, until the consumer must begin making
fully amortizing payments; and that the interest rate rises as quickly
as possible after consummation under the terms of the legal obligation.
Thus, creditors must assume that the consumer makes the minimum
periodic payment until any negative amortization cap is reached or
until the period permitting minimum periodic payments expires,
whichever occurs first. ``Loan amount'' is defined in Sec.
226.43(b)(5); ``negative amortization loan'' is defined in Sec.
226.18(s)(7)(v).
2. Assumed interest rate. In calculating the maximum loan amount
for an adjustable-rate mortgage that is a negative amortization loan,
the creditor must assume that the interest rate will increase as
rapidly as possible after consummation, taking into account any
periodic interest rate adjustment caps provided in the loan agreement.
For an adjustable-rate mortgage with a lifetime maximum interest rate
but no periodic interest rate adjustment cap, the creditor must assume
that the interest rate increases to the maximum lifetime interest rate
at the first adjustment.
[[Page 27491]]
3. Examples. The following are examples of how to determine the
maximum loan amount for a negative amortization loan (all amounts are
rounded):
i. Adjustable-rate mortgage with negative amortization. A. Assume
an adjustable-rate mortgage in the amount of $200,000 with a 30-year
loan term. The loan agreement provides that the consumer can make
minimum monthly payments that cover only part of the interest accrued
each month until the principal balance reaches 115% of its original
balance (i.e., a negative amortization cap of 115%) or for the first
five years of the loan (60 monthly payments), whichever occurs first.
The introductory interest rate at consummation is 1.5%. One month after
consummation, the interest rate adjusts and will adjust monthly
thereafter based on the specified index plus a margin of 3.5%. The
maximum lifetime interest rate is 10.5%; there are no other periodic
interest rate adjustment caps that limit how quickly the maximum
lifetime rate may be reached. The minimum monthly payment for the first
year is based on the initial interest rate of 1.5%. After that, the
minimum monthly payment adjusts annually, but may increase by no more
than 7.5% over the previous year's payment. The minimum monthly payment
is $690 in the first year, $742 in the second year, and $798 in the
first part of the third year.
B. To determine the maximum loan amount, assume that the initial
interest rate increases to the maximum lifetime interest rate of 10.5%
at the first adjustment (i.e., the second month) and accrues at that
rate until the loan is recast. Assume the consumer makes the minimum
monthly payments as scheduled, which are capped at 7.5% from year-to-
year. As a result, the consumer's minimum monthly payments are less
than the interest accrued each month, resulting in negative
amortization (i.e., the accrued but unpaid interest is added to the
principal balance). Thus, assuming that the consumer makes the minimum
monthly payments for as long as possible and that the maximum interest
rate of 10.5% is reached at the first rate adjustment (i.e., the second
month), the negative amortization cap of 115% is reached on the due
date of the 27th monthly payment and the loan is recast. The maximum
loan amount as of the due date of the 27th monthly payment is $229,243.
ii. Fixed-rate, graduated payment mortgage with negative
amortization. A loan in the amount of $200,000 has a 30-year loan term.
The loan agreement provides for a fixed interest rate of 7.5%, and
requires the consumer to make minimum monthly payments during the first
year, with payments increasing 12.5% every year for four years. The
payment schedule provides for payments of $943 in the first year,
$1,061 in the second year, $1,194 in the third year, $1,343 in the
fourth year, and $1,511 for the remaining term of the loan. During the
first three years of the loan, the payments are less than the interest
accrued each month, resulting in negative amortization. Assuming that
the consumer makes the minimum periodic payments for as long as
possible, the maximum loan amount is $207,659, which is reached at the
end of the third year of the loan (on the due date of the 36th monthly
payment). See comment 43(c)(5)(ii)(C)-3 providing examples of how to
determine the consumer's repayment ability for a negative amortization
loan.
43(b)(8) Mortgage-related obligations.
1. General. Mortgage-related obligations include expected property
taxes and premiums for mortgage-related insurance required by the
creditor as set forth in Sec. 226.45(b)(1), such as insurance against
loss of or damage to property or against liability arising out of the
ownership or use of the property, and insurance protecting the creditor
against the consumer's default or other credit loss. A creditor need
not include premiums for mortgage-related insurance that it does not
require, such as an earthquake insurance or credit insurance, or fees
for optional debt suspension and debt cancellation agreements.
Mortgage-related obligations also include special assessments that are
imposed on the consumer at or before consummation, such as a one-time
homeowners' association fee that will not be paid by the consumer in
full at or before consummation. See commentary to Sec.
226.43(c)(2)(v), discussing the requirement to take into account any
mortgage-related obligations.
43(b)(10) Prepayment penalty.
Paragraph 43(b)(10)(i)(A).
1. Interest accrual amortization method. A prepayment penalty
includes charges determined by treating the loan balance as outstanding
for a period after prepayment in full and applying the interest rate to
such balance, even if the charge results from the interest accrual
amortization method used on the transaction. ``Interest accrual
amortization'' refers to the method by which the amount of interest due
for each period (e.g., month), in a transaction's term is determined.
For example, ``monthly interest accrual amortization'' treats each
payment as made on the scheduled, monthly due date even if it is
actually paid early or late (until the expiration of a grace period).
Thus, under monthly interest accrual amortization, if the amount of
interest due on May 1 for the preceding month of April is $3000, the
creditor will require payment of $3000 in interest whether the payment
is made on April 20, on May 1, or on May 10. In this example, if the
interest charged for the month of April upon prepayment in full on
April 20 is $3000, the charge constitutes a prepayment penalty of $1000
because the amount of interest actually earned through April 20 is only
$2000.
43(b)(11) Recast.
1. Date of the recast. The term ``recast'' means, for an
adjustable-rate mortgage, the expiration of the period during which
payments based on the introductory fixed rate are permitted; for an
interest-only loan, the expiration of the period during which the
interest-only payments are permitted; and, for a negative amortization
loan, the expiration of the period during which negatively amortizing
payments are permitted. For adjustable-rate mortgages, interest-only
loans, and negative amortization loans, the date on which the
``recast'' is considered to occur is the due date of the last monthly
payment based on the introductory fixed rate, the interest-only
payment, or the negatively amortizing payment, respectively. To
illustrate: A loan in an amount of $200,000 has a 30-year loan term.
The loan agreement provides for a fixed interest rate and permits
interest-only payments for the first five years of the loan (60
months). The loan is recast on the due date of the 60th monthly
payment. Thus, the term of the loan remaining as of the date the loan
is recast is 25 years (300 months).
43(b)(12) Simultaneous loan.
1. General. Section 226.43(b)(12) defines a simultaneous loan as
another covered transaction or home equity line of credit subject to
Sec. 226.5b (HELOC) that will be secured by the same dwelling and made
to the same consumer at or before consummation of the covered
transaction, whether it is made by the same creditor or a third-party
creditor. For example, assume a consumer will enter into a legal
obligation that is a covered transaction with Creditor A. Immediately
prior to consummation of the covered transaction with Creditor A, the
consumer opens a HELOC that is secured by the same dwelling with
Creditor B. For purposes of this section, the loan extended by Creditor
B is a simultaneous loan. See commentary to
[[Page 27492]]
Sec. 226.43(c)(2)(iv) and (c)(6), discussing the requirement to
consider the consumer's payment obligation on any simultaneous loan for
purposes of determining the consumer's ability to repay the covered
transaction subject to this section.
2. Same consumer. For purposes of the definition of ``simultaneous
loan,'' the term ``same consumer'' includes any consumer, as that term
is defined in Sec. 226.2(a)(11), that enters into a loan that is a
covered transaction and also enters into another loan (e.g., second-
lien covered transaction or HELOC) secured by the same dwelling. Where
two or more consumers enter into a legal obligation that is a covered
transaction, but only one of them enters into another loan secured by
the same dwelling, the ``same consumer'' includes the person that has
entered into both legal obligations. For example, assume Consumer A and
Consumer B will both enter into a legal obligation that is a covered
transaction with a creditor. Immediately prior to consummation of the
covered transaction, Consumer B opens a HELOC that is secured by the
same dwelling with the same creditor; Consumer A is not a signatory to
the HELOC. For purposes of this definition, Consumer B is the same
consumer and the creditor must include the HELOC as a simultaneous
loan.
43(b)(13) Third-party record.
1. Electronic records. Third-party records include records
transmitted electronically. For example, to verify a consumer's credit
history using third-party records as required by Sec.
226.43(c)(2)(viii) and 226.43(c)(3), creditors may use a credit report
prepared by a consumer reporting agency and transmitted or viewed
electronically.
2. Forms. A record prepared by a third party includes a form a
creditor gives a third party for providing information, even if the
creditor completes parts of the form unrelated to the information
sought. For example, if a creditor gives a consumer's employer a form
for verifying the consumer's employment status and income, the creditor
may fill in the creditor's name and other portions of the form
unrelated to the consumer's employment status or income.
Paragraph 43(b)(13)(i).
1. Reviewed record. Under Sec. 226.43(b)(13)(i), a third-party
record includes a document or other record prepared by the consumer,
the creditor, the mortgage broker, or the creditor's or mortgage
broker's agent, if the record is reviewed by a third party. For
example, a profit-and-loss statement prepared by a self-employed
consumer and reviewed by a third-party accountant is a third-party
record under Sec. 226.43(b)(13)(i).
Paragraph 43(b)(13)(iii).
1. Creditor's records. Section 226.43(b)(13)(iii) provides that
third-party record includes a record the creditor maintains for an
account of the consumer held by the creditor. Examples of such accounts
include checking accounts, savings accounts, and retirement accounts.
Examples of such accounts also include accounts related to a consumer's
outstanding obligations to a creditor. For example, a third-party
record includes the creditor's records for a first-lien mortgage to a
consumer who applies for a subordinate-lien home equity loan.
43(c) Repayment ability.
1. Widely accepted standards. To evaluate a consumer's repayment
ability under Sec. 226.43(c), creditors may look to widely accepted
governmental or non-governmental underwriting standards, such as the
Federal Housing Administration's handbook on Mortgage Credit Analysis
for Mortgage Insurance on One- to Four-Unit Mortgage Loans. For
example, creditors may use such standards in determining:
i. Whether to classify particular inflows, obligations, or property
as ``income,'' ``debt,'' or ``assets'';
ii. Factors to consider in evaluating the income of a self-employed
or seasonally employed consumer; and
iii. Factors to consider in evaluating the credit history of a
consumer who has obtained few or no extensions of traditional
``credit,'' as defined in Sec. 226.2(a)(14).
43(c)(1) General requirement.
1. Repayment ability at consummation. Section 226.43(c)(1) requires
the creditor to determine that a consumer will have a reasonable
ability at the time the loan is consummated to repay the loan. A change
in the consumer's circumstances after consummation (for example, a
significant reduction in income due to a job loss or a significant
obligation arising from a major medical expense) that is not reflected
in the consumer's application or the records used to determine
repayment ability is not relevant to determining a creditor's
compliance with the rule. However, if the application or records state
there will be a change in a consumer's repayment ability after
consummation (for example, if a consumer's application states that the
consumer plans to retire within 12 months without obtaining new
employment or that the consumer will transition from full-time to part-
time employment), the creditor must consider that information.
2. Interaction with Regulation B. Section 226.43(c)(1) does not
require or permit the creditor to make inquiries or verifications that
would be prohibited by Regulation B, 12 CFR part 202.
Paragraph 43(c)(2)(i).
1. Income or assets generally. A creditor may base its
determination of repayment ability on current or reasonably expected
income from employment or other sources, assets other than the dwelling
that secures the covered transaction, or both. The creditor may
consider any type of current or reasonably expected income, including,
for example, the following: Salary; wages; self-employment income;
military or reserve duty income; bonus pay; tips; commissions; interest
payments; dividends; retirement benefits or entitlements; rental
income; royalty payments; trust income; public assistance payments; and
alimony, child support, and separate maintenance payments. The creditor
may consider any of the consumer's assets, other than the value of the
dwelling that secures the covered transaction, including, for example,
the following: funds in a savings or checking account, amounts vested
in a retirement account, stocks, bonds, certificates of deposit, and
amounts available to the consumer from a trust fund. (For purposes of
Sec. 226.43(c)(2)(i), the value of the dwelling includes the value of
the real property to which the real property is attached, if the real
property also secures the covered transaction. See comment 43(a)-2.)
2. Income or assets relied on. If a creditor bases its
determination of repayment ability entirely or in part on a consumer's
income, the creditor need consider only the income necessary to support
a determination that the consumer can repay the covered transaction.
For example, if a consumer's loan application states that the consumer
earns an annual salary from both a full-time job and a part-time job
and the creditor reasonably determines that the consumer's income from
the full-time job is sufficient to repay the loan, the creditor need
not consider the consumer's income from the part-time job. Further, a
creditor need verify only the income (and assets) relied on to
determine the consumer's repayment ability. See comment 43(c)(4)-1.
3. Expected income. If a creditor relies on expected income, either
in addition to or instead of current income, the expectation that the
income will be available for repayment must be reasonable and verified
with third-party records that provide reasonably reliable evidence of
the consumer's expected
[[Page 27493]]
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 records that show the consumer's past
annual bonuses, and the expected bonus must bear a reasonable
relationship to the past bonuses. Similarly, if the creditor relies on
a consumer's expected salary from a job the consumer has accepted and
will begin after receiving 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.
4. Seasonal or irregular income. A creditor reasonably may
determine that a consumer can make periodic loan payments even if the
consumer's income, such as self-employment income, is seasonal or
irregular. For example, assume a consumer receives income during a few
months each year from the sale of crops. If the creditor determines
that the consumer's annual income divided equally across 12 months is
sufficient for the consumer to make monthly loan payments, the creditor
reasonably may determine that the consumer can repay the loan, even
though the consumer may not receive income during certain months.
Paragraph 43(c)(2)(ii).
1. Employment status and income. Employment may be full-time, part-
time, seasonal, irregular, military, or self-employment. Under Sec.
226.43(c)(2)(ii), a creditor need verify a consumer's current
employment status only if the creditor relies on the consumer's
employment income in determining the consumer's repayment ability. For
example, if a creditor relies wholly on a consumer's investment income
to determine repayment ability, the creditor need not verify or
document employment status. See comment 43(c)(4)-2 for guidance on
which income to consider where multiple consumers apply jointly for a
loan.
2. Military personnel. Creditors may verify the employment status
of military personnel using the electronic database maintained by the
Department of Defense to facilitate identification of consumers covered
by credit protections provided pursuant to 10 U.S.C. 987.
Paragraph 43(c)(2)(iii).
1. General. For purposes of the repayment ability determination
required under Sec. 226.43(c)(2), a creditor must consider the
consumer's monthly payment on a covered transaction that is calculated
as required under Sec. 226.43(c)(5), taking into account any mortgage-
related obligations. ``Mortgage-related obligations'' is defined in
Sec. 226.43(b)(8).
Paragraph 43(c)(2)(iv).
1. Home equity lines of credit. For purposes of Sec.
226.43(c)(2)(iv), a simultaneous loan includes any covered transaction
or home equity line of credit subject to Sec. 226.5b (HELOC) that will
be made to the same consumer at or before consummation of the covered
transaction and secured by the same dwelling that secures the covered
transaction. A HELOC that is a simultaneous loan that the creditor
knows or has reason to know about must be considered as a mortgage
obligation in determining a consumer's ability to repay the covered
transaction even though the HELOC is not a covered transaction subject
to Sec. 226.43. See Sec. 226.43(a) discussing the scope of this
section. ``Simultaneous loan'' is defined in Sec. 226.43(b)(12). For
further explanation of ``same consumer,'' see comment 43(b)(12)-2.
2. Knows or has reason to know. In determining a consumer's
repayment ability for a covered transaction under Sec. 226.43(c)(2), a
creditor must consider the consumer's payment obligation on any
simultaneous loan that the creditor knows or has reason to know will be
made at or before consummation of the covered transaction. For example,
where a covered transaction is a home purchase loan, the creditor must
consider the consumer's periodic payment obligation for any
``piggyback'' second-lien loan that the creditor knows or has reason to
know will be used to finance part of the consumer's down payment. The
creditor complies with this requirement where, for example, the
creditor follows policies and procedures that show at or before
consummation that the same consumer has applied for another credit
transaction secured by the same dwelling. To illustrate, assume a
creditor receives an application for a home purchase loan where the
requested loan amount is less than the home purchase price. The
creditor's policies and procedures require the consumer to state the
source of the downpayment. If the creditor determines the source of the
downpayment is another extension of credit that will be made to the
same consumer at or before consummation and secured by the same
dwelling, the creditor knows or has reason to know of the simultaneous
loan and must consider the simultaneous loan. Alternatively, if the
creditor has information that suggests the downpayment source is the
consumer's income or existing assets, the creditor would be under no
further obligation to determine whether a simultaneous loan will be
extended at or before consummation of the covered transaction.
3. Scope of timing. For purposes of Sec. 226.43(c)(2)(iv), a
simultaneous loan includes a loan that comes into existence
concurrently with the covered transaction subject to Sec. 226.43(c).
In all cases, a simultaneous loan does not include a credit transaction
that occurs after consummation of the covered transaction that is
subject to this section.
4. Verification of simultaneous loans. Although a credit report may
be used to verify current obligations, it will not reflect a
simultaneous loan that has not yet been consummated or has just
recently been consummated. If the creditor knows or has reason to know
that there will be a simultaneous loan extended at or before
consummation, the creditor may verify the simultaneous loan by
obtaining third-party verification from the third-party creditor of the
simultaneous loan. For example, the creditor may obtain a copy of the
promissory note or other written verification from the third-party
creditor in accordance with widely accepted governmental or non-
governmental standards. For further guidance, see comments 43(c)(3)-1
and -2 discussing verification using third-party records.
43(c)(2)(v) Mortgage-related obligations.
1. General. A creditor must include in its repayment ability
assessment the consumer's mortgage-related obligations, such as the
expected property taxes and premiums for mortgage-related insurance
required by the creditor as set forth in Sec. 226.45(b)(1), but need
not include mortgage-related insurance premiums that the creditor does
not require, such as credit insurance or fees for operational debt
suspension and debt cancellation agreements. Mortgage-related
obligations must be included in the creditor's determination of
repayment ability regardless of whether the amounts are included in the
monthly payment or whether there is an escrow account established. See
Sec. 226.43(b)(8) defining the term ``mortgage-related obligations.''
2. Pro rata amount. In considering mortgage-related obligations
that are not paid monthly, a creditor may look to widely accepted
governmental or non-governmental standards in determining the pro rata
monthly payment amount.
3. Estimates. Estimates of mortgage-related obligations should be
based upon information that is known to the creditor at the time the
creditor underwrites the mortgage obligation.
[[Page 27494]]
Information is known if it is reasonably available to the creditor at
the time of underwriting the loan. See comment 17(c)(2)(i)-1 discussing
the ``reasonably available'' standard. For purposes of this section,
the creditor need not project potential changes, such as by estimating
possible increases in taxes and insurance.
4. Verification of mortgage-related obligations. Creditors must
make the repayment ability determination required under Sec. 226.43(c)
based on information verified from reasonably reliable records. For
guidance regarding verification of mortgage-related obligations see
comments 43(c)(3)-1 and -2, which discuss verification using third-
party records.
Paragraph 43(c)(2)(vi).
1. Consideration and verification of current debt obligations. In
determining how to define ``current debt obligations'' and how to
verify such obligations, creditors may look to widely accepted
governmental and non-governmental underwriting standards. For example,
a creditor must consider student loans, automobile loans, revolving
debt, alimony, child support, and existing mortgages. To verify the
obligations as required by Sec. 226.43(c)(3), a creditor may, for
instance, look to credit reports, student loan statements, automobile
loan statements, credit card statements, alimony or child support court
orders, and existing mortgage statements.
2. Discrepancies between a credit report and an application. If a
credit report reflects a current debt obligation that a consumer has
not listed on the application, the creditor must consider the
obligation. The credit report is deemed a reasonably reliable third-
party record under Sec. 226.43(c)(3). If a credit report does not
reflect a current debt obligation that a consumer has listed on the
application, the creditor must consider the obligation. However, the
creditor need not verify the existence or amount of the obligation
through another source. If a creditor nevertheless verifies an
obligation, the creditor must consider the obligation based on the
information from the verified source.
Paragraph 43(c)(2)(vii).
1. Monthly debt-to-income ratio and residual income. See Sec.
226.43(c)(7) regarding the definitions and calculations for the monthly
debt-to-income ratio and residual income.
Paragraph 43(c)(2)(viii).
1. Consideration and verification of credit history. In determining
how to define ``credit history'' and how to verify credit history,
creditors may look to widely accepted governmental and non-governmental
underwriting standards. For example, a creditor may consider factors
such as the number and age of credit lines, payment history, and any
judgments, collections, or bankruptcies. To verify credit history as
required by Sec. 226.43(c)(3), a creditor may, for instance, look to
credit reports from credit bureaus, or nontraditional credit references
contained in third-party documents, such as rental payment history or
public utility payments.
43(c)(3) Verification using third-party records.
1. Records specific to the individual consumer. Records used to
verify a consumer's repayment ability must be specific to the
individual consumer. Records regarding average incomes in the
consumer's geographic location or average incomes paid by the
consumer's employer, for example, would not be specific to the
individual consumer and are not sufficient.
2. Obtaining records. To determine repayment ability, creditors may
obtain records from a third-party service provider, such as a party the
consumer's employer uses to respond to income verification requests, as
long as the records are reasonably reliable and specific to the
individual consumer. Creditors also may obtain third-party records
directly from the consumer. For example, creditors using payroll
statements to verify the consumer's income (as allowed under Sec.
226.43(c)(4)(iii) may obtain the payroll statements from the consumer.
43(c)(4) Verification of income or assets.
1. Income or assets relied on. A creditor need consider, and
therefore need verify, only the income or assets the creditor relies on
to evaluate the consumer's repayment ability. See comment 43(c)(2)(i)-
2. For example, if a consumer's application states that the consumer
earns a salary and is paid an annual bonus and the creditor relies on
only the consumer's salary to evaluate the consumer's repayment
ability, the creditor need verify only the salary.
2. Multiple applicants. If multiple consumers jointly apply for a
loan and each lists income or assets on the application, the creditor
need verify only the income or assets the creditor relies on in
determining repayment ability.
3. Tax-return transcript. Under Sec. 226.43(c)(4), creditors may
verify a consumer's income using an Internal Revenue Service (IRS) tax-
return transcript, which summarizes the information in a consumer's
filed tax return, another record that provides reasonably reliable
evidence of the consumer's income, or both. Creditors may obtain a copy
of a tax-return transcript or a filed tax return directly from the
consumer or from a service provider and need not obtain the copy
directly from the IRS or other taxing authority. See comment 43(c)(3)-
2.
Paragraph 43(c)(4)(vi).
1. Government benefits. In verifying a consumer's income, creditors
may use a written or electronic record from a government agency of the
amount of any benefit payments or awards, such as a ``proof of income
letter'' issued by the Social Security Administration (also known as a
``budget letter,'' ``benefits letter,'' or ``proof of award letter'').
43(c)(5) Payment calculation.
43(c)(5)(i) General rule.
1. General. For purposes of Sec. 226.43(c)(2)(iii), a creditor
must determine the consumer's ability to repay the covered transaction
using the payment calculation methods set forth in Sec. 226.43(c)(5).
The payment calculation methods differ depending on whether the covered
transaction has a balloon payment, or is an interest-only or negative
amortization loan. The payment calculation method set forth in Sec.
226.43(c)(5)(i) applies to any covered transaction that does not have a
balloon payment, or that is not an interest-only or negative
amortization loan, whether it is a fixed-rate, adjustable-rate or step-
rate mortgage. The terms ``fixed-rate mortgage,'' ``adjustable-rate
mortgage,'' ``step-rate mortgage,'' ``interest-only loan'' and
``negative amortization loan,'' are defined in Sec. 226.18(s)(7)(i),
(ii), (iii), (iv) and (v), respectively. For the meaning of the term
``balloon payment,'' see Sec. 226.18(s)(5)(i). The payment calculation
method set forth in Sec. 226.43(c)(5)(ii) applies to any covered
transaction that is a loan with a balloon payment, interest-only loan,
or negative amortization loan. See commentary to Sec. 226.43(c)(5)(i)
and (ii), which provides examples for calculating the monthly payment
for purposes of the repayment ability determination required under
Sec. 226.43(c)(2)(iii).
2. Greater of the fully indexed rate or introductory rate; premium
adjustable-rate transactions. A creditor must determine a consumer's
repayment ability for the covered transaction using substantially
equal, monthly, fully amortizing payments that are based on the greater
of the fully indexed rate or any introductory interest rate. In some
adjustable-rate transactions, creditors may set an initial interest
rate that is not determined by the index or formula used to make later
interest rate adjustments. Typically, this initial rate charged to
consumers is lower than the rate would be if it were determined by
using the the index plus margin, or formula (i.e., fully indexed rate).
However, an initial rate that is a
[[Page 27495]]
premium rate is higher than the rate based on the index or formula. In
such cases, creditors must calculate the fully amortizing payment based
on the initial ``premium'' rate. ``Fully indexed rate'' is defined in
Sec. 226.43(b)(3).
3. Monthly, fully amortizing payments. Section 226.43(c)(5)(i) does
not prescribe the terms or loan features that a creditor may choose to
offer or extend to a consumer, but establishes the calculation method a
creditor must use to determine the consumer's repayment ability for a
covered transaction. For example, the terms of the loan agreement may
require that the consumer repay the loan in quarterly or bi-weekly
scheduled payments, but for purposes of the repayment ability
determination, the creditor must convert these scheduled payments to
monthly payments in accordance with Sec. 226.43(c)(5)(i)(B).
Similarly, the loan agreement may not require the consumer to make
fully amortizing payments, but for purposes of the repayment ability
determination the creditor must convert any non-amortizing payments to
fully amortizing payments.
4. Substantially equal. In determining whether monthly, fully
amortizing payments are substantially equal, creditors should disregard
minor variations due to payment-schedule irregularities and odd
periods, such as a long or short first or last payment period. That is,
monthly payments of principal and interest that repay the loan amount
over the loan term need not be equal, but the monthly payments should
be substantially the same without significant variation in the monthly
combined payments of both principal and interest. For example, where no
two monthly payments vary from each other by more than 1% (excluding
odd periods, such as a long or short first or last payment period),
such monthly payments would be considered substantially equal for
purposes of this section. In general, creditors should determine
whether the monthly, fully amortizing payments are substantially equal
based on guidance provided in Sec. 226.17(c)(3) (discussing minor
variations), and Sec. 226.17(c)(4)(i)-(iii) (discussing payment-
schedule irregularities and measuring odd periods due to a long or
short first period) and associated commentary.
5. Examples. The following are examples of how to determine the
consumer's repayment ability based on substantially equal, monthly,
fully amortizing payments as required under Sec. 226.43(c)(5)(i) (all
amounts are rounded):
i. Fixed-rate mortgage. A loan in an amount of $200,000 has a 30-
year loan term and a fixed interest rate of 7%. For purposes of Sec.
226.43(c)(2)(iii), the creditor must determine the consumer's ability
to repay the loan based on a payment of $1,331, which is the
substantially equal, monthly, fully amortizing payment that will repay
$200,000 over 30 years using the fixed interest rate of 7%.
ii. Adjustable-rate mortgage with discount for five years. A loan
in an amount of $200,000 has a 30-year loan term. The loan agreement
provides for a discounted interest rate of 6% that is fixed for an
initial period of five years, after which the interest rate will adjust
annually based on a specified index plus a margin of 3%, subject to a
2% annual periodic interest rate adjustment cap. The index value in
effect at consummation is 4.5%; the fully indexed rate is 7.5% (4.5%
plus 3%). Even though the scheduled monthly payment required for the
first five years is $1,199, for purposes of Sec. 226.43(c)(2)(iii) the
creditor must determine the consumer's ability to repay the loan based
on a payment of $1,398, which is the substantially equal, monthly,
fully amortizing payment that will repay $200,000 over 30 years using
the fully indexed rate of 7.5%.
iii. Step-rate mortgage. A loan in an amount of $200,000 has a 30-
year loan term. The loan agreement provides that the interest rate will
be 6.5% for the first two years of the loan, 7% for the next three
years of the loan, and 7.5% thereafter. Accordingly, the scheduled
payment amounts are $1,264 for the first two years, $1,328 for the next
three years, and $1,388 thereafter for the remainder of the term. For
purposes of Sec. 226.43(c)(2)(iii), the creditor must determine the
consumer's ability to repay the loan based on a payment of $1,398,
which is the substantially equal, monthly, fully amortizing payment
that would repay $200,000 over 30 years using the fully indexed rate of
7.5%.
43(c)(5)(ii) Special rules for loans with a balloon payment,
interest-only loans, and negative amortization loans.
Paragraph 43(c)(5)(ii)(A).
1. General. For loans with a balloon payment, the rules differ
depending on whether the loan is a higher-priced covered transaction,
as defined under Sec. 226.43(b)(4), or is not a higher-priced covered
transaction because the annual percentage rate does not exceed the
applicable average prime offer rate (APOR) for a comparable
transaction. ``Average prime offer rate'' is defined in Sec.
226.45(a)(2)(ii); ``higher-priced covered transaction'' is defined in
Sec. 226.43(b)(4). For higher-priced covered transactions with a
balloon payment, the creditor must consider the consumer's ability to
repay the loan based on the payment schedule under the terms of the
legal obligation, including any required balloon payment. For loans
with a balloon payment that are not higher-priced covered transactions,
the creditor should use the maximum payment scheduled during the first
five years of the loan following consummation. ``Balloon payment'' is
defined in Sec. 226.18(s)(5)(i).
2. First five years after consummation. Under Sec.
226.43(c)(5)(ii)(A)(1), the creditor must determine a consumer's
ability to repay a loan with a balloon payment that is not a higher-
priced covered transaction using the maximum payment scheduled during
the first five years (60 months) after consummation. For example,
assume a loan with a balloon payment due at the end of a five-year loan
term. The loan is consummated on August 15, 2011, and the first monthly
payment is due on October 1, 2011. The first five years after
consummation occurs on August 15, 2016. The balloon payment must be
made on the due date of the 60th monthly payment, which is September 1,
2016. For purposes of determining the consumer's ability to repay the
loan under Sec. 226.43(c)(2)(iii), the creditor need not consider the
balloon payment that is due on September 1, 2016.
3. Renewable balloon loan; loan term. A balloon loan that is not a
higher-priced covered transaction could provide that a creditor is
unconditionally obligated to renew a balloon loan at the consumer's
option (or is obligated to renew subject to conditions within the
consumer's control). See comment 17(c)(1)-11 discussing renewable
balloon loans. For purposes of this section, the loan term does not
include any the period of time that could result from a renewal
provision. To illustrate, assume a 3-year balloon loan that is not a
higher-priced covered transaction contains an unconditional obligation
to renew for another three years at the consumer's option. In this
example, the loan term for the balloon loan is 3 years, and not the
potential 6 years that could result if the consumer chooses to renew
the loan. Accordingly, the creditor must underwrite the loan using the
maximum payment scheduled in the first five years after consummation,
which includes the balloon payment due at the end of the 3-year loan
term. See comment 43(c)(5)(ii)(A).ii, which provides an example of how
to determine the consumer's repayment ability for a 3-year renewable
balloon loan.
[[Page 27496]]
4. Examples of loans with a balloon payment that are not higher-
priced covered transactions. The following are examples of how to
determine the maximum payment scheduled during the first five years
after consummation (all amounts are rounded):
i. Balloon payment loan with a three-year loan term; fixed interest
rate. A loan agreement provides for a fixed interest rate of 6%, which
is below the APOR threshold for a comparable transaction, thus the loan
is not a higher-priced covered transaction. The loan amount is
$200,000, and the loan has a three-year loan term but is amortized over
30 years. The monthly payment scheduled for the first three years
following consummation is $1,199, with a balloon payment of $193,367
due at the end of the third year. For purposes of Sec.
226.43(c)(2)(iii), the creditor must determine the consumer's ability
to repay the loan based on the balloon payment of $193,367.
ii. Renewable balloon payment loan with a three-year loan term.
Assume the same facts above in 43(c)(5)(ii)(A).i, except that the loan
agreement also provides that the creditor is unconditionally obligated
to renew the balloon payment mortgage at the consumer's option at the
end of the three-year term for another three years (the creditor
retains the option to increase the interest rate at the time of
renewal). In determining the maximum payment scheduled during the first
five years after consummation, the creditor must use a loan term of
three years. Accordingly, for purposes of Sec. 226.43(c)(2)(iii), the
creditor must determine the consumer's ability to repay the loan based
on the balloon payment of $193,367.
iii. Balloon payment loan with a five-year loan term; fixed
interest rate. A loan provides for a fixed interest rate of 6%, which
is below the APOR threshold for a comparable transaction, and thus, the
loan is not a higher-priced covered transaction. The loan amount is
$200,000, and the loan has a five-year loan term but is amortized over
30 years. The loan is consummated on March 15, 2011, and the monthly
payment scheduled for the first five years following consummation is
$1,199, with the first monthly payment due on May 1, 2011. The first
five years after consummation end on March 15, 2016. The balloon
payment of $187,308 is required on the due date of the 60th monthly
payment, which is April 1, 2016 (more than five years after
consummation). For purposes of Sec. 226.43(c)(2)(iii), the creditor
must determine the consumer's ability to repay the loan based on the
monthly payment of $1,199, and need not consider the balloon payment of
$187,308 due on April 1, 2016.
5. Example of a higher-priced covered transaction with a balloon
payment. The following is an example of how to determine the consumer's
repayment ability based on the loan's payment schedule, including any
balloon payment (all amounts are rounded):
i. Balloon payment loan with a 10-year loan term; fixed interest
rate. The loan is a higher-priced covered transaction with a fixed
interest rate of 7%. The loan amount is $200,000 and the loan has a 10-
year loan term, but is amortized over 30 years. The monthly payment
scheduled for the first ten years is $1,331, with a balloon payment of
$172,956. For purposes of Sec. 226.43(c)(2)(iii), the creditor must
consider the consumer's ability to repay the loan based on the payment
schedule that fully repays the loan amount, including the balloon
payment of $172,956.
Paragraph 43(c)(5)(ii)(B).
1. General. For loans that permit interest-only payments, the
creditor must use the fully indexed rate or introductory rate,
whichever is greater, to calculate the substantially equal, monthly
payment of principal and interest that will repay the loan amount over
the term of the loan remaining as of the date the loan is recast. For
discussion regarding the fully indexed rate and the meaning of
``substantially equal,'' see comments 43(b)(3)-1 through -5 and
43(c)(5)(i)-4, respectively. Under Sec. 226.43(c)(5)(ii)(B), the
relevant term of the loan is the period of time that remains as of the
date the loan is recast to require fully amortizing payments. For a
loan on which only interest and no principal has been paid, the loan
amount will be the outstanding principal balance at the time of the
recast. ``Loan amount'' and ``recast'' are defined in Sec.
226.43(b)(5) and (b)(11), respectively. ``Interest-only'' and
``Interest-only loan'' are defined in Sec. 226.18(s)(7)(iv).
2. Examples. The following are examples of how to determine the
consumer's repayment ability based on substantially equal, monthly
payments of principal and interest under Sec. 226.43(c)(5)(ii)(B) (all
amounts are rounded):
i. Fixed-rate mortgage with interest-only payments for five years.
A loan in an amount of $200,000 has a 30-year loan term. The loan
agreement provides for a fixed interest rate of 7%, and permits
interest-only payments for the first five years. The monthly payment of
$1167 scheduled for the first five years would cover only the interest
due. The loan is recast on the due date of the 60th monthly payment,
after which the scheduled monthly payments increase to $1414, a monthly
payment that repays the loan amount of $200,000 over the 25 years
remaining as of the date the loan is recast (300 months). For purposes
of Sec. 226.43(c)(2)(iii), the creditor must determine the consumer's
ability to repay the loan based on a payment of $1414, which is the
substantially equal, monthly, fully amortizing payment that would repay
$200,000 over the 25 years remaining as of the date the loan is recast
using the fixed interest rate of 7%.
ii. Adjustable-rate mortgage with discount for three years and
interest-only payments for five years. A loan in an amount of $200,000
has a 30-year loan term, but provides for interest-only payments for
the first five years. The loan agreement provides for a discounted
interest rate of 5% that is fixed for an initial period of three years,
after which the interest rate will adjust each year based on a
specified index plus a margin of 3%, subject to an annual interest rate
adjustment cap of 2%. The index value in effect at consummation is
4.5%; the fully indexed rate is 7.5% (4.5% plus 3%). The monthly
payments of $833 for the first three years and $1250 for the following
two years would cover only the interest due. The loan is recast on the
due date of the 60th monthly payment, after which the scheduled monthly
payments increase to $1478, a monthly payment that will repay the loan
amount of $200,000 over the remaining 25 years of the loan (300
months). For purposes of Sec. 226.43(c)(2)(iii), the creditor must
determine the consumer's ability to repay the loan based on a monthly
payment of $1,478, which is the substantially equal, monthly payment of
principal and interest that would repay $200,000 over the 25 years
remaining as of the date the loan is recast using the fully indexed
rate of 7.5%.
Paragraph 43(c)(5)(ii)(C).
1. General. For purposes of determining the consumer's ability to
repay a negative amortization loan, the creditor must use substantially
equal, monthly payments of principal and interest based on the fully
indexed rate or the introductory rate, whichever is greater, that will
repay the maximum loan amount over the term of the loan that remains as
of the date the loan is recast. Accordingly, before determining the
substantially equal, monthly payments the creditor must first determine
the maximum loan amount and the period of time that remains in
[[Page 27497]]
the loan term after the loan is recast. ``Recast'' is defined in Sec.
226.43(b)(11). Second, the creditor must use the fully indexed rate or
introductory rate, whichever is greater, to calculate the substantially
equal, monthly payment amount that will repay the maximum loan amount
over the term of the loan remaining as of the date the loan is recast.
For discussion regarding the fully indexed rate and the meaning of
``substantially equal,'' see comments 43(b)(3)-1 through -5 and
43(c)(5)(i)-4, respectively. For the meaning of the term ``maximum loan
amount'' and a discussion of how to determine the maximum loan amount
for purposes of Sec. 226.43(c)(5)(ii)(C), see Sec. 226.43(b)(7) and
associated commentary. ``Negative amortization loan'' is defined in
Sec. 226.18(s)(7)(v).
2. Term of loan. Under Sec. 226.43(c)(5)(ii)(C), the relevant term
of the loan is the period of time that remains as of the date the terms
of the legal obligation recast. That is, the creditor must determine
substantially equal, monthly payments of principal and interest that
will repay the maximum loan amount based on the period of time that
remains after any negative amortization cap is triggered or any period
permitting minimum periodic payments expires, whichever occurs first.
3. Examples. The following are examples of how to determine the
consumer's repayment ability based on substantially equal, monthly
payments of principal and interest as required under Sec.
226.43(c)(5)(ii)(C) (all amounts are rounded):
i. Adjustable-rate mortgage with negative amortization. A. Assume
an adjustable-rate mortgage in the amount of $200,000 with a 30-year
loan term. The loan agreement provides that the consumer can make
minimum monthly payments that cover only part of the interest accrued
each month until the date on which the principal balance reaches 115%
of its original balance (i.e., a negative amortization cap of 115%) or
for the first five years of the loan (60 monthly payments), whichever
occurs first. The introductory interest rate at consummation is 1.5%.
One month after consummation, the interest rate adjusts and will adjust
monthly thereafter based on the specified index plus a margin of 3.5%.
The index value in effect at consummation is 4.5%; the fully indexed
rate is 8% (4.5% plus 3.5%). The maximum lifetime interest rate is
10.5%; there are no other periodic interest rate adjustment caps that
limit how quickly the maximum lifetime rate may be reached. The minimum
monthly payment for the first year is based on the initial interest
rate of 1.5%. After that, the minimum monthly payment adjusts annually,
but may increase by no more than 7.5% over the previous year's payment.
The minimum monthly payment is $690 in the first year, $742 in the
second year, and $798 in the first part of the third year.
B. To determine the maximum loan amount, assume that the interest
rate increases to the maximum lifetime interest rate of 10.5% at the
first adjustment (i.e., the second month), and interest accrues at that
rate until the loan is recast. Assume that the consumer makes the
minimum monthly payments scheduled, which are capped at 7.5% from year-
to-year, for the maximum possible time. Because the consumer's minimum
monthly payments are less than the interest accrued each month,
negative amortization occurs (i.e., the accrued but unpaid interest is
added to the principal balance). Thus, assuming that the consumer makes
the minimum monthly payments for as long as possible and that the
maximum interest rate of 10.5% is reached at the first rate adjustment
(i.e., the second month), the negative amortization cap of 115% is
reached on the due date of the 27th monthly payment and the loan is
recast as of that date. The maximum loan amount as of the due date of
the 27th monthly payment is $229,243, and the remaining term of the
loan is 27 years and nine months (333 months).
C. For purposes of Sec. 226.43(c)(2)(iii), the creditor must
determine the consumer's ability to repay the loan based on a monthly
payment of $1,716, which is the substantially equal, monthly payment of
principal and interest that will repay the maximum loan amount of
$229,243 over the remaining loan term of 333 months using the fully
indexed rate of 8%. See comments 43(b)(7)-1 and -2 discussing the
calculation of the maximum loan amount, and Sec. 226.43(b)(11) for the
meaning of the term ``recast.''
ii. Fixed-rate, graduated payment mortgage. A loan in the amount of
$200,000 has a 30-year loan term. The loan agreement provides for a
fixed-interest rate of 7.5%, and requires the consumer to make minimum
monthly payments during the first year, with payments increasing 12.5%
every year for four years (the annual payment cap). The payment
schedule provides for payments of $943 in the first year, $1061 in the
second year, $1194 in the third year, $1343 in the fourth year, and
then requires $1511 for the remaining term of the loan. During the
first three years of the loan, the payments are less than the interest
accrued each month, resulting in negative amortization. Assuming the
minimum payments increase year-to-year up to the 12.5% payment cap, the
consumer will begin making payments that cover at least all of the
interest accrued at the end of the third year. Thus, the loan is recast
on the due date of the 36th monthly payment. The maximum loan amount on
that date is $207,659, and the remaining loan term is 27 years (324
months). For purposes of Sec. 226.43(c)(2)(iii), the creditor must
determine the consumer's ability to repay the loan based on a monthly
payment of $1497, which is the substantially equal, monthly payment of
principal and interest that will repay the maximum loan amount of
$207,659 over the remaining loan term of 27 years using the fixed
interest rate of 7.5%.
43(c)(6) Payment calculation for simultaneous loans.
1. Scope. In determining the consumer's repayment ability for a
covered transaction under Sec. 226.43(c)(2)(iii), creditors must
include consideration of any simultaneous loan which it knows, or has
reason to know, will be made at or before consummation of the covered
transaction. For a discussion of the standard ``knows or has reason to
know,'' see comment 43(c)(2)(iv)-2. For the meaning of the term
``simultaneous loan,'' see Sec. 226.43(b)(12).
2. Payment calculation--covered transaction. For a simultaneous
loan that is a covered transaction, as that term is defined under Sec.
226.43(b)(12), a creditor must determine a consumer's ability to repay
the monthly payment obligation for a simultaneous loan as set forth in
Sec. 226.43(c)(5), taking into account any mortgage-related
obligations. For the meaning of the term ``mortgage-related
obligations,'' see Sec. 226.43(b)(8).
3. Payment calculation--home equity line of credit. For a
simultaneous loan that is a home equity line of credit subject to Sec.
226.5b, the creditor must consider the periodic payment required under
the terms of the plan when assessing the consumer's ability to repay
the covered transaction secured by the same dwelling as the
simultaneous loan. Under Sec. 226.43(c)(6)(ii), a creditor must
determine the periodic payment required under the terms of the plan by
considering the actual amount of credit to be drawn by the consumer at
consummation of the covered transaction. The amount to be drawn is the
amount requested by the consumer; when the amount requested will be
disbursed, or actual receipt of funds, is not determinative. For
example, where
[[Page 27498]]
the creditor's policies and procedures require the source of
downpayment to be verified, and the creditor verifies that a
simultaneous loan that is a HELOC will provide the source of
downpayment for the first-lien covered transaction, the creditor must
consider the periodic payment on the HELOC by assuming the amount drawn
is the downpayment amount. In general, a creditor should determine the
periodic payment based on guidance in staff commentary to Sec.
226.5b(d)(5) (discussing payment terms).
43(c)(7) Monthly debt-to-income ratio or residual income.
1. Monthly debt-to-income ratio and monthly residual income. Under
Sec. 226.43(c)(2)(vii), the creditor must consider the consumer's
monthly debt-to-income ratio, or the consumer's monthly residual
income, in accordance with the requirements in Sec. 226.43(c)(7). To
determine the appropriate threshold for the monthly debt-to-income
ratio or the monthly residual income, the creditor may look to widely
accepted governmental and non-governmental underwriting standards.
2. Use of both debt-to-income ratio and monthly residual income. If
a creditor considers both the consumer's monthly debt-to-income ratio
and the residual income, the creditor may base the ability-to-repay
determination on either the consumer's debt-to-income ratio or residual
income, even if the ability-to-repay determination would differ with
the basis used.
3. Compensating factors. The creditor may consider compensating
factors to mitigate a higher debt-to-income ratio or lower residual
income. For example, the creditor may consider the consumer's assets
other than the dwelling securing the covered transaction or the
consumer's residual income as a compensating factor for a higher debt-
to-income ratio. In determining whether and in what manner to consider
compensating factors, creditors may look to widely accepted
governmental and non-governmental underwriting standards.
43(d) Refinancing of non-standard mortgages.
43(d)(1) Scope.
1. Written application. For an explanation of the requirements for
a ``written application'' in Sec. 226.43(d)(1)(iii), (d)(1)(iv) and
(d)(1)(v), see comment 19(a)(1)(i)-3.
Paragraph 43(d)(1)(ii).
1. Materially lower. The exemptions afforded under Sec.
226.43(d)(3) apply to a refinancing only if the monthly payment for the
new loan is ``materially lower'' than the monthly payment for an
existing non-standard mortgage. The payments to be compared must be
calculated based on the requirements under Sec. 226.43(d)(5). Whether
the new loan payment is ``materially lower'' than the non-standard
mortgage payment depends on the facts and circumstances. In all cases,
a payment reduction of 10 percent or more meets the ``materially
lower'' standard.
Paragraph 43(d)(1)(iv).
1. Late payment--24 months prior to application. Under Sec.
226.43(d)(1)(iv), the exemptions in Sec. 226.43(d)(3) apply to a
covered transaction only if, during the 24 months immediately preceding
the creditor's receipt of the consumer's written application for a
refinancing, the consumer has made no more than one payment on the non-
standard mortgage more than 30 days late. (For an explanation of
``written application,'' see comment 43(d)(1)-1.) For example, assume a
consumer applies for a refinancing on May 1, 2011. Assume also that the
consumer made a non-standard mortgage payment on August 15, 2009, that
was 45 days late. The consumer made no other late payments on the non-
standard mortgage between May 1, 2009, and May 1, 2011. In this
example, the requirement under Sec. 226.43(d)(1)(iv) is met because
the consumer made only one payment that was over 30 days late within
the 24 months prior to applying for the refinancing (i.e., 20 and one-
half months prior to application).
2. Payment due date. Whether a payment is more than 30 days late is
measured in relation to the contractual due date not accounting for any
grace period. For example, if the contractual due date for a non-
standard mortgage payment is the first day of every month, but no late
fee will be charged as long as the payment is received by the 16th of
the month, the payment due date for purposes of Sec. 226.43(d)(1)(iv)
and (d)(1)(v) is the first day of the month, not the 16th day of the
month. Thus, a payment due under the contract on September 1st that is
paid on October 1st is made more than 30 days after the payment due
date.
Paragraph 43(d)(1)(v).
1. Late payment--six months prior to application. Under Sec.
226.43(d)(1)(v), the exemptions in Sec. 226.43(d)(3) apply to a
covered transaction only if, during the six months immediately
preceding the creditor's receipt of the consumer's written application
for a refinancing, the consumer has made no payments on the non-
standard mortgage more than 30 days late. (For an explanation of
``written application'' and how to determine the payment due date, see
comments 43(d)(1)-1 and 43(d)(1)(iv)-2.) For example, assume a consumer
with a non-standard mortgage applies for a refinancing on May 1, 2011.
If the consumer made a 45-day late payment on March 15, 2011, the
requirement under Sec. 226.43(d)(1)(v) is not met because the consumer
made a payment more than 30 days late just one and one-half months
prior to application. If the number of months between consummation of
the non-standard mortgage and the consumer's application for the
standard mortgage is six or fewer, the consumer may not have made any
payment more than 30 days late on the non-standard mortgage.
43(d)(2) Definitions.
43(d)(2)(i) Non-standard mortgage.
Paragraph 43(d)(2)(i)(A).
1. Adjustable-rate mortgage with an introductory fixed rate. Under
Sec. 226.43(d)(2)(i)(A), an adjustable-rate mortgage with an
introductory fixed interest rate for one year or longer is considered a
``non-standard mortgage.'' For example, a covered transaction that has
a fixed introductory rate for the first two, three or five years and
then converts to a variable rate for the remaining 28, 27 or 25 years,
respectively, is a ``non-standard mortgage.'' A covered transaction
with an introductory rate for six months that then converts to a
variable rate for the remaining 29 and \1/2\ years is not a ``non-
standard mortgage.''
43(d)(2)(ii) Standard mortgage.
Paragraph 43(d)(2)(ii)(A).
1. Regular periodic payments. Under Sec. 226.43(d)(2)(ii)(A), a
``standard mortgage'' must provide for regular periodic payments that
do not result in an increase of the principal balance (negative
amortization), allow the consumer to defer repayment of principal (see
comment 43(e)(2)(i)-2), or result in a balloon payment. Thus, the terms
of the legal obligation must require the consumer to make payments of
principal and interest on a monthly or other periodic basis that will
repay the loan amount over the loan term. Except for payments resulting
from any interest rate changes after consummation in an adjustable-rate
or step-rate mortgage, the periodic payments must be substantially
equal. For an explanation of the term ``substantially equal,'' see
comment 43(c)(5)(i)-4. In addition, a single-payment transaction is not
a ``standard mortgage'' because it does not require ``regular periodic
payments.'' See also comment 43(e)(2)(i)-1.
Paragraph 43(d)(2)(ii)(D).
1. First five years after consummation. A ``standard mortgage''
must have an interest rate that is fixed for at least the first five
years (60 months) after consummation. For example, assume an
[[Page 27499]]
adjustable-rate mortgage that applies the same fixed interest rate to
determine the first 60 payments of principal and interest due. The loan
consummates on August 15, 2011, and the first monthly payment is due on
October 1, 2011. The first five years after consummation occurs on
August 15, 2016. The first interest rate adjustment occurs on the due
date of the 60th monthly payment, which is September 1, 2016. This loan
meets the criterion for a ``standard mortgage'' under Sec.
226.43(d)(2)(ii)(D) because the interest rate is fixed until September
1, 2016, which is more than five years after consummation. For guidance
regarding step-rate mortgages, see comment 43(e)(2)(iv)-3.iii.
Paragraph 43(d)(2)(ii)(E).
1. Permissible use of proceeds. To qualify as a ``standard
mortgage,'' the mortgage proceeds may be used for only two purposes:
paying off the non-standard mortgage and paying for closing costs,
including paying escrow amounts required at or before closing. If the
proceeds of a covered transaction are used for other purposes, such as
to pay off other liens or to provide additional cash to the consumer
for discretionary spending, the transaction does not meet the
definition of a ``standard mortgage.''
43(d)(3) Exemption from certain repayment ability requirements.
Paragraph 43(d)(3)(i).
1. Two-part determination. To qualify for the exemptions in Sec.
226.43(d)(3), a creditor must have considered, first, whether the
consumer is likely to default on the existing mortgage once that loan
is recast, and second, whether the new mortgage will prevent the
consumer's default.
2. Likely default. In considering whether a consumer is likely to
default on the standard mortgage once it is recast, a creditor may look
to widely-accepted governmental and non-governmental standards for
analyzing a consumer's likelihood of default.
Paragraph 43(d)(3)(ii).
1. Payment calculation for repayment ability requirements. If the
conditions in Sec. 226.43(d)(3)(i) are met, the creditor may meet the
payment calculation requirements for determining a consumer's ability
to repay the new loan by applying the calculation prescribed under
Sec. 226.43(d)(5)(ii), rather than the calculations prescribed under
Sec. 226.43(c)(2)(iii) and (c)(5). For example, assume that a
``standard mortgage'' is an adjustable-rate mortgage that has an
initial fixed interest rate for the first five years after
consummation. The loan consummates on August 15, 2011, and the first
monthly payment is due on October 1, 2011. Five years after
consummation occurs on August 15, 2016. The first interest rate
adjustment occurs on the due date of the 60th monthly payment, which is
September 1, 2016. Under Sec. 226.43(d)(3)(ii), to calculate the
payment required for the ability-to-repay rule under Sec.
226.43(c)(2)(iii), the creditor should use the payment based on the
interest rate that is fixed for the first five years after consummation
(from August 15, 2011, until August 15, 2016), and is not required to
account for the payment resulting after the first interest rate
adjustment on September 1, 2016.
43(d)(5) Payment calculations.
43(d)(5)(i) Non-standard mortgage.
1. Payment calculation for a non-standard mortgage. In determining
whether the monthly periodic payment for a standard mortgage is
materially lower than the monthly periodic payment for the non-standard
mortgage under Sec. 226.43(d)(1)(ii), the creditor must consider the
monthly payment for the non-standard mortgage that will result after
the loan is ``recast,'' assuming substantially equal payments of
principal and interest that amortize the remaining loan amount over the
remaining term as of the date the mortgage is recast. For guidance
regarding the meaning of ``substantially equal,'' see comment
43(c)(5)(i)-4. For the meaning of ``recast,'' see Sec. 226.43(b)(11)
and associated commentary.
2. Fully indexed rate. The term ``fully indexed rate'' in Sec.
226.43(d)(5)(i)(A) for calculating the payment for a non-standard
mortgage is generally defined in Sec. 226.43(b)(3) and associated
commentary. Under Sec. 226.43(b)(3) the fully indexed rate is
calculated at the time of consummation. For purposes of Sec.
226.43(d)(5)(i), however, the fully indexed rate is calculated within a
reasonable period of time before or after the date the creditor
receives the consumer's written application for the standard mortgage.
Thirty days is generally considered ``a reasonable period of time.''
3. Written application. For an explanation of the requirements for
a ``written application'' in Sec. 226.43(d)(5)(i), see comment
19(a)(1)(i)-3.
4. Payment calculation for an adjustable-rate mortgage with an
introductory fixed rate. Under Sec. 226.43(d)(5)(i), the monthly
periodic payment for an adjustable-rate mortgage with an introductory
fixed interest rate for a period of one or more years must be
calculated based on several assumptions.
i. First, the payment must be based on the outstanding principal
balance as of the date on which the mortgage is recast, assuming all
scheduled payments have been made up to that date and the last payment
due under those terms is made and credited on that date. For example,
assume an adjustable-rate mortgage with a 30-year loan term. The loan
agreement provides that the payments for the first 24 months are based
on a fixed rate, after which the interest rate will adjust annually
based on a specified index and margin. The loan is recast on the due
date of the 24th payment. If the 24th payment is due on September 1,
2013, the creditor must calculate the outstanding principal balance as
of September 1, 2013, assuming that all 24 payments under the fixed
rate terms have been made and credited timely.
ii. Second, the payment calculation must be based on substantially
equal monthly payments of principal and interest that will fully repay
the outstanding principal balance over the term of the loan remaining
as of the date the loan is recast. Thus, in the example above, the
creditor must assume a loan term of 28 years (336 payments).
iii. Third, the payment must be based on the fully indexed rate, as
defined in Sec. 226.43(b)(3), as of the date of the written
application for the standard mortgage.
5. Example of payment calculation for an adjustable-rate mortgage
with an introductory fixed rate. The following example illustrates the
rule described in comment 43(d)(5)(i)-4:
i. A loan in an amount of $200,000 has a 30-year loan term. The
loan agreement provides for a discounted introductory interest rate of
5% that is fixed for an initial period of two years, after which the
interest rate will adjust annually based on a specified index plus a
margin of 3 percentage points.
ii. The non-standard mortgage consummates on February 15, 2011, and
the first monthly payment is due on April 1, 2011. The loan is recast
on the due date of the 24th monthly payment, which is March 1, 2013.
iii. On March 15, 2012, the creditor receives the consumer's
written application for a refinancing after the consumer has made 12
monthly on-time payments. On this date, the index value is 4.5%.
iv. To calculate the non-standard mortgage payment that must be
compared to the standard mortgage payment under Sec. 226.43(d)(1)(ii),
the creditor must use--
A. The outstanding principal balance as of March 1, 2013, assuming
all scheduled payments have been made up to March 1, 2013, and the last
payment due under the fixed rate terms is made
[[Page 27500]]
and credited on March 1, 2013. In this example, the outstanding
principal balance is $193,948.
B. The fully indexed rate of 7.5%, which is the index value of 4.5%
as of March 15, 2012 (the date on which the application for a
refinancing is received) plus the margin of 3%.
C. The remaining loan term as of March 1, 2013, the date of the
recast, which is 28 years (336 payments).
v. Based on these assumptions, the monthly payment for the non-
standard mortgage for purposes of determining whether the standard
mortgage monthly payment is lower than the non-standard mortgage
monthly payment (see Sec. 226.43(d)(1)(ii)) is $1,383. This is the
substantially equal, monthly payment of principal and interest required
to repay the outstanding principal balance at the fully-indexed rate
over the remaining term.
6. Payment calculation for an interest-only loan. Under Sec.
226.43(d)(5)(i), the monthly periodic payment for an interest-only loan
must be calculated based on several assumptions.
i. First, the payment must be based on the loan amount, as defined
in Sec. 226.43(b)(5) (for a loan on which only interest and no
principal has been paid, the ``loan amount'' will be the outstanding
principal balance at the time of the recast), assuming all scheduled
payments are made under the terms of the legal obligation in effect
before the mortgage is recast. For example, assume that a mortgage has
a 30-year loan term, and provides that the first 24 months of payments
are interest-only. If the 24th payment is due on September 1, 2013, the
creditor must calculate the outstanding principal balance as of
September 1, 2013, assuming that all 24 payments under the interest-
only payment terms have been made and credited timely.
ii. Second, the payment calculation must be based on substantially
equal monthly payments of principal and interest that will fully repay
the loan amount over the term of the loan remaining as of the date the
loan is recast. Thus, in the example above, the creditor must assume a
loan term of 28 years (336 payments).
iii. Third, the payment must be based on the fully indexed rate, as
defined in Sec. 226.43(b)(3), as of the date of the written
application for the standard mortgage.
7. Example of payment calculation for an interest-only loan. The
following example illustrates the rule described in comment
43(d)(5)(i)-6:
i. A loan in an amount of $200,000 has a 30-year loan term. The
loan agreement provides for a fixed interest rate of 7%, and permits
interest-only payments for the first two years (the first 24 payments),
after which time amortizing payments of principal and interest are
required.
ii. The non-standard mortgage consummates on February 15, 2011, and
the first monthly payment is due on April 1, 2011. The loan is recast
on the due date of the 24th monthly payment, which is March 1, 2013.
iii. On March 15, 2012, the creditor receives the consumer's
written application for a refinancing, after the consumer has made 12
monthly on-time payments.
iv. To calculate the non-standard mortgage payment that must be
compared to the standard mortgage payment under Sec. 226.43(d)(1)(ii),
the creditor must use--
A. The loan amount, which is the outstanding principal balance as
of March 1, 2013, assuming all scheduled interest-only payments have
been made and credited up to that date. In this example, the loan
amount is $200,000.
B. An interest rate of 7%, which is the interest rate in effect at
the time of consummation of this fixed-rate non-standard mortgage.
C. The remaining loan term as of March 1, 2013, the date of the
recast, which is 28 years (336 payments).
v. Based on these assumptions, the monthly payment for the non-
standard mortgage for purposes of determining whether the standard
mortgage monthly payment is lower than the non-standard mortgage
monthly payment (see Sec. 226.43(d)(1)(ii)) is $1,359. This is the
substantially equal, monthly payment of principal and interest required
to repay the loan amount at the fully-indexed rate over the remaining
term.
8. Payment calculation for a negative amortization loan. Under
Sec. 226.43(d)(5)(i), the monthly periodic payment for a negative
amortization loan must be calculated based on several assumptions.
i. First, the calculation must be based on the maximum loan amount,
as defined in Sec. 226.43(b)(7). For examples of how to calculate the
maximum loan amount, see comment 43(b)(7)-3.
ii. Second, the calculation must be based on substantially equal
monthly payments of principal and interest that will fully repay the
maximum loan amount over the term of the loan remaining as of the date
the loan is recast. For example, if the loan term is 30 years and the
loan is recast on the due date of the 60th monthly payment, the
creditor must assume a loan term of 25 years (300 payments).
iii. Third, the payment must be based on the fully-indexed rate as
of the date of the written application for the standard mortgage.
9. Example of payment calculation for a negative amortization loan.
The following example illustrates the rule described in comment
43(d)(5)(i)-8:
i. A loan in an amount of $200,000 has a 30-year loan term. The
loan agreement provides that the consumer can make minimum monthly
payments that cover only part of the interest accrued each month until
the date on which the principal balance increases to the negative
amortization cap of 115% of the loan amount, or for the first five
years of monthly payments (60 payments), whichever occurs first. The
loan is an adjustable-rate mortgage that adjusts monthly according to a
specified index plus a margin of 3.5%.
ii. The non-standard mortgage consummates on February 15, 2011, and
the first monthly payment is due on April 1, 2011. Assume that, based
on the calculation of the maximum loan amount required under Sec.
226.43(b)(7) and associated commentary, the negative amortization cap
of 115% would be reached on July 1, 2013, the due date of the 28th
monthly payment.
iii. On March 15, 2012, the creditor receives the consumer's
written application for a refinancing, after the consumer has made 12
monthly on-time payments. On this date, the index value is 4.5%.
iv. To calculate the non-standard mortgage payment that must be
compared to the standard mortgage payment under Sec. 226.43(d)(1)(ii),
the creditor must use--
A. The maximum loan amount of $229,243 as of July 1, 2013.
B. The fully indexed rate of 8%, which is the index value of 4.5%
as of March 15, 2012 (the date on which the creditor receives the
application for a refinancing) plus the margin of 3.5%.
C. The remaining loan term as of July 1, 2013, the date of the
recast, which is 27 years and eight months (332 monthly payments).
v. Based on these assumptions, the monthly payment for the non-
standard mortgage for purposes of determining whether the standard
mortgage monthly payment is lower than the non-standard mortgage
monthly payment (see Sec. 226.43(d)(1)(ii)) is $1,717. This is the
substantially equal, monthly payment of principal and interest required
to repay the maximum loan amount at the fully-indexed rate over the
remaining term.
43(d)(5)(ii) Standard mortgage.
1. Payment calculation for a standard mortgage. In determining
whether the monthly periodic payment for a standard mortgage is
materially lower than the monthly periodic payment for
[[Page 27501]]
a non-standard mortgage, the creditor must consider the monthly payment
for the standard mortgage that will result in substantially equal,
monthly, fully amortizing payments (as defined in Sec. 226.43(b)(2))
using the rate as of consummation. For guidance regarding the meaning
of ``substantially equal'' see comment 43(c)(5)(i)-4. For a mortgage
with a single, fixed rate for the first five years, the maximum rate
that will apply during the first five years after consummation will be
the rate at consummation. For a step-rate mortgage, however, which is a
type of fixed-rate mortgage, the rate that must be used is the highest
rate that will apply during the first five years after consummation.
For example, if the rate for the first two years is 4%, the rate for
the second two years is 5%, and the rate for the next two years is 6%,
the rate that must be used is 6%.
2. Example of payment calculation for a standard mortgage. The
following example illustrates the rule described in comment
43(d)(5)(ii)-1: A loan in an amount of $200,000 has a 30-year loan
term. The loan agreement provides for a discounted interest rate of 6%
that is fixed for an initial period of five years, after which time the
interest rate will adjust annually based on a specified index plus a
margin of 3%, subject to a 2% annual interest rate adjustment cap. The
creditor must determine whether the standard mortgage monthly payment
is materially lower than the non-standard mortgage monthly payment (see
Sec. 226.43(d)(1)(ii)) based on a standard mortgage payment of $1,199.
This is the substantially equal, monthly payment of principal and
interest required to repay $200,000 over 30 years at an interest rate
of 6%.
43(e) Presumption of compliance for qualified mortgages.
Alternative 1--Paragraph 43(e)(1)-1
43(e)(1) Safe harbor.
1. In general. A creditor or assignee that satisfies the
requirements of Sec. 226.43(e)(2) or Sec. 226.43(f), as applicable,
is deemed to have complied with Sec. 226.43(c)(1). That is, a creditor
or assignee need not demonstrate compliance with Sec. 226.43(c)(2)-(7)
if the terms of the loan comply with Sec. 226.43(e)(2)(i)-(ii) (or, if
applicable, Sec. 226.43(f)); the loan's points and fees do not exceed
the limits set forth in Sec. 226.43(e)(2)(iii); and the creditor has
complied with the underwriting criteria described in Sec.
226.43(e)(2)(iv)-(v) (or, if applicable, Sec. 226.43(f)). The consumer
may show the loan is not a qualified mortgage with evidence that the
terms, points and fees, or underwriting did not comply with Sec.
226.43(e)(2)(i)-(v) (or Sec. [thn x sp]226.43(f), if
applicable). If a loan is not a qualified mortgage (for example because
the loan provides for negative amortization), then the creditor or
assignee must demonstrate that the loan complies with all of the
requirements in Sec. 226.43(c) (or, if applicable, Sec. 226.43(d)).
Alternative 2--Paragraph 43(e)(1)-1
43(e)(1) Presumption of compliance.
1. In general. Under Sec. 226.43(c)(1), a creditor must make a
reasonable and good faith determination at or before consummation that
the consumer will have a reasonable ability, at the time of
consummation, to repay the loan according to its terms, including any
mortgage-related obligations. Under Sec. 226.43(e)(1), a creditor or
assignee of a covered transaction is presumed to have complied with the
repayment ability requirement of Sec. 226.43(c)(1) if the terms of the
loan comply with Sec. 226.43(e)(2)(i)-(ii) (or, if applicable, Sec.
226.43(f)); the points and fees do not exceed the limit set forth in
Sec. 226.43(e)(2)(iii), and the creditor has complied with the
underwriting criteria described in Sec. 226.43(e)(2)(iv)-(v) (or, if
applicable, Sec. 226.43(f)). If a loan is not a qualified mortgage
(for example because the loan provides for negative amortization), then
the creditor or assignee must demonstrate that the loan complies with
all of the requirements in Sec. 226.43(c) (or, if applicable, Sec.
226.43(d)). However, even if the loan is a qualified mortgage, the
consumer may rebut the presumption of compliance with evidence that the
loan did not comply with Sec. 226.43(c)(1). For example, evidence of a
high debt-to-income ratio with no compensating factors, such as
adequate residual income, could be sufficient to rebut the presumption.
43(e)(2) Qualified mortgage defined.
Paragraph 43(e)(2)(i).
1. Regular periodic payments. Under Sec. 226.43(e)(2)(i), a
qualified mortgage must provide for regular periodic payments that may
not result in an increase of the principal balance (negative
amortization), deferral of principal repayment, or a balloon payment.
Thus, the terms of the legal obligation must require the consumer to
make payments of principal and interest, on a monthly or other periodic
basis, that will fully repay the loan amount over the loan term. The
periodic payments must be substantially equal except for the effect
that any interest rate change after consummation has on the payment in
the case of an adjustable-rate or step-rate mortgage. In addition,
because Sec. 226.43(e)(2)(i) requires that a qualified mortgage
provide for regular periodic payments, a single-payment transaction may
not be a qualified mortgage.
2. Deferral of principal repayment. Under Sec. 226.43(e)(2)(i)(B),
a qualified mortgage's regular periodic payments may not allow the
consumer to defer repayment of principal, except as provided in Sec.
226.43(f). A loan allows the deferral of principal repayment if one or
more of the periodic payments may be applied solely to accrued interest
and not to loan principal. Deferred principal repayment also occurs if
the payment is applied to both accrued interest and principal but the
consumer is permitted to make periodic payments that are less than the
amount that would be required under a payment schedule that has
substantially equal payments that fully repay the loan amount over the
loan term. Graduated payment mortgages, for example, allow deferral of
principal repayment in this manner and therefore may not be qualified
mortgages.
Paragraph 43(e)(2)(iv).
1. Maximum interest rate during the first five years after
consummation. For a qualified mortgage, the creditor must underwrite
the loan using a periodic payment of principal and interest based on
the maximum interest rate that may apply during the first five years
after consummation. Creditors must use the maximum rate that could
apply at any time during the first five years after consummation,
regardless of whether the maximum rate is reached at the first or
subsequent adjustment during the five year period.
2. Fixed-rate mortgage. For a fixed-rate mortgage, creditors should
use the interest rate in effect at consummation. ``Fixed-rate
mortgage'' is defined in Sec. 226.18(s)(7)(iii).
3. Interest rate adjustment caps. For an adjustable-rate mortgage,
creditors should assume the interest rate increases after consummation
as rapidly as possible, taking into account the terms of the legal
obligation. That is, creditors should account for any periodic interest
rate adjustment cap that may limit how quickly the interest rate can
increase under the terms of the legal obligation. Where a range for the
maximum interest rate during the first five years is provided, the
highest rate in that range is the maximum interest rate for purposes of
this section. Where the terms of the legal obligation are not based on
an index plus margin or formula, the creditor must use the maximum
interest rate that occurs during the first five years after
consummation. To illustrate:
i. Adjustable-rate mortgage with discount for three years. Assume
an
[[Page 27502]]
adjustable-rate mortgage has an initial discounted rate of 5% that is
fixed for the first three years of the loan, after which the rate will
adjust annually based on a specified index plus a margin of 3%. The
index value in effect at consummation is 4.5%. The loan agreement
provides for an annual interest rate adjustment cap of 2%, and a
lifetime maximum interest rate of 10%. The first rate adjustment occurs
on the due date of the 36th monthly payment; the rate can adjust to no
more than 7% (5% initial discounted rate plus 2% annual interest rate
adjustment cap). The second rate adjustment occurs on the due date of
the 48th monthly payment; the rate can adjust to no more than 9% (7%
rate plus 2% annual interest rate adjustment cap). The third rate
adjustment occurs on the due date of the 60th monthly payment, which
occurs more than five years after consummation. The maximum interest
rate during the first five years after consummation is 9% (the rate on
the due date of the 48th monthly payment). For further discussion of
how to determine whether a rate adjustment occurs during the first five
years after consummation, see comment 43(e)(2)(iv)-2.
ii. Adjustable-rate mortgage with discount for three years. Assume
the same facts above except that the lifetime maximum interest rate is
8%, which is less than the maximum interest rate in the first five
years of 9%. The maximum interest rate during the first five years
after consummation is 8%.
iii. Step-rate mortgage. Assume a step-rate mortgage with an
interest rate fixed at 6.5% for the first two years, 7% for the next
three years, and then 7.5% for remainder of the loan term. The maximum
interest rate during the first five years after consummation is 7%.
4. First five years after consummation. Under Sec.
226.43(e)(2)(iv)(A), the creditor must underwrite the loan using the
maximum interest rate that may apply during the first five years after
consummation. To illustrate, assume an adjustable-rate mortgage with an
initial fixed interest rate of 5% for the first five years after
consummation, after which the interest rate will adjust annually to the
specified index plus a margin of 6%, subject to a 2% annual interest
rate adjustment cap. The index value in effect at consummation is 5.5%.
The loan consummates on September 15, 2011, and the first monthly
payment is due on November 1, 2011. The first five years after
consummation occurs on September 15, 2016. The first rate adjustment to
no more than 7% (5% plus 2% annual interest rate adjustment cap) occurs
on the due date of the 60th monthly payment, which is October 1, 2016,
and therefore, the rate adjustment does not occur during the first five
years after consummation. To meet the definition of qualified mortgage
under Sec. 226.43(e)(2), the creditor must underwrite the loan using a
monthly payment of principal and interest based on an interest rate of
5%, which is the maximum interest rate during the first five years
after consummation.
5. Loan amount. To meet the definition of qualified mortgage under
Sec. 226.43(e)(2), a creditor must determine the periodic payment of
principal and interest using the maximum interest rate permitted during
the first five years after consummation that repays either--
i. The outstanding principal balance as of the earliest date the
maximum interest rate during the first five years after consummation
can take effect under the terms of the legal obligation, over the
remaining term of the loan. To illustrate, assume a loan in an amount
of $200,000 has a 30-year loan term. The loan agreement provides for a
discounted interest rate of 5% that is fixed for an initial period of
three years, after which the interest rate will adjust annually based
on a specified index plus a margin of 3%, subject to a 2% annual
interest rate adjustment cap and a lifetime maximum interest rate of
10%. The index value in effect at consummation equals 4.5%. Assuming
the interest rate increases after consummation as quickly as possible,
the rate adjustment to the maximum interest rate of 9% occurs on the
due date of the 48th monthly payment. The outstanding principal balance
on the loan at the end of the fourth year (after the 48th monthly
payment is credited) is $188,218. The creditor will meet the definition
of qualified mortgage if it underwrites the covered transaction using
the monthly payment of principal and interest of $1,564 to repay the
outstanding principal balance of $188,218 over the remaining 26 years
of the loan term (312 months) using the maximum interest rate during
the first five years of 9%; or
ii. The loan amount, as that term is defined in Sec. 226.43(b)(5),
over the entire loan term, as that term is defined in Sec.
226.43(b)(6). Using the same example above, the creditor will meet the
definition of qualified mortgage if it underwrites the covered
transaction using the monthly payment of principal and interest of
$1,609 to repay the loan amount of $200,000 over the 30-year loan term
using the maximum interest rate during the first five years of 9%.
6. Mortgage-related obligations. Section 226.43(e)(2)(iv) requires
creditors to take mortgage-related obligations into account when
underwriting the loan. For the meaning of the term ``mortgage-related
obligations,'' see Sec. 226.43(b)(8) and associated commentary.
7. Examples. The following are examples of how to determine the
periodic payment of principal and interest based on the maximum
interest rate during the first five years after consummation for
purposes of meeting the definition of qualified mortgage under Sec.
226.43(e) (all payment amounts are rounded):
i. Fixed-rate mortgage. A loan in an amount of $200,000 has a 30-
year loan term and a fixed interest rate of 7%. The maximum interest
rate during the first five years after consummation for a fixed-rate
mortgage is the interest rate in effect at consummation, which is 7%
under this example. The monthly fully amortizing payment scheduled over
the 30 years is $1,331. The creditor will meet the definition of
qualified mortgage if it underwrites the loan using the fully
amortizing payment of $1,331.
ii. Adjustable-rate mortgage with discount for three years.
A. A loan in an amount of $200,000 has a 30-year loan term. The
loan agreement provides for a discounted interest rate of 5% that is
fixed for an initial period of three years, after which the interest
rate will adjust annually based on a specified index plus a margin of
3%, subject to a 2% annual interest rate adjustment cap. The index
value in effect at consummation is 4.5%. The loan consummates on March
15, 2011, and the first regular periodic payment is due May 1, 2011.
The loan agreement provides that the first rate adjustment occurs on
April 1, 2014 (the due date of the 36th monthly payment); the second
rate adjustment occurs on April 1, 2015 (the due date of the 48th
monthly payment); and the third rate adjustment occurs on April 1, 2016
(the due date of the 60th monthly payment), which occurs more than five
years after consummation of the loan. Under this example, the maximum
interest rate during the first five years after consummation is 9%,
which applies beginning on April 1, 2015 (the due date of the 48th
monthly payment). The outstanding principal balance at the end of the
fourth year (after the 48th payment is credited) is $188,218.
B. The creditor will meet the definition of a qualified mortgage if
it underwrites the loan using the monthly payment of principal and
interest of $1,564 to repay the outstanding principal balance at the
end of the fourth year of $188,218 over the remaining 26 years of the
loan term (312 months), using the maximum interest
[[Page 27503]]
rate during the first five years after consummation of 9%.
Alternatively, the creditor will meet the definition of a qualified
mortgage if it underwrites the loan using the monthly payment of
principal and interest of $1,609 to repay the loan amount of $200,000
over the 30-year loan term, using the maximum interest rate during the
first five years after consummation of 9%.
iii. Adjustable-rate mortgage with discount for five years.
A. A loan in an amount of $200,000 has a 30-year loan term. The
loan agreement provides for a discounted interest rate of 6% that is
fixed for an initial period of five years, after which the interest
rate will adjust annually based on a specified index plus a margin of
3%, subject to a 2% annual interest rate adjustment cap. The index
value in effect at consummation is 4.5%. The loan consummates on March
15, 2011 and the first regular periodic payment is due May 1, 2011.
Under the terms of the loan agreement, the first rate adjustment is on
April 1, 2016 (the due date of the 60th monthly payment), which occurs
more than five years after consummation of the loan. Thus, the maximum
interest rate under the terms of the loan during the first five years
after consummation is 6%.
B. The creditor will meet the definition of a qualified mortgage if
it underwrites the loan using the monthly payment of principal and
interest of $1,199 to repay the loan amount of $200,000 over the 30-
year loan term using the maximum interest rate during the first five
years of 6%.
iv. Step-rate mortgage. A. A loan in an amount of $200,000 has a
30-year loan term. The loan agreement provides that the interest rate
is 6.5% for the first two years of the loan, 7% for the next three
years, and then 7.5% for remainder of the loan term. The maximum
interest rate during the first five years after consummation is 7%,
which occurs on the due date of the 24th monthly payment. The
outstanding principal balance at the end of the second year (after the
24th payment is credited) is $195,379.
B. The creditor will meet the definition of a qualified mortgage if
it underwrites the loan using a monthly payment of principal and
interest of $1,328 to repay the outstanding principal balance of
$195,379 over the remaining 28 years of the loan term (336 months),
using the maximum interest rate during the first five years of 7%.
Alternatively, the creditor will meet the definition of a qualified
mortgage if it underwrites the loan using a monthly payment of
principal and interest of $1,331 to repay $200,000 over the 30-year
loan term using the maximum interest rate during the first five years
of 7%.
Alternative 1--Paragraph 43(e)(2)(v)
Paragraph 43(e)(2)(v).
1. Income or assets. Creditors may rely on commentary to Sec.
226.43(c)(2)(i), (c)(3), and (c)(4) for guidance regarding considering
and verifying the consumer's income or assets to satisfy the conditions
under Sec. 226.43(e)(2)(v) for a ``qualified mortgage.''
Alternative 2--Paragraph 43(e)(2)(v)
Paragraph 43(e)(2)(v).
1. Repayment ability. Creditors may rely on commentary to Sec.
226.43(c)(2)(i), (ii), (iv), and (vi) through (viii), (c)(3), (c)(4),
(c)(6), and (c)(7) for guidance regarding considering and verifying the
consumer's repayment ability to satisfy the conditions under Sec.
226.43(e)(2)(v) for a ``qualified mortgage.''
43(e)(3) Limits on points and fees for qualified mortgages.
Paragraph 43(e)(3)(i).
1. Total loan amount. For an explanation of how to calculate the
``total loan amount'' under Sec. 226.43(e)(3)(i), see comment
32(a)(1)(ii)-1.
2. Calculation of allowable points and fees. A creditor must
determine which category the loan falls into based on the face amount
of the note (the ``loan amount''), but must apply the allowable points
and fees percentage to the ``total loan amount,'' which may be
different than the face amount of the note. A creditor must calculate
the allowable amount of points and fees for a qualified mortgage as
follows:
i. First, the creditor must determine the ``tier'' into which the
loan falls based on the loan amount. The loan amount is the principal
amount the consumer will borrow as reflected in the promissory note or
loan contract. See Sec. 226.43(b)(5). For example, if the loan amount
is $75,000, the loan falls into the tier for loans of $75,000 or more,
to which a three percent cap on points and fees applies.
ii. Second, the creditor must determine the ``total loan amount''
based on the calculation for the ``total loan amount'' under comment
32(a)(1)(ii)-1. If the loan amount is $75,000, for example, the ``total
loan amount'' may be a different amount, such as $73,000.
iii. Third, the creditor must apply the percentage cap on points
and fees to the ``total loan amount.'' For example, for a loan of
$75,000 where the ``total loan amount'' is $73,000, the allowable
points and fees is three percent of $73,000 or $2,190.
Alternative 1--Comment 43(e)(3)(i)-3
3. Sample determination of allowable points and fees for a $50,000
loan. A covered transaction with a loan amount of $50,000 falls into
the third points and fees tier, to which a points and fees cap of 3.5
percent of the total loan amount applies. See Sec. 226.43(e)(3)(i)(C).
If a $48,000 total loan amount is assumed, the allowable points and
fees for this $50,000 loan is 3.5 percent of $48,000 or $1,920.
Alternative 2--Comment 43(e)(3)(i)-3
3. Sample determination of allowable points and fees for a $50,000
loan. A covered transaction with a loan amount of $50,000 falls into
the second points and fees tier, requiring application of a formula to
derive the allowable points and fees. See Sec. 226.43(e)(3)(i)(B). If
a $48,000 total loan amount is assumed, the required formula must be
applied as follows:
i. First, the amount of $20,000 must be subtracted from $48,000 to
yield the number of dollars to which the .0036 basis points multiple
must be applied--in this case, $28,000.
ii. Second, $28,000 must be multiplied by .0036--in this case
resulting in 100.8.
iii. Third, 100.8 must be subtracted from 500. (The maximum
allowable points and fees on any loan is five percent of the total loan
amount for loans of less than $20,000. Five percent expressed in basis
points is 500). Five hundred minus 100.8 equals 399.2, which is the
allowable points and fees in basis points.
iv. Finally, the allowable points and fees in basis points must be
translated into the appropriate percentage of the ``total loan
amount,'' which is achieved by multiplying 399.2 by .01. The result is
3.99 percent. Accordingly, the allowable points and fees for this
$50,000 loan as a dollar figure is 3.99 percent of $48,000 or
$1,915.20.
Paragraph 43(e)(3)(ii).
1. Charges not retained by the creditor, loan originator, or an
affiliate of either. In general, a creditor is not required to count in
``points and fees'' for a qualified mortgage any bona fide third party
charge not retained by the creditor, loan originator, or an affiliate
of either. For example, if a creditor charges a consumer $400 for an
appraisal conducted by a third party not affiliated with the creditor,
pays the third party appraiser $300 for the appraisal, and retains
$100, the creditor may exclude $300 of this fee but count the $100 it
retains in ``points and fees'' for a qualified mortgage.
2. Private mortgage insurance. For qualified mortgages, the
exclusion for
[[Page 27504]]
bona fide third party charges not retained by the creditor, loan
originator, or an affiliate of either is limited by Sec.
226.32(b)(1)(i)(B) in the general definition of ``points and fees.''
Section 226.32(b)(1)(i)(B) requires inclusion in ``points and fees'' of
premiums or other charges payable at or before closing for any private
guaranty or insurance protecting the creditor against the consumer's
default or other credit loss to the extent that the premium or charge
exceeds the amount payable under policies in effect at the time of
origination under section 203(c)(2)(A) of the National Housing Act (12
U.S.C. 1709(c)(2)(A)). These premiums or charges must also be included
if the premiums or charges are not required to be refundable on a pro-
rated basis, or the refund is not required to be automatically issued
upon notification of the satisfaction of the underlying mortgage loan.
Under these circumstances, even if the premiums or other charges are
not retained by the creditor, loan originator, or an affiliate of
either, they must be included in the ``points and fees'' calculation
for qualified mortgages. See comments 32(b)(1)(i)-3 and -4 for further
discussion of including upfront private mortgage insurance premiums in
the points and fees calculation.
3. Exclusion of up to two bona fide discount points. Section
226.43(e)(3)(ii)(B) provides that, under certain circumstances, up to
two ``bona fide discount points,'' as defined in Sec.
226.43(e)(3)(iii), may be excluded from the ``points and fees''
calculation for a qualified mortgage. The following example illustrates
the rule:
i. Assume a covered transaction that is a first-lien, purchase
money home mortgage with a fixed interest rate and a 30-year term.
Assume also that the consumer locks in an interest rate of 6.00 percent
on May 1, 2011, that was discounted from a rate of 6.50 percent because
the consumer paid two discount points. Finally, assume that the average
prime offer rate (APOR) as of May 1, 2011 for home mortgages with a
fixed interest rate and a 30-year term is 5.50 percent.
ii. The creditor may exclude two discount points from the ``points
and fees'' calculation because the rate from which the discounted rate
was derived (6.50 percent) exceeded APOR for a comparable transaction
as of the date the rate on the covered transaction was set (5.25
percent) by only one percent. For the meaning of ``comparable
transaction,'' refer to comment 43(e)(3)(ii)-5.
4. Exclusion of up to one bona fide discount point. Section
226.43(e)(3)(ii)(C) provides that, under certain circumstances, up to
one ``bona fide discount point,'' as defined in Sec.
226.43(e)(3)(iii), may be excluded from the ``points and fees''
calculation for a qualified mortgage. The following example illustrates
the rule:
i. Assume a covered transaction that is a first-lien, purchase
money home mortgage with a fixed interest rate and a 30-year term.
Assume also that the consumer locks in an interest rate of 6.00 percent
on May 1, 2011, that was discounted from a rate of 7.00 percent because
the consumer paid four discount points. Finally, assume that the
average prime offer rate (APOR) as of May 1, 2011, for home mortgages
with a fixed interest rate and a 30-year term is 5.00 percent.
ii. The creditor may exclude one discount point from the ``points
and fees'' calculation because the rate from which the discounted rate
was derived (7.00 percent) exceeded APOR for a comparable transaction
as of the date the rate on the covered transaction was set (5.00
percent) by only two percent.
5. Comparable transaction. The table of average prime offer rates
published by the Board indicates how to identify the comparable
transaction. See comment 45(a)(2)(ii)-2.
43(f) Balloon-payment qualified mortgages made by certain
creditors.
43(f)(1) Exception.
Paragraph 43(f)(1)(i).
1. Satisfaction of qualified mortgage requirements. Under Sec.
226.43(f)(1)(i), a qualified mortgage that provides for a balloon
payment must satisfy all of the requirements for a qualified mortgage
in Sec. 226.43(e)(2), other than Sec. 226.43(e)(2)(i)(B),
(e)(2)(i)(C), and (e)(2)(iv). Therefore, to satisfy this condition, a
covered transaction with balloon payment terms must provide for regular
periodic payments that do not result in an increase of the principal
balance, pursuant to Sec. 226.43(e)(2)(i)(A); must have a loan term
that does not exceed 30 years, pursuant to Sec. 226.43(e)(2)(ii); must
have total points and fees that do not exceed specified thresholds
pursuant to Sec. 226.43(e)(2)(iii); and must satisfy the consideration
and verification requirements in Sec. 226.43(e)(2)(v).
Paragraph 43(f)(1)(ii).
1. Example. Under Sec. 226.43(f)(1)(ii), if a qualified mortgage
provides for a balloon payment, the creditor must determine that the
consumer is able to make all scheduled payments under the legal
obligation other than the balloon payment. For example, assume a loan
in an amount of $200,000 that has a five-year loan term, but is
amortized over 30 years. The loan agreement provides for a fixed
interest rate of 6%. The loan consummates on March 15, 2011, and the
monthly payment of principal and interest scheduled for the first five
years is $1,199, with the first monthly payment due on May 1, 2011. The
balloon payment of $187,308 is required on the due date of the 60th
monthly payment, which is April 1, 2016. The loan remains a qualified
mortgage if the creditor underwrites the loan using the scheduled
principal and interest payment of $1,199 (plus all mortgage-related
obligations, pursuant to Sec. 226.43(f)(1)(iii)(B)).
2. Creditor's determination. A creditor must determine that the
consumer is able to make all scheduled payments other than the balloon
payment to satisfy Sec. 226.43(f)(1)(ii), but the creditor is not
required to meet the repayment ability requirements of Sec.
226.43(c)(2)-(7) because those requirements apply only to covered
transactions that are not qualified mortgages. Nevertheless, a creditor
satisfies Sec. 226.43(f)(1)(ii) if it complies with the requirements
of Sec. 226.43(c)(2)-(7). A creditor also may make the determination
that the consumer is able to make the scheduled payments (other than
the balloon payment) by other means. For example, a creditor need not
determine that the consumer is able to make the scheduled payments
based on a payment amount that is calculated in accordance with Sec.
226.43(c)(5)(ii)(A) or may choose to consider a debt-to-income ratio
that is not determined in accordance with Sec. 226.43(c)(7).
Paragraph 43(f)(1)(iii).
1. Amortization period. Under Sec. 226.43(f)(1)(ii), if a
qualified mortgage provides for a balloon payment, the creditor must
determine that the consumer is able to make all scheduled payments
under the legal obligation other than the balloon payment. Under Sec.
226.43(f)(1)(iii), those scheduled payments must be determined using an
amortization period that does not exceed 30 years and must include all
mortgage-related obligations. Balloon payments often result when the
periodic payment would fully repay the loan amount only if made over
some period that is longer than the loan term. For example, a loan term
of 10 years with periodic payments based on an amortization period of
20 years would result in a balloon payment being due at the end of the
loan term. Whatever the loan term, the amortization period used to
determine the scheduled periodic payments that the consumer must pay
under the terms of the legal obligation may not exceed 30 years.
Paragraph 43(f)(1)(v).
[[Page 27505]]
1. Creditor qualifications. Under Sec. 226.43(f)(1)(v), to make a
qualified mortgage that provides for a balloon payment, the creditor
must satisfy the following four criteria:
i. During the preceding calendar year, the creditor extended over
50% of its total covered transactions with balloon payment terms in
counties that are ``rural'' or ``underserved,'' as defined in Sec.
226.43(f)(2). Pursuant to that section, the Board determines annually
which counties in the United States are rural or underserved and
publishes on its public Web site a list of those counties to enable
creditors to determine whether they meet this criterion. Thus, for
example, if a creditor originated 90 covered transactions with balloon
payment terms during 2010, the creditor meets this element of the
exception in 2011 if at least 46 of those loans are secured by
properties located in one or more counties that are on the Board's list
for 2010.
Alternative 1--Paragraph 43(f)(1)(v)-1.ii
ii. During the preceding calendar year, the creditor together with
all affiliates extended covered transactions with principal amounts
that in the aggregate total $-------- or less.
Alternative 2--Paragraph 43(f)(1)(v)-1.ii
ii. During the preceding calendar year, the creditor together with
all affiliates extended ------ or fewer covered transactions.
Alternative 1--Paragraph 43(f)(1)(v)-1.iii
iii. On and after [effective date of final rule], the creditor has
not sold, assigned, or otherwise transferred legal title to the debt
obligation for any covered transaction with a balloon-payment term.
Alternative 2--Paragraph 43(f)(1)(v)-1.iii
iii. During the preceding or current calendar year, the creditor
has not sold, assigned, or otherwise transferred legal title to the
debt obligation for any covered transaction with a balloon-payment
term. Thus, for example, if a creditor sells a covered transaction with
a balloon-payment term on April 1, 2012, the creditor becomes
ineligible for the exception for the remainder of 2012 (but not
retroactively for January through March of 2012) and all of 2013. If
the creditor sells no covered transactions with balloon-payment terms
during 2013, it then may become eligible again for the exception
beginning on January 1, 2014 and remains eligible until and unless it
sells such loans during 2014.
iv. As of the end of the preceding calendar year, the creditor had
total assets that do not exceed the current asset threshold established
by the Board. For calendar year 2011, the asset threshold is
$2,000,000,000. Creditors that had total assets of $2,000,000,000 or
less on December 31, 2010 satisfy this criterion for purposes of the
exception during 2011.
43(f)(2) ``Rural'' and ``underserved'' defined.
1. Requirements for ``rural or underserved'' status. A county is
considered ``rural or underserved'' for purposes of Sec.
226.43(f)(1)(v)(A) if it satisfies either of the two tests in Sec.
226.43(f)(2). The Board applies both tests to each county in the United
States and, if a county satisfies either test, includes that county on
the annual list of ``rural or underserved'' counties. The Board
publishes on its public Web site the applicable list for each calendar
year by the end of that year. A creditor's originations of covered
transactions with balloon-payment terms in such counties during that
year are considered in determining whether the creditor satisfies the
condition in Sec. 226.43(f)(1)(v)(A) and therefore will be eligible
for the exception during the following calendar year. The Board
determines whether each county is ``rural'' by reference to the
currently applicable Urban Influence Codes (UICs), established by the
United States Department of Agriculture's Economic Research Service
(USDA-ERS). Specifically, the Board classifies a county as ``rural'' if
the USDA-ERS categorizes the county under UIC 7, 10, 11, or 12. The
Board determines whether each county is ``underserved'' by reference to
data submitted by mortgage lenders under the Home Mortgage Disclosure
Act (HMDA).
43(g) Prepayment penalties.
43(g)(2) Limits on prepayment penalties.
1. Maximum period and amount. Section 226.43(g)(2) establishes the
maximum period during which a prepayment penalty may be imposed and the
maximum amount of the prepayment penalty. A covered transaction may
include a prepayment penalty that may be imposed during a shorter
period or in a lower amount than provided under Sec. 226.43(g)(2). For
example, a covered transaction may include a prepayment penalty that
may be imposed for two years after consummation and equals two percent
of the amount prepaid in each of those two years.
43(g)(3) Alternative offer required.
Paragraph 43(g)(3)(i).
1. Same type of interest rate. Under Sec. 226.43(g)(3)(i), if a
creditor offers a consumer a covered transaction with a prepayment
penalty, the creditor must offer the consumer an alternative covered
transaction without a prepayment penalty and with an annual percentage
rate that cannot increase after consummation. Further, the covered
transaction with a prepayment penalty and the alternative covered
transaction without a prepayment penalty must both be fixed-rate
mortgages or both be step-rate mortgages, as defined in Sec.
226.18(s)(7)(iii) and (ii), respectively.
Paragraph 43(g)(3)(iv).
1. Points and fees. Whether or not an alternative covered
transaction without a prepayment penalty satisfies the points and fees
conditions for a qualified mortgage is determined based on the
information known to the creditor at the time the creditor offers the
consumer the transaction. At the time a creditor offers a consumer an
alternative covered transaction without a prepayment penalty under
Sec. 226.43(g)(3), the creditor may know the amount of some, but not
all, of the points and fees that will be charged for the transaction.
For example, a creditor may not know that a consumer intends to buy
single-premium credit unemployment insurance, which would be included
in the points and fees for the covered transaction. The points and fees
condition under Sec. 226.43(g)(3)(ii)(C) is satisfied if a creditor
reasonably believes, based on information known to the creditor at the
time the offer is made, that the amount of points and fees to be
charged for an alternative covered transaction without a prepayment
penalty will be less than or equal to the amount of points and fees
allowed for a qualified mortgage under Sec. 226.43(e)(2)(iii).
Paragraph 43(g)(3)(v).
1. Transactions for which the consumer likely qualifies. Under
Sec. 226.43(g)(3)(v), the alternative covered transaction without a
prepayment penalty the creditor must offer under Sec. 226.43(g)(3)
must be a transaction for which the creditor has a good faith belief
the consumer likely qualifies. For example, assume the creditor has a
good faith belief the consumer can afford monthly payments of up to
$800. If the creditor offers the consumer a fixed-rate mortgage with a
prepayment penalty for which monthly payments are $700 and an
alternative covered transaction without a prepayment penalty for which
monthly payments are $900, the requirements of Sec. 226.43(g)(3)(v)
are not met. The creditor's belief that the consumer likely qualifies
for the
[[Page 27506]]
covered transaction without a prepayment penalty should be based on the
information known to the creditor at the time the creditor offers the
transaction. In making this determination, the creditor may rely on
information provided by the consumer, even if the information
subsequently is determined to be inaccurate.
43(g)(4) Offer through a mortgage broker.
1. Rate sheet. Under Sec. 226.43(g)(4), where the creditor offers
covered transactions with a prepayment penalty to consumers through a
mortgage broker, as defined in Sec. 226.36(a)(2), the creditor must
present the mortgage broker an alternative covered transaction that
satisfies the requirements of Sec. 226.43(g)(3). Creditors may comply
with this requirement by providing a rate sheet to the mortgage broker
that states the terms of such an alternative covered transaction
without a prepayment penalty.
2. Alternative to creditor's offer. Section 226.43(g)(4)(ii)
requires that the creditor provide, by agreement, for the mortgage
broker to present the consumer an alternative covered transaction
without a prepayment penalty offered by either (1) the creditor, or (2)
another creditor, if the other creditor offers a covered transaction
with a lower interest rate or a lower total dollar amount of
origination points or fees and discount points. The agreement may
provide for the mortgage broker to present both the creditor's covered
transaction and a covered transaction offered by another creditor with
a lower interest rate or a lower total dollar amount of origination
points or fees and discount points. See comment 36(e)(3)-3 for guidance
in determining which step-rate mortgage has a lower interest rate.
3. Agreement. The creditor's agreement with a mortgage broker for
purposes of Sec. 226.43(g)(4) may be part of another agreement with
the mortgage broker, for example, a compensation agreement. Thus, the
creditor need not enter into a separate agreement with the mortgage
broker with respect to each covered transaction with a prepayment
penalty.
43(g)(5) Creditor that is a loan originator.
1. Loan originator. The definition of ``loan originator'' in Sec.
226.36(a)(1) applies for purposes of Sec. 226.43(g)(5). Thus, a loan
originator includes any creditor that satisfies the definition of loan
originator but makes use of ``table-funding'' by a third party. See
comment 36(a)-1.i, -1.ii.
2. Lower interest rate. Under Sec. 226.43(g)(5), a creditor that
is a loan originator must present an alternative covered transaction
without a prepayment penalty that satisfies the requirements of Sec.
226.43(g)(3) offered by either the assignee for the covered transaction
or another person, if that other person offers a transaction with a
lower interest rate or a lower total dollar amount of origination
points or fees or discount points. See comment 36(e)(3)-3 for guidance
in determining which step-rate mortgage has a lower interest rate.
43(h) Evasion; open-end credit.
1. Subject to closed-end credit rules. Where a loan is documented
as open-end credit but the features and terms or other circumstances
demonstrate that it does not meet the definition of open-end credit,
the loan is subject to the rules for closed-end credit, including Sec.
226.43.[ltrif]
* * * * *
By order of the Board of Governors of the Federal Reserve
System, April 18, 2011.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 2011-9766 Filed 5-10-11; 8:45 am]
BILLING CODE 6210-01-P